OrganiGram Holdings Inc

TSX:OGI

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Organigram Holdings Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Max Schwartz, you may begin your conference.

[Max Schwartz, Director, IR]

Good morning, and thank you for joining us today. As a reminder, this conference call is being recorded and a recording will be available on Organigram’s website 24 hours after today’s call..

Listeners should be aware that today’s call will include estimates and other forward-looking information from which the company’s actual results could differ. Please review the cautionary language in our press release dated July 13, 2023 on various factors, assumptions and risks that could cause our actual results to differ.

Further, references will be made to certain non-IFRS measures during this call, including adjusted EBITDA, free cash flow and adjusted gross margin among others. These measures do not have any standardized meaning under IFRS and are intended to provide additional information and as such should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS.

Our approach to calculating these measures may differ from other issuers, so these measures may not be directly comparable. Please see today’s earnings report for more information about these measures.

Listeners should also be aware that the company relies on reputable third-party providers with making certain statements relating to market share data. Unless otherwise indicated, all references to market data are sourced from Hifyre in combination with data from Weedcrawler, provincial boards, retailers and our internal sales figures.

I will now introduce Beena Goldenberg, Chief Executive Officer of Organigram Holdings Inc. Please go ahead, Ms. Goldenberg.

[Beena Goldenberg, CEO]

Thank you, Max, and good morning, everyone. With me are Tim Emberg, our Chief Commercial Officer; and Derrick West, our Chief Financial Officer. For today's call, we'll discuss the results for the three and nine months ended May 31, 2023 and the general business update. We will then open the call for questions.

In Q3, the team at Organigram continues to position the company for sustainable long term success while navigating the short-term challenges present in the industry. We were successful in the continued growth of our Canadian recreational business versus last quarter, with a 7% increase in net revenue driven largely by success in hash and a late rebound in flower.

Year-to-date, recreational net revenue also increased by $8 million or 10% over the same prior year period, reflecting growth in pre-rolls, gummies, and hash. Despite this positive momentum, three factors outside of our control contributed to the softening we saw in our Q3 financial results, lower than expected growth in the flower category for Organigram, delayed international shipments and the impact of our patent pending Edison JOLTS being removed from the market had the largest impact on our net sales and gross margin for the quarter.

Regarding our flower growth trajectory, I want to first address the issue of THC inflation. The increasingly widespread practice by certain licensed producers of inflating the stated THC potency on flower products through selective sampling and testing practices. As Health Canada's regulations prevent dialogue and education around Cannabis products, the consumer is left with fewer tools to make educated decisions about which products best suit them. The result is that price and THC content have become their paramount decision drivers when purchasing flower, which has led LPs to race to the bottom on price with many falsely overstating the THC content of their products.

Let me be clear, as an industry leader in the nascent cannabis industry, Organigram has not nor do we intend to engage in the practice of inflating THC levels on our label. We firmly believe that we have a responsibility to act ethically and responsibility -- and responsibly in our regulated industry. We are dedicated to our consumers and believe they have the right to transparency when it comes to their label. And we also believe that it's our responsibility to build an industry that we can be proud of. THC fixing deceives consumers and hurts our credibility as an industry.

In the context of today's regulations, this is happening because Health Canada has not yet prescribed specific and rigorous testing standards for cannabis as they have in other categories like tobacco as an example. Given the strength of our balance sheet, Organigram can weather the financial impact of the rational pricing in THC fixing and as such, we are tackling the issue the right way.

First, the THC content of our flower cultivars is trending upwards through recent operational optimization and the addition of new more potent cultivars. Second, we are working collaboratively with key stakeholders in the industry on several initiatives aimed at bringing solutions regarding standardized testing and sampling.

The second event impacting our results in Q3 was our international sales. In Q2, we achieved a banner quarter in export sales due to a pipeline of new cultivars. We anticipated that Q3 would return to normal replenishment levels. However, a newly enforced CUMCS testing protocol meant that we were unable to ship product to Israel in the quarter. During Q3, we have refined our testing protocols in line with these regulations and have built inventory to meet demand going forward.

The third event impacting our results, was the stop sale of Health Canada on our high margin patent pending Edison JOLTS product. We remain confident in our categorization of JOLTS as an ingestible extract and await the judicial review in late July that will determine whether Organigram can resume producing and selling the JOLTS under the ingestible extract category. We still believe that JOLTS is an important product within the extract category as its format, potency, and price point was highly successful in converting illicit market users to legal product.

Now I'd like to move on to discuss some of the exciting developments from this quarter and what they mean moving into Q4 in fiscal 2024. Our strong balance sheet continues to be an asset in this competitive landscape and has allowed us to make investments in synergistic companies while maintaining our competitive edge in both consumer-centric innovation and production efficiency.

In March, we made a $4 million investment into Green Tank Technologies. The investment provides Organigram with access to new industry leading vaporization technology that will be exclusively available with Organigram products for a period of 18 months post-commercialization. This technology not only solves the clogging and declining flavor performance issues we see in the legacy vapes in the market, though, we anticipate that consumers will experience a noticeable difference in potency.

Green Tank enabled vape cartridges are slated to hit the market in Q4 with two new SKUs and an additional SKU extending through into 2024. Our investment in Green Tank reaffirms our commitment to accelerating our focus on the vape category by delivering meaningful differentiation to consumers.

