Organigram Holdings Inc.

Good morning and welcome to Organigram Holding Inc's first quarter earnings conference call for the fiscal year 2022. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session with analysts. We ask you to please limit yourself to one question and one follow-up question. You may re-queue if you have further questions. As a reminder, this conference call is being recorded and a transcript will be available on Organigram's website. Listeners should be aware that today's call will include estimates and other forward-looking information. Please review the cautionary language in today's press release on various factors, assumptions, and risks that could cause the company's actual results to differ. Furthermore, during this call, reference will be made to certain non-IFRS measures, including adjusted EBITDA and adjusted gross margin. These measures do not have any standardized meaning under IFRS, and our approach in calculating these measures may differ from that of other issuers, and so these measures may not be directly comparable. Please see today's earnings report for more information about these measures. I would now like to introduce Bina Goldenberg, Chief Executive Officer of Organigram Holdings, Inc. Please go ahead, Ms. Goldenberg.

Thank you, and good morning, everyone. With me is Derek West, our Chief Financial Officer. For today's call, we'll discuss the financial results for the three months ended November 30th, 2021, and I will provide a general business update. We will then open the call for questions. The first quarter of fiscal 2022 showed continued momentum from the progress we achieved in the last quarter of 2021. We achieved record net revenue in the quarter, the highest in the history of the company. we solidified our number four market share position among Canadian LPs in the recreational market in Canada, becoming one of the few larger Canadian LPs registering market share growth. Subsequent to quarter end, we completed an accretive acquisition of Laurentian that expands our product and brand portfolio and bolsters our geographic presence in Quebec. And we made further progress on our goal to achieve profitable adjusted EBITDA, which should be accelerated with the purchase of Laurentian. Now net revenue in Q1 was $30.4 million, a 57% increase over Q1 in fiscal 2021. This record level of net revenue speaks to our success at innovating to best address consumer needs and introducing compelling brands that resonate with consumers. We continue to hold the number four market share position among Canadian LPs in the quarter at 7.5%. A year ago, before our product revitalization program, our market share was 4.4%. The HIFIRE data provides detail on how our products are being received in the market. Shred continues to be the most popular flower brand, with Tropic Thunder and Funkmaster SKUs holding the number one and two positions, respectively, for November, and Tropic Thunder and Narberry as the top two SKUs in December, based on sales and volume. Shred also remained the number one search brand on the OCS website for 13 of the past 14 months. These sustained positive results, while the price of Shred was increased in Alberta and Ontario, demonstrates its exceptional consumer demand. Shred and Gummies were introduced in August 2021 and are quickly gaining distribution and traction in the market. In November, they were ranked number three in terms of both sales and volume of units sold. Edison Jolt, our unique high-potency THC lozenge, maintains its best-selling position within the ingestible extracts category. Our momentum continues after quarter end. December data from High Fire highlights that Organigram achieved 7.6% market share, up 10 basis points from November, holding the number one position in the important flower category, number three position in gummies, and moving up to the number four position in pre-rolls. We're very pleased with these results, and you should also note that this market share does not reflect the contribution from the sales of Laurentian products that will get us closer to an 8% market share. In November, we launched Bonjour, a wellness brand providing large-format CBD-infused soft chews in berry-medley and citrus-medley flavors. Both flavors are available in vegan-friendly and sugar-free formats for maximum consumer choice. In the short time since its launch last month, Monjour has already shown strong momentum in the market. We are very pleased with the start and look forward to this new brand achieving the same