Yet another example of our commitment to innovation is the strategic investment we made in May into Phylos Bioscience, an industry leader in seed genetics. Aside from being our first U.S. investment, this arrangement is exciting from multiple perspectives. First, Phylos has delivered cultivars with THCV concentrations that are significantly higher than anything else we've seen in the market. This make seed cultivars commercially viable for extraction for derivative products containing THCV.

Given that it's very difficult to grow cultivates with high concentrations of THCV, is our belief that we will maintain a competitive advantage in whole flower derived THCV products. Now consumers are excited about THCV, because like CBD, it is non-psychoactive and acts as an antagonist for some of the qualities associated with THC.

For example, THCV is reported to mitigate the appetite stimulation associated with THC, earning it the nickname giant weed in the media. Further, it is reported to enhance focus, creativity, and calmness. We intend to incorporate THCV into various formulations across different formats starting with gummies, followed by vapes.

Our investment in Phylos goes beyond THCV. Our technical relationship with Phylos will allow us to convert a portion of our garden to seed-based production as opposed to the cone-based propagation we see across the industry today. This is exciting because seed-based production is cheaper, faster, and results in more robust, disease resistant and consistent plants across key characteristics such as potency, terpene content and aroma. Clone-based production has a foothold in the industry now, as it is faster for creating and experimenting with different cultivars.

However, given its many advantages, we believe that seed-based production is the future of cannabis while cone-based experimentation will remain on a smaller scale. We have already begun converting a portion of our garden to seed-based production and will increase our seed footprint over time. Our investment in Phylos is consistent with our commitment to becoming the most advanced cannabis company in Canada.

On the international front, in May, we added Germany to our list of export partners for medical cannabis through our supply agreement with Sanity Group. We continue to grow our list of international business partners and are actively pursuing opportunities in this business segment.

Operationally in Moncton, we have invested in a variety of efficiency improving and cost cutting CapEx projects that will realize $7 million in annualized savings. We have internalized some of our testing requirements, implemented remediation in house, commissioned rapid drying machines, which decrease drying time while increasing the available footprint in our Moncton facility for hang dried flower.

We automated our SHRED packaging, which reduced headcount. Our new Cantos pre-roll machine is producing two style pre-rolls at scale. And our new speed mixer has allowed us to infuse our milled (ph) cannabis for infused pre-rolls with distillate, diamonds and botanical terpenes in a one step process. In addition to these initiatives, we are currently targeting further productivity savings of $8 million over the next 12 months to 18 months.

It's amazing to see how our Moncton facility has developed over the 10 years Organigram has been in operation. This quarter, we achieved a company milestone, our 2,500 harvest. Over a decade ago, our first harvest tested at 13% THC, given our steady approach to growth and our disciplined data driven strategies to optimize microenvironment, our 2,500 harvest tested over 26% THC with over 3% terpene content. Incredibly, we have now cultivated and harvested over 200 different cultivars.

At our hash and craft cannabis facility in Lac-Superieur, our newly commissioned ultrasonic knife and automatic labeling has allowed us to keep up with the strong demand for our newly launched SHRED X Rip Strips, while cutting headcount by over 50%. Further, construction of our craft roll-ins is complete and we expect them to come online this October. In Winnipeg, our state-of-the-art Edibles production facility continues to drive impressive results, producing approximately 3.2 million gummies per month to support our SHRED'ems and Monjour brands.

Finally, I'd like to provide an update on our research and development activities with BAT at our Center of Excellence in Moncton. Both the product development collaboration and the Organigram commercial business are seeing significant benefits from a scientific development standpoint and in terms of revenue driving commercial capabilities. The in-house extraction laboratory has resulted in the imminent commercialization of high potency THCV extract derived from exclusive whole plant flower.

Organigram has been able to test and learn about the inclusion of several minor cannabinoids which has allowed it to expand into more complex minor cannabinoid stacks across several brands in the Winnipeg facility. The PDC is in late stage development of the suite of emulsions, novel vapor formulations, flavor innovations, and packaging solutions, which are planned to be used alone and in combinations across the Organigram portfolio of products.

The broad focus of the PDC has been the development of improved cannabinoid delivery, rapid and predictable onset, and products that target and satisfy a range of consumer needs. For ingestible innovations, Organigram is currently beginning recruitment for clinical studies, so that the company can quantify and substantiate the benefit of these innovations. So, after two years of R&D with the PDC, we are excited to begin commercializing the technologies developed within the Center of Excellence.

And so to recap, we continued to grow our recreational business in Canada. And despite the softer net revenue and gross margin in Q3, we feel confident that we are entering Q4 and 2024 with a strong foundation in place that sets us up for long-term success. We have positioned ourselves to drive further cost out of our facilities, we continue to focus on the consumer with our investments in innovation, and we have a strong balance sheet with responsible stewardship of capital, all geared to delivering shareholder value in the long run.

And on that note, I'd like to invite our Chief Commercial Officer, Tim Emberg, to provide his insights on Organigram's market share performance this quarter, new product performance and commentary on trends we are seeing in the market.

[Tim Emberg, Chief Commercial Officer]

Thank you, Beena, and good morning, everyone. As Beena mentioned, Q3 saw the continued growth of our Canadian recreational business. This increase is a testament to our continued focus on growth here in Canada by bringing innovative and consumer-focused products to the market and by executing with excellence at retail.