success as our recent brand introductions. We continue to focus on the needs of premium cannabis consumers through our flagship Edison brand. As stated last quarter, Brightfield data has shown growth in Edison's brand awareness and a significant increase in its number of social mentions and positive consumer sentiment scores. Seven new high-potency strains were introduced in fiscal 2021, and fiscal 2022 started off with the launch of several new products, including the Edison Blue Velvet Vape and yet another first-to-market product, the Edison Pinners Combo Pack, the first pre-roll 10-pack in the market to offer consumers two unique genetics within one pack. Consumer demand has been strong on these innovations and we're excited to continue to offer new relevant products to the market throughout the rest of the year. Now let's look at our operations. In Q1, our yield per plant was 129 grams compared to 86 grams in Q1 of fiscal 2021. As we have brought on new grow rooms and improved operational efficiencies, our cost per gram has been reduced by half while increasing THC levels. At the Moncton Cultivation Centre, upgrades to the facility are currently underway. This includes increasing capacity through our 4C expansion, a second harvesting area, adding environmental enhancements and performing upgrades to the irrigation system. These will further enhance yields and flower quality. In terms of automation, the second pre-roll machine was commissioned last quarter, and investment in high-speed pouch lines for Big Bag of Buds and Shred is underway. Our product development collaboration with BAT advanced in the quarter with the completion of the Quality Assurance and Control Laboratory. Construction has also begun on the BioLab, which will conduct advanced plant science research, and on the GPP Food and Edibles Facility. Both of these are expected to be completed in February of 2022. This is an important milestone. The research conducted as part of our PDC will contribute to ongoing development activities, which could result in new products in the future, support market share growth, and our reputation as a consumer-centric innovator. Initial development is focused on CBD and other cannabinoid edibles, drinks, vapes, and ingestible products, with focus on products that improve delivery, efficacy, convenience, and create new usage occasions. Our commitment to innovation is also reflected in our increased investment in Hyacinth Biologicals. Hyacinth is a leader in cannabinoid science that is using biosynthesis to produce THC, CBD, and rare cannabinoids without the use of cannabis plants. This greatly reduces the cost and production time of the compounds with a smaller environmental footprint. In December, we increased our total investment in Hyacinth to $10 million. This provides us with approximately 49% interest in the company and two board seats. Once hyacinth commences commercial production, we have the option to purchase its cannabinoids at a discount to the wholesale market price for a period of 10 years. Producing any major or rare cannabinoid quickly and at scale opens up multiple possibilities for medical, wellness, and recreational products. As one of only three large LPs investing in biosynthesis, Organic Room is well positioned to take advantage of these opportunities. Finally, I'd like to highlight the acquisition of Laurentian we made in December. Laurentian is a Quebec-based LP of artisanal craft cannabis sold under the Laurentian brand and Quebec's top-selling hash sold under the Tremblant cannabis brand. Laurentian's current annual capacity is about 600 kilograms of flour and 1 million hash units. We intend to invest $7 million in growth capex behind Laurentian's expansion program, which will increase capacity to about 3,000 kilograms of flour and 2 million units of hash by the second half of 2022. We are excited to further expand the distribution of Laurentian's brands outside of Quebec, leveraging the strength of our national sales force. The acquisition cost was $36 million, consisting of $10 million in cash and $20 million in shares, as well as potential earn-out considerations. This is a significant acquisition, and that strengthens our premium portfolio with high-margin products and increases our presence in Quebec. It is also accretive, as Laurentian has been averaging since it entered the Ontario market in November, an annual net revenue run rate of $17 million, with $6 million in EBITDA. Now I will turn it over to Derek to present the financial overview. Derek?