With our overall markets -- while our overall market share dipped in Q3, we quickly reversed this trend at the midway point in April and regained the number three position nationally in May and June with solid market share gains and positive momentum on several fronts. We continued to strengthen our market share position in gummies in Q3, growing 1.2 market share points versus Q2 and reaching the number two position nationally in May.

We also maintained our strong number one position in pure CBD gummies, driven by continued success with our Monjour brand, which holds more than half of pure CBD gummies sales in the country, increasing our share in Q3 to 50.2% from 48.2% in Q2.

In Q3, we maintained our leadership position in the hash segment, achieving a 25% growth versus Q2, which was heavily driven by our truly innovative SHRED X Rip Strips. We increased our overall market share by 2.5 points, moving from 19.3% to a 22% overall national market share.

Our success in hash and gummies highlights our strength of identifying right targets for M&A that are complementary to our business and leveraging our expertise in consumer insights, marketing, sales and operations to deliver maximum value to the business. Our acquisition of both EIC and Laurentian in Quebec have proven to be accretive to our business.

From a flower standpoint, we are really happy to experience a rebound in Q3 with sequential quarter-over-quarter growth. While our flower volume remained stable year-to-date, flower dollar sales were down versus the same period last year due to inflated THC levels in the market essentially forcing us to reduce our prices to maintain our competitiveness in the marketplace.

Given our high market share in flower, any type of price compression or questionable competitive practices do impact our flower business disproportionately. As mentioned previously though, we are actively working on industry-wide solutions to this issue. And at the same time, we continue to improve our THC levels on all of our flower SKUs.

It's no surprise that we continue to dominate in the milled flower segment with our phenomenally successful SHRED brand. In May, we achieved our highest market share since November of 2022 at 53% of the milled flower segment. So in other words, one of every two Canadians that go into a retail store or buy a milled flower online are purchasing our SHRED-branded milled product.

From a pre-roll standpoint, we expanded significantly into the fast-growing infused pre-rolls segment with our SHRED-X Heavies, which are performing extremely well after initial shipments, helping fuel our growth in this segment. Our Heavies clock in at over 40% THC and are infused with both botanical terpenes as well as diamonds and distillate. We're going to continue to expand nationally in Q4 and are committed to further disruption (ph) into this fast-growing category.

We were very active in Q3 with product launches and we listed and rolled out the highest number of launches for us at any given quarter with 28 new SKUs. Many of these new innovations are performing well above expectations, with Holy Mountain Tropical Reign, SHRED Dessert Storm and SHRED X Rip Strip Hash, which was launched in late Q2, leading the way.

The success of SHRED X Rip Strips is yet another first-to-market innovation, similar to what we've done with SHRED Blends and Edison JOLTS. It highlights our continued success in delivering consumer-centric innovation and addressing unmet needs of cannabis consumers in Canada.

From a provisional perspective, we continued our growth momentum in the second most populated market in Canada, Quebec. And based on the latest Weedcrawler data, we increased our market share by 0.7 points in the province, moving from 7.6% share in Q2 to 8.3% share in Q3. This was our highest market share ever in the province and we continue to grow, hitting the 9% market share mark for the month of May.

We grew by 17.6% sequentially and almost 28% versus Q3 of last year. We are very much looking forward to our craft grow rooms at Lac-Superieur facility coming online in October to help meet this growing demand.

In Ontario, the largest addressable market, we continue to be one of the top LPs in the marketplace. In May and June, we maintained the number three market position in the province. And we continue to hold the number one market position in Atlantic Canada in Q3 with a whopping 14.8% overall market share.

As we look to continue our rebound in flower, we are also focused on growing our foothold in our under-indexing categories of regular pre-rolls, infused pre-rolls and vapes. And we are extremely bullish about our innovation pipeline, including the launch of THCV, a full portfolio of new tube style pre-rolls and a new and innovative vape technology, which we expect will offer consumers a differentiated experience. We believe this new line of products will help drive growth across these categories as consumers discover the next big thing in cannabis through Organigram's relentless focus on innovation.

With that, I will now turn the call over to our Chief Financial Officer, Derrick West, to review our financial results for the quarter. Derrick?

[Derrick West, CFO]

Thanks, Tim. In fiscal Q3, gross revenue decreased 12%, while net revenue decreased 14% compared to Q3 fiscal '22. The decrease over the previous year was primarily due to market share fluctuations and recreational flower sales. As Tim mentioned, price compression in combination with THC inflation, did have an impact on the quarter.

The cost of sales in Q3 fiscal '23 was $32.3 million compared to $29.4 million in Q3 fiscal '22, an increase of 10%. The increase in the cost of sales on a year-over-year basis was due to a $2.8 million net realizable value adjustment on low potency flower repurposed as inputs for Organigram's growing derivative business and a $2.8 million provision for excess and unsalable inventories.

We harvested approximately 19,000 kilos of flower during Q3 compared to about 13,000 kilos in Q3 of the prior year, which represents an increase of 46%. During the quarter, we accelerated a change in the operational conditions for plant care to increase THC levels. This resulted in a decrease to plant yields, which had a negative impact to our cost of cultivation, which temporarily reduced the company's gross margins and gross margin rate.