Thanks, Vita. Turning to our earnings results for Q1 fiscal 2022. Gross revenue grew 75% from Q1 2021 to $44.3 million, and net revenue grew 57% from the same period in fiscal 2021 to $30.4 million. These revenue increases were primarily due to higher recreational net revenue, which grew 9% from Q4 fiscal 2021 and 49% from the same period in 2021. and the resumption of shipments to Israel under our agreement with CanDoc. While gross revenues grew 75%, cost of sales increased only 21% year-over-year to $28 million. There was no charge for unabsorbed fixed overhead for unused grow rooms in Q1 fiscal 2022 compared to $2.7 million in Q1 of the prior year. We harvested approximately 11.6,000 kilograms of flower during Q1 fiscal 2022, compared to about 3,900 kilograms in Q1 of the prior year, an increase of 197%. This increase was directly related to increased yield per plant, along with the increased cultivation planting during Q4 fiscal 21 and Q1 of fiscal 22 to meet the growing demands for our products. Largely due to lower cultivation and post-harvest costs, lower changes in fair value of biological offsets and inventory provisions, the gross margin in Q1 improved to $610,000 from negative $16.7 million in Q1 2021. On an adjusted basis, gross margin was $5.5 million compared to $1.9 million in Q1 2021. We expect that the price increase to shred The addition of higher-margin premium products to our offering and lower production costs will further improve margins. SGA, excluding non-pass share-based compensation, increased to $12.6 million in Q1 2022 from $10.5 million in the prior year's comparison quarter, largely due to higher employee costs due to increased headcount, general wage increases, increased professional fees due to technology fees and the auditor fees from the new requirement to have an integrated audit, and higher trade investment and marketing spend initiatives done to support the launch of our new gummy and other derivative products. Also, due to improved revenue and margins, the negative adjusted EBITDA was reduced from 5.7 million in Q1 of 2021 to 1.9 million in the current quarter. We also reduced our net loss year over year from $34.3 million to $1.3 million. Overall, we are pleased with our improving financials and the continued momentum we are seeing. In addition, starting in December of 2021, we began to recognize revenue from the Laurentian acquisition. Based on this, we have now advanced our view on achieving positive adjusted EBITDA by Q3 of fiscal 2022. In terms of our statement of cash flows, net cash used in operating activities was $9.3 million during Q1 of fiscal 2022, compared to cash generated of $294,000 in Q1 of the prior year. The change was primarily due to the current period's investment in working capital assets as we supported the growth of the business. Net cash used by financing activities was $270,000 during Q1 fiscal 2022, primarily driven by reduction of debt and lease liability. Net cash generated from investing activities was $54 million during Q1 fiscal 2022, an increase of $38 million from the prior year's comparison quarter. During the current period, there was $60 million from short-term investment proceeds. $1 million from restricted funds, net of $7 million incurred for capital expenditures. In terms of our balance sheet, on November 30, 2021, we had $168 million of unrestricted cash and short-term investments compared to $184 million at the end of fiscal 2021. The decrease during the period is primarily due to the company's investment in both its working capital assets and capital expenditures for facility improvements. This concludes my comments. Thank you. I would like to turn the call back to Dina.

Thanks, Derek. To close, we are very pleased with the record results in the past quarter. We continue to generate significant momentum that I believe positions us for a successful fiscal 2022. Investors can continue to expect strong revenue and volume growth, more new and exciting product introductions, increased brand penetration, and further improvements in our adjusted gross margin. Thank you for joining us today. I look forward to updating you on our progress. And now, operator, you may open the call for questions.

At this time, if you would like to ask a question, you may do so by pressing star then the number one. Again, that's star then the number one in order to ask a question. Your first question comes from the line of Rupesh Parikh of Oppenheimer & Company.

Good morning. Thanks for taking my question. So I guess the first area I want to go to is just market share. So a significant increase in market share year over year. What would you guys attribute the key efforts that drove that market share increase?

Sure, thank you for the question. So, you know, we saw significant growth in the interest in our Shred brand. It's really been quite an increased demand from consumers, really related to not only, you know, the convenience, but the high flavor profile of the offering that's attracted consumers, and we've seen really strong growth behind that brand. In addition, we have started, you know, we launched into the gummies category after our acquisition of EIC back last April. We launched into the category in August and saw significant traction behind our Shredums brand. We came in with a competitive cost into the marketplace and, you know, built to the number three position in the market by November, so pretty quickly. So we continue to focus on building our derivatives offerings. And in addition, you know, as I mentioned earlier, we launched our pinners, our Edison pinners, which is, you know, a pre-roll offering 10-pack that has two different strains in it. It's a unique offering to the marketplace. So we're just listening to our consumers, understanding what they're looking for, and launching products that meet their demand. And this has helped us gain our market share.

Great. That's awful, Connor. Maybe just one follow-up question. So on the Laurentian, its acquisition, so it's pretty impressive. They already have $6 million EBITDA run rate on a sales base of $17 million. What's unique about the business that already generates such strong EBITDA on a fairly low revenue base?

Right. So, I mean, their focus in Laurentian is predominantly on selling hash products, and they're the number one selling hash in the Quebec marketplace. So it's, you know, a premium product offering with good margins on it that has been – really drove great consumer appreciation for its taste and flavor and feel of the product. So they've been able to maintain really strong margins on that offering. They complement that with some Kraft flour. We know Kraft flour is a good margin product. So their focus has been on the Quebec market. We'll continue to expand those offerings as we build up capacity. to take advantage of those higher margin offerings to our overall portfolio.

Great. Thank you.

Your next question comes from a line with Tammy Chin of BMO Capital Markets.

Hi, good morning. Thanks for the question. First, I wanted to ask a bit more about the cost structure and margins. So can you help us understand, you know, once you are up and running on the expanded capacity of, I recall, somewhere around the 70,000 kilograms a year, what sort of, you know, minimum sales level would you need at that level of capacity to maintain positive margins in EVA-DA? I ask because While you're gaining share now, which is a positive, the market does change a lot, and who is gaining share could fluctuate from time to time. So I wanted to understand the flexibility or operating leverage or deleverage nature of your cost structure.

Hi, Jamie. It's Derek here. We are revising the outlook in terms of the total capacity to move from 70,000 to 75,000 based on the improved yields that we have been getting consistently over the last three, four months. And we are operating at capacity now based on the rooms available. And just by increasing over the last few quarters, we have significantly reduced our cost structure to the point that we've gone from negative adjusted gross margins to positive adjusted gross margin. There is a fixed cost element to the facility that's beyond the variable cost on the labor. And as such, We do plan based on the demand on our products that at this point far exceeds or exceeds our current capacity but we're only going to be planting in the rooms as this demand continues to outstrip our current capacity and based on the success of our our products and our plans for innovation and launching new products we do feel that as we complete the construction and add the rooms to take us from this 55 000 capacity we have today to the 75 000 that we will be able to be operating at our near capacity. So we're not viewing this from a perspective whereby there is a significant downside to doing the expansion just given where the demand is today based on the capacity that we have today moving from this 55,000 annualized run rate to 75,000. But of course, um as with all uh canvas companies if there is an element whereby you're not operating at capacity with uh the competition in the marketplace there there there is a cost or a fixed cost element that will be a direct charge in uh two cost of sales um should we not be operating our capacity but we feel that there is so much more that we can provide on cost reduction just based on moving from $55,000 to $75,000. And especially we think it will be sufficient buffer should there be sufficient slowing in demand in our products, which, again, we do not expect.

Great. Let me just add one more comment on top of what Derek just said. Tammy, right now our very popular Shred brand is really only available in two marketplaces, in two provinces, in Ontario and Alberta. We have some small volume that is in Quebec, but we haven't been able to expand the distribution to other markets due to the lack of supply. We do believe there's a lot more opportunity for us to expand that brand and take advantage of, what we believe is a great product offering out in the marketplace. While I recognize your comment that consumers have been swapping between brands, we've seen some pretty sustained demand on our Shred brand and continued great performance, and we're looking forward to having that extra capacity to be able to expand our distribution.

Got it. Thanks for the comment there. That's actually a good segue to my follow-up question. So, Bina, that's very interesting on Shred because I was going to ask how much more upside in consumer demand you see in the Shred brand because it's gotten so much success over the last year. So to clarify, Shred is really only in Alberta and Ontario and not really in the other provinces. So I see the upside there. How about in the provinces, Ontario and Alberta, that shred is already in. Do you continue to anticipate or see that there is still even more demand upside on shreds? Thank you.