We have optimized growing conditions during Q3 and we have now realized higher flower yields commensurate with historical levels during June and July, while maintaining increased THC levels. These higher yields will reduce the cost of cultivation during Q4. And as this flower is sold, we will achieve a higher gross margin rate. Furthermore, we expect to be able to consistently achieve these higher flower yields and lower cost of cultivation through 2024.

On an adjusted basis, Q3 gross margin was $6.1 million or 19% of net revenue compared to $9.3 million or 24% in Q3 fiscal '22. The compression in adjusted gross margin was primarily attributable to lower net revenues and higher flower costs, combined with the impact of the lost contribution from the sale of Edison JOLTS occurring as a consequence of restrictions imposed by Health Canada.

SG&A, excluding non-cash share-based compensation, increased to $19 million in Q3 '23 from $17.5 million in Q3 '22. The increase in expenses was largely due to higher audit and legal fees and ERP implementation costs. In the quarter, adjusted EBITDA was negative $2.9 million compared to $583,000 in Q3 '22. The decrease was primarily due to lower net revenues, combined with a lower gross margin rate.

However, looking at a broader picture, adjusted EBITDA for the first-nine months of fiscal '23 was $8.3 million, exceeding the $3.5 million realized for the full fiscal -- 2022 fiscal year by 137%. As we dial in on further production efficiency, consumer trends, resume international shipments to Israel and begin shipments to Germany, we anticipate an improvement in our adjusted EBITDA in Q4.

International shipments, which for the first-nine months of fiscal '23 was $18.3 million, exceeded the $15.4 million realized for the full fiscal 2022 year by 19% and we expect international growth to continue through fiscal '24.

During Q3 subsidiary (ph), as a consequence of the company's market capitalization trading significantly below its shareholders' equity, combined with the current quarter's operational results, management determined that there were economic indicators of impairment warranting a calculation of the recoverable amount of the assets. This analysis was done on a consolidated basis and also by cash generating units.

The impairment test considers several factors, including forecasted operational cash flows, net of the tax impact, ongoing investments into working capital and sustaining capital expenditures, post-tax discount rate, terminal value growth rate and this analysis resulted in the recognition of an impairment loss of $191 million. A meaningful contributing factor to the quantum of the impairment charge was related to the impact to flower sales and margins due to THC inflation.

When considering the significant sales and margin that flower product categories, specifically all of dried flower, milled flower, pre-rolls, IPRs and international flower sales collectively contribute to Organigram's financial results. This was a key driver to the amount of the impairment loss, which was allocated to intangible assets and goodwill in the amount of $38 million and $153 million in relation to property, plant and equipment.

In the quarter, we had a net loss of $213 million compared to a net loss of $3 million in Q3 '22 and this was mainly driven by the $191 million impairment charge. It should be noted that, all things remain equal, this impairment loss recorded on the company's TPE will result in an approximate 5% improvement to the gross margin rate as we move forward.

From a statement of cash flows perspective, net cash used in operating activities before working capital change was $5.5 million in Q3 fiscal '23 compared to $6.4 million in the prior year period, which is primarily due to favorable changes in working capital, partially offset by lower adjusted EBITDA. Cash used in investment activities in Q3 '23 was $3.5 million compared to cash provided at $51.7 million in Q3 '22.

The net cash outflow for Q3 was primarily from the $8 million related to CapEx at the facilities combined with $10 million cumulative investment in Green Tank and Phylos, net of redemptions on short-term investments. On a year-to-date basis, the company utilized cash for capital expenditures of $22 million, investments of $10 million and $5 million was invested into its net working capital assets.

In terms of our balance sheet, on May 31, we had unrestricted cash of $53 million and restricted cash of $22 million, for a total of $75 million with very low debt. We believe our capital position is healthy and that there is sufficient liquidity available for the near to medium term.

While the company expects to resume generating positive adjusted EBITDA in Q4 '23, periods when the company achieves significant increases to sales will result in increases to receivables and this will negatively impact cash from operating activities. The company forecasts a remaining cash CapEx spend of approximately $10 million for fiscal '23. And if completed as planned during this fiscal year, the company expects to generate positive free cash flow by the end of calendar '23.

This concludes my comments. I will now turn the call back to Beena.

[Beena Goldenberg, CEO]

Thanks, Derrick. As a leading pure-play cannabis company, we are constantly evaluating market opportunities, investing in the industry-leading R&D, both internally and in partnership with BAT, and fine-tuning our long-term growth strategy to drive down costs and gain market share domestically and internationally.

We continue to position Organigram to deliver long-term shareholder value through industry-leading production facilities, compelling and differentiated consumer product introductions that leverage our highly successful brands and synergistic strategic investments. This vigilant and consistent long-term focus, combined with our financial discipline are expected to deliver solid results through 2024.

Now on a final note on the state of the industry. We take no pleasure in saying this, but the majority of Canadian publicly listed LPs are now trading at market capitalizations of less than $50 million and in many cases are carrying material debt balances, stretching payables, are in arrears on paying their excise taxes to the Canada Revenue Agency and regulatory fees to Health Canada. Many may not have enough cash to operate as going concerns.