Yes, so we absolutely see opportunities in those markets, and I should correct, we do have a little bit of business also on shred in Quebec in a 15-gram format versus the 7-gram format we have in Ontario and Alberta. But we do see upside because currently we're on allocation. We can't supply the demand that's currently out there. This is why the increase in our production capacity and our improved yields is helping us. We'll continue to be able to fulfill orders as they come in. But in just having our joint business planning meetings with the OCS, they're basically telling us there's big demand from the retailers and we can't supply that demand at this point. We're really looking forward to our expanded capacity so we could fulfill that demand. And I think it all comes back to the fact that we're offering a product that is competitively priced to the illicit market. And so we're bringing product and people in from the illicit market into the legal market through this brand, introducing them to high-quality offerings. And so I do think there's lots of upside as more people move over from the illicit market to the legal market as well. Great. Thank you.

Your next question comes from the line of Aaron Gray of AGP.

Hi, good morning, and thank you for the question.

So first question for me, I just want to touch on Israel. You had sales begin again this quarter. So just on the go forward, two questions on this.

First of all, could you comment maybe on the margin profile that you guys are receiving for some of the products to Israel? And then how do we think about sales going forward? Should they continue in 2022? I just want to know relative to the revenue you receive in the first quarter, whether or not it should continue to be lumpy.

I think that's kind of a good base to build off of. Thank you.

Right, so thank you for the question. At this point, we had strong, you know, we resumed shipments to Israel in Q1 of fiscal 2022. We have a great partnership with CanDoc, and they're very interested in receiving ongoing product from Israel. what what they sell in their market is you know premium indoor grown cannabis from canada they see it as a big draw they get a premium um price for that product and uh with our shipment that we made in q1 of fiscal 22 they were very pleased with the performance of our strains i believe we shipped them mac one that sold out in their stores within uh 24 hours. So, you know, they're very pleased. They're looking for more product. We expect to be on a cadence of, you know, shipment once a quarter to CANDOC. Obviously, that does depend on, you know, no changes to the regulatory environment. But at this point, we have a strong partnership with CANDOC, and we do expect to see ongoing shipment throughout the balance of our fiscal year.

Okay, great. Thank you. And then just a quick follow-up. Can you just comment if any color on the margin profile? Sure. Sorry.

You did ask that. Okay. Yes, so certainly we have good margins on the product that we sell to Israel, and that's obviously because when you sell export markets, you don't have the excise tax impact that you have when you sell within the recreational market. And so it's a strong margin for us, and it helps drive our overall net revenue. I don't know, Derek, if you want to provide any more color.

I guess we don't normally get into the margin by product categories specifically, but we do have healthy margins on the B2B business as a consequence of the excess tax. That was noted as well, just because of the packaging that you're doing and sending on the export. It's a more simplified process in terms of both labor and the packaging element. it does allow for margins that are enhanced than as compared to the flower margins in the Canadian market. Well, that's helpful qualitative color. I appreciate that. Second question for me then, just in terms of high-level view on the market and pricing, Some peers have talked about potential continued pricing pressure and using price as a lever to kind of regain market share. So I just want to get your overall view in terms of what the risk price increases and shreds and how you're going to look at pricing and kind of maintain price gaps kind of as we go through 2022, especially relative to potential changes in market share. As was mentioned earlier, we've seen different fluctuations over time with different brands. Thank you.

Right. So I think we've seen the price compression that's happened in the flour category, but from my perspective, we've basically seen it sort of level off. We got to a place in flour where supply and demand are getting more aligned in the marketplace. The price compression we're seeing now is coming in other segments. You see quite significant compression coming in the vape category. We have a good competitive cost structure for our gummies, so we're not concerned in that category in terms of price compression. We know that we have to be competitive in the value segment to prices offered in the illicit market to maintain that momentum. So I think, you know, you obviously have to watch the pricing. We certainly have seen the compression in the flower category over the last year, but it's, I think, really a good indication of the strength of our Shred brand that we're able to take pricing in