We've also seen trading stock market volumes shrink for many of these players and the ability to successfully pull off financing diminish. As a result of this, we believe we are going to see the pace of corporate restructurings, including bankruptcies increase. And as this unfolds, we will capture market share that becomes available. Our plan is, as it has always been, to remain prudent from a financial management perspective and to ensure that our actions are aligned with being a respected industry leader.

Thank you for joining us today. Operator, you may open the call for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Tamy Chen from BMO. Your line is open.

[Tamy Chen, BMO]

Hi. Good morning. Thanks for the question. I wanted to ask about the THC inflation. The phenomenon you're describing, I think it's been happening for quite some time now, just given consumers are very fixated on higher THC. So I'm just wondering, why all of a sudden this quarter, you're calling it out and it seems to have quite an impact on your flower business?

[Beena Goldenberg, CEO]

Thanks for the question, Tamy. And yes, while it might have been happening for a very long time, it really just increased the -- it was more a widespread in the last year, I would say, really started to unfold. And just to give you some stats on that, we look at -- like, in the third quarter, almost 50% of flower sales came from 26% plus THC flower. And the number of SKUs that have THC-labeled values above 26% has doubled in the last 10 months.

And really, another stat that we look at is the number of SKUs labeled above 30% grew ten-fold versus last year. So while this might have been out there for longer, the really -- the prevalence of this has really shown up in the last year, in the last 10 months. And in particular and where the impact has really been felt by us has been in the 28 gram flower category, where the number of SKUs above 27% THC has increased five-fold since last July, where historically, there's been no product selling on 28 grams at that level.

So we look at this data and there is a national retailer out there that does post data of flower sales based on the different THC levels. And we see that there are some license producers who were averaging sales of flower in the 21%, 22% range and all of a sudden have a step change and now are showing 28% to 32%. This is not something that even the most advanced cultivation techniques can make happen. There is something and I think it's the increasing behavior that's really starting to impact the results.

And as we said on the call, really, we get felt -- we get the impact disproportionately because of our reliance on whole flower, especially in the 28 gram. So it started to have its effect. We did have to respond by taking pricing down so we could address the value equation to consumers because -- or lower potency and I'd say that potency at 23% flower should be considered good quality product. And yet, we had to discount our pricing to get the movement because they were seeing a lot of product at the 27%, 28%.

But then when you test it, it's not really 27% or 28%. So it's a substantial impact and the more widespread of this practice that has been impacting our results. Basically, we started to see the dip in our flower market share in January. We took actions in our own facility. We accelerated some changes to really get to the higher potency product to get it out there to compete. And it did have a short-term impact on our cost of flower as we made those changes in our facility. But we're doing what we can to move up our potency in a proper way with proper testing.

And at the same time, we have been talking to key stakeholders. We've been speaking -- sending in comments to Health Canada. We've been talking to the Board. And we've been talking to other labs and really looking at finding solutions to address this issue because we feel strongly that it's not fair to our consumers, it's deceiving them. And so that's our way of approaching this issue and what we consider a leadership position.

[Tamy Chen, BMO]

I see. Okay. Thank you for the added context on that. So it impacted particularly the 28 gram format for you. We also noticed, looking at Hifyre, the top products that are sold every month. I think SHRED before would quite dominate the top five, I think three of your products before were in the top five, but it has since dropped out of that. So did this THC phenomenon also impact SHRED and your milled flower products, too?

[Beena Goldenberg, CEO]

Yeah. So certainly, it impacted all flower -- it affected pre-rolls. It affected our milled flower. But you could find milled flower out in the marketplace that claims 30% plus. And everybody knows that when you milled flower, you lose tricones, and that's just not something that could happen. Like that's just not a correct label. So there is impact there as well. But I think the other impact to our SHRED milled flower is that because pricing has come down so significantly on whole flower, the value equation of milled is not as it used to be, as people are getting higher potencies at lower prices on just whole flower.

And so to address this on milled flower and we started to see again some good momentum as we moved out of the quarter. We started to introduce some new flavors. We brought in a strong Dessert Storm offering that has received great reviews. But on top of that, we started to introduce a 14 gram offering. So we have historically been in 7 grams. So we are addressing it. But yes, absolutely, we're seeing it in milled flower.

And just one more comment around pre-rolls. You're seeing it in pre-rolls as well. And we had a third-party lab go out and had -- sorry, eight different labs testing a sample of pre-rolls for their potency. And the eight labs on average came in at 18.7% potency for those pre-rolls, and yet the package was labeled at 25.5%. So we are seeing this across formats in flower and pre-rolls and it’s an issue. And it’s why we highlight it as a big, important issue the industry has to deal with.

[Tamy Chen, BMO]

Thank you.

[Beena Goldenberg, CEO]

Thank you.

[Operator]

And your next question comes from the line of Frederico Gomes from ATB Capital Markets. Your line is open.

[Frederico Gomes, ATB Capital Markets]

Hi. Good morning. Thank you for taking my question. Still on this THC inflation topic and this higher THC trends. I'm curious, what is this strategy to better compete with these higher THC flower, pre-rolls going forward? Is it just about adjusting your cultivation or is there anything else you can do to differentiate your product, given that new consumers are mostly interested about THC content? And then longer term, what is your view on this sort of THC rate? Well, where are we going to end up here as we continue to get flower with higher and higher THC levels? Thank you.

[Beena Goldenberg, CEO]

Right. Thank you, Fred. And yes, so there's a lot of things that we're doing and they're sort of short term and then there's longer term. We recognize that going to government and to Health Canada, those are the right things to do. We need to get standardized testing protocols regulated from Health Canada, but those things take longer term. We have approached the provincial boards and they are exploring the potential of requiring a second certificate of analysis from licensed producers on any flower over a 27% or 28% potency.

And they're exploring it and what's interesting about this is, that has been put into place in Michigan, where they saw similar issues with elevated potency levels. So this isn't a unique phenomenon in Canada. It happens wherever cannabis is sold and in the legal market. So there is an opportunity to force secondary certificates of analysis in the short term that might cut down on this.

But interestingly, yesterday, Health Canada came out with -- an article came out in which they were saying that they are now going to start testing potencies. So they're feeling the pressure because this is widespread. And they're looking at ways to address it as well. So I think from a marketplace, there are some things that could impact short term.

For us internally, we are working on new cultivars, introducing new cultivars with higher potency into our garden. We are looking at -- we have started to hang dry some of our flower to drive higher potencies. And we are seeing our potency rate in our garden go up. So this is -- just as an example, in Q1 of this year, 25% of our flower was above 23%. And in Q3, almost 50% of it is above 23%. So we're making the moves internally as well.

And while this is going on, our focus really will be on our gummies, our hash, bringing innovation to the market. And really, while we have to make sure we have the right value equation out there for consumers, we're looking at putting in these cost savings initiatives to drive our cost down to improve our margins. So there was a lot of talk about how much capital we have invested in our facility, but we're starting to realize the savings.

We've identified the $7 million that will start to flow through our P&L and we have $8 million more in savings that we expect will come. So we're here for the long term, Fred, we're here -- we have the balance sheet to live through this short-term issue. We're doing the right thing and trying to address it through all stakeholders. But at the same time, we're working on getting our costs down so we could become, again, improve our margins in this price compressed margin.

And sorry, I forgot one last thing. As you know, the Ontario -- the OCS has changed their markup model. We expect to see that flow through in the fall. And again, that's something that one of the Board is doing to help us address margins in this category. So the Boards are involved, the government, Health Canada is involved. We're acting -- we're working with other labs to get this addressed.

[Frederico Gomes, ATB Capital Markets]

Thank you. And then just about your investment on seed-based production, can you maybe provide a little bit more color about why have you decided to make this investment at this moment, given that it appears that you are one of the first movers in this regard. And when should we expect to see some impact of that in your financials, as well as what are the potential risks that you see in that initiative, given that, again, you are one of the first movers to try to move to a seed-based production at scale, so how should we look at those risks? Thank you.

[Beena Goldenberg, CEO]

Right. Thanks for that question. So we're going to be rolling out our seed-based production slowly with a test and learn. We're not obviously going to go out and convert our whole facility. So this is going to be something that rolls-out. We have started already in four grow rooms. We're excited about this because it is a significantly faster grow. So when you have coning and propagation, it takes 21 days. And when you cultivate with seeds, it's zero days, right, just put a seed into the pot.

The flower grows probably in the same amount of time, but in total, you're going from what is like 100 days to like 65 to 80 days. So you're reducing significant number of days in the – like, in the grow, but that reduces a significant amount of labor. And then we -- one of the things that's really great about working with seed production is that you don't have some of the disease that you would get in normal cone production, so something like powdery mildew. You have the -- every seed is clean and grows clean.

And so you have more standardized flowers. So the lollipopping and the leafing becomes more standard. So there's a whole bunch of reasons why this is good. It's less cost. It will turn our rooms faster and we're excited about it. Now we're not, as I mentioned, going to change our whole production facility over. There is currently still a need to experiment with new cultivars, bringing new -- because new is always what consumers are looking for. So there will always be a portion of our garden that's going to be clone.

You get that faster because it takes a long time to get F1 seeds that are strong and will be able to produce predictable plants. So this is going to be a process. We expect to see some cost savings into next year. Part of the $8 million that I identified as next year’s -- over the next 12 months to 18 months, part of that is coming from the benefits of seed-based production.

[Frederico Gomes, ATB Capital Markets]

Thank you. I’ll hop back into queue.

[Operator]

And your next question comes from the line of Aaron Grey from Alliance Global Partners. Your line is open.

[Aaron Grey, Alliance Global Partners]

Hi. Great. Thanks for the question. Just one for me. So just in terms of your commentary in terms of the restructurings and bankruptcies increasing that you're expecting to come. Can you talk more about the timing that you might expect this to come into fruition? It's something that a lot of people have called for in the industry sometimes, consolidation, actually more of a shift to people saying that we need shakeouts.

So what are you seeing kind of giving more of the confidence that we might start to see that now? You talked about some of the payments in arrears, some of the taxes. So do you think there's going to be a more portion that? Can you just talk about some things in the industry to why that market now starts to come to fruition?

[Beena Goldenberg, CEO]

Sure. Thanks. So look, we're already seeing it. I think somebody said the stat last year was, I think, 40% of bankruptcies in Canada last year were cannabis companies. We've seen a handful of companies just in the last two months that have announced restructurings. So it's happening now. We track how much cash these players have and what their payables look like and we see the stretch payables. This isn't new news. CRA has identified over 70% of LPs out there that are behind on paying their excise taxes.

And they actually sent out an article saying they would work on payment plans, but they are starting to put their foot down on people that aren't paying. And just think about it this way. If companies aren't paying their excise taxes and are using the money perhaps to drive some retail activity with their brands, like this is, again, not a level playing field. They're using borrowed money. Their runway is going to run out. And so we've heard from CRA, the Health Canada stat just came out in an article last week that people, the people that haven't paid is up 225%.

So back to your original question, how long do I think this is going to happen or when are these changes going to happen? I think it's going to accelerate over the course of the next 12 months. The capital markets are very tight. People can't raise money. And they're just -- their runway is going to be up, right? And so we are just -- we're there. We're watching it. We're understanding. And we're going to go after listings where a company who's gone into some form of restructuring is likely not going to continue to replenish at that level.

And if we have competitive products, we’re using our data, which stores, where are the listings? How do we gain that market share and continue to strengthen our business as this turbulence goes on through our industry? I think your comment is right. We need to see consolidation in the industry. It is way too fragmented. And I think the dynamics in the market will see that happen over the next 12 months.

[Aaron Grey, Alliance Global Partners]

Okay. Great. Thank you very much the commentary. I’ll jump back in the queue.

[Operator]

And your next question comes from the line of Andrew Partheniou from Stifel. Your line is open.

[Andrew Partheniou, Stifel GMP]

Hi. Good morning. Thanks for taking my questions. I wanted to talk a little bit about your guidance and as well as the impairment reported. So you had lower international sales this quarter that was just delay and higher production costs from lower yields, among some other things. But these seem to be the main causes of the lower EBITDA. So both of these things are -- seem to be quickly reversed, and you're guiding for positive EBITDA next quarter.

There could be -- maybe a rather large international shipment in Q4. And that could bring your sales back to levels that we saw in prior quarters in the low $40 million range. So that all suggests a pretty quick rebound. But at the same time, you had a $190 million impairment.

So just a two-part question. First is on the positive EBITDA guidance for next quarter, do you think that could occur, including R&D costs? And the second part of the question is just to reconcile the quick rebound and the large impairment that -- if that could -- if you could talk a little bit more about that, it would be helpful.

[Beena Goldenberg, CEO]

Derrick, over to you.

[Derrick West, CFO]

Thanks, Beena. Thanks for your question, Andrew. Okay. I think I'll start first with EBITDA and the churn that we would see. I mean, there's no question that the current quarter was impacted, just where we're heavy in flower and where we did have a significant decrease in our yields as we were modulating some of the plant science of facility to get improved THC. This increased our cost of cultivation quite significantly, quite quickly. And kind of into the cost of the flower that essentially was part of our cost of goods sold this quarter.

Now by the very end of Q3 and the first part of Q4, we have returned to prior higher yields, and that is the main driver on the overall cost of cultivation. And the cost of cultivation is the main driver for flower margins, which accounts for 70% of our revenues. So that flower will need to push through our P&L. I would say we'll get a pickup during Q4 on the lower cost of flower that we're starting to harvest now. There will be a bit of a drag still, from some of the higher costs that did occur during Q3. But overall, we will see an improvement to our flower margins.

I think that our international, our B2B sales were lower in Q3 than 1 would be on a normalized quarter for us. We do -- those tend to be higher margin category for us. So we do see a pickup there for Q4. As well, we have other cost initiatives that we have done that Beena spoke to and more automation allows for throughput. So we do feel that we will be able to further improve our margins and throughput the facility with the automation, helping us for Q4 to get back to positive.

Will I cover the R&D and I'm not going to provide specific guidance on that, I think we're getting too exact. But we do believe that we'll get back to a positive EBITDA in Q4 and into fiscal '24, growing as we move forward. As it relates to the impairment, the consequence of the impairment were really driven by two factors: one, Canada share prices being so low for us and others. Then as compared to what that means for our market cap compared to our carrying value. So that becomes an indicator where there's a review.

Secondly, when you consider that our Q3 operational results are below our internal expectations. And that -- the close two combined together to lead us to require to do a detailed analysis and review. As we did this review, we're starting at a lower point than we were when we did this review in the past, in the sense that there is -- with THC inflation and headwinds in the near term on this that does somewhat impact the modeling as we look out, despite optimism and innovation that we do plan to bring to the table, allowing for growth to sales and margins. As well [Technical Difficulty] discount rate. The interest rates have gone up. The risk factor for cannabis companies and for forecasting is higher. So the block of the discount factor is higher than it would have been in the past.

And I think that combined to result in the need to book an impairment this quarter. I would say that the small benefit from doing this adjustment is that the allocation to property plant and equipment will decrease our depreciation and our cost of goods sold moving forward. And we do expect a 5 point improvement to our margin rate as this fully flows through the P&L. But based on the economic conditions of the market of the industry, it takes us to do this review and given all factors that did require us to make this impairment.

[Andrew Partheniou, Stifel GMP]

Okay. Thanks for that. And then maybe talking a little bit more about your yield. You talked about changes to your growing conditions, which lowered yield, but it increased THC potency but in the last month of the quarter, the yield rebounded and the THC level remained strong. I'm not sure how much you want to go into details here, but any kind of detail would be helpful to talk about what kind of changes did you make that resulted in a temporary loss of yield? As I would imagine, if you're changing growing conditions in an environment and then keeping those growing conditions stable then that yield loss would be permanent.

[Beena Goldenberg, CEO]

Yes. So Andrew, good question, and let me explain that. I think we've talked in earlier calls about the implementation of fractional watering in our facility. And we had done a lot of work in our plant science area on the benefits to fractional watering over the course of the day rather than flooding in an approach to watering the plant. We rolled out our fractional watering because we honestly believed it was going to give us higher THC content, but we went too quickly.

We rushed it. We accelerated through, didn't get the right conditions. We saw a drop in our yields as we were growing those plants. And unfortunately, you kind of have to wait 3 months to see the impact of the implementation. As such, we started to adjust our approach to fractional watering. We got it right. We were able to reproduce what we saw in our plant science area, so we were able to get back to our historical yields yet keep the higher potency that we saw as a result of moving to that practice.

So it was a bit of a probably accelerated to get to the higher THC faster and didn't execute as well as we could have. But as we worked through these details and optimized it, we've got it working properly now and we're starting to see it. So the THC did come back. The yields did come -- or the THC came up and the yields did come back. So I think that the lesson here was move a little bit slower. But we felt the urgency in the market because our value equation to consumers wasn't working and we needed to get faster, higher THC levels into our flower to sell.

[Andrew Partheniou, Stifel GMP]

Thanks for that additional color. Glad to hear that everything is back on track now.

[Operator]

And your next question comes from the line of Ty Collin from Eight Capital. Your line is open.

[Ty Collin, Eight Capital]

Hey. Good morning and thanks for taking my question. Just wondering if you could comment on the price reductions you took in the quarter. Were these applied pretty broadly across the product portfolio or really kind of just concentrated in the 28 gram flower category? And then as an add-on to that, do you think there's room to claw some of that pricing back over time as some of your more potent product and new innovations starts to hit the market?

[Beena Goldenberg, CEO]

Thanks for the question, Ty. Maybe I'll turn this over to Tim.

[Tim Emberg, Chief Commercial Officer]

Sure. Thanks for the question, Ty. So we did start looking at price adjustments and primarily on our 28 gram size format. If you look at our overall SKU mix, 60% of our flower volume comes from SHRED and 40% comes from whole flower. And really, the impact to us was really around the 28 gram value equation that Beena referenced to. So we look to do a price increase on our Big Bag O' Buds in early spring. And so that's where we had the biggest impact.

And in some cases, we took a price decrease of about 20%. So we are retailing at about 142 originally, went down to 119. And then THCs continued to go up, but our value equation was imbalanced. So our price to THC ratio was off. So we had -- in order to be more competitive, we had to lower our price even further.

So we went down to the floor for our Big Bag O' Buds, about $99 ounce in Ontario. And then some other product, it depends on the problem. It wasn't across the board, but we did make some changes in certain provinces to ensure that our value equation was balanced. So if we look at the overall market right now, volume growth is growing in flower.

Now the last six months versus the previous 6 months, we're seeing volume go up by about 10%. We're just seeing sales dollars go down by about 3.5%. So there is price compression in the market, and it's likely due to most competitors or most LPs on the market making adjustments to balance off that value equation or the price-to-THC ratio. In our case, we've gone as deep as a 20% adjustment, but in some cases, it hasn't been that deep.

[Ty Collin, Eight Capital]

Okay. Great. Thanks for that. And then, Beena, regarding your continued interest in the U.S. market. Obviously, a couple of key catalysts in play there before year-end, including Safe Banking and the Biden admin’s scheduling review. Are those catalysts influencing your thinking on how and when to make additional investments in the U.S.? And to the extent that you’re still considering THC assets, how might that sort of investment be structured, particularly given BAT?

[Beena Goldenberg, CEO]

Right. Good question. So first of all, we do continue to look at the U.S. market. It’s obviously an interesting market for us. But while it remains not legal federally, we obviously have to protect our TSX and NASDAQ listings. But we’re watching it carefully. I’m not sure SAFE Banking makes it a big change, but certainly, the de-scheduling is something that we are looking at to understand our opportunities.

But at the same time, when you think about what we did with Phylos, we dipped our toe into this -- into the U.S. market with that investment through a convertible loan. We found a way to do that kind of investment and still stay on side with our listings. And so, we will continue to look at opportunities. Look, the market is depressed right now. There are assets in the U.S. that are depressed as well and there are opportunities out there. So we do have the balance sheet. We do have a great strategic investor in BAT and we’ll continue to look at ways that we can take advantage of the market conditions, while we focus on strengthening our business in Canada.

[Ty Collin, Eight Capital]

Great. Thanks, Beena.

[Operator]

And we have now reached the end of our question-and-answer session. I will now turn the call back over to Beena Goldenberg for some final closing remarks.

[Beena Goldenberg, CEO]

Well, thank you, everybody for joining today. We’re really playing the long game here at Organigram. We’re focusing on what is the right thing to do for this industry. We’re focusing on innovation and differentiation and getting our costs lower so we could improve our margins. We feel very confident that we have a winning formula here, and we look forward to updating you again on our Q4 results. Thank you for joining.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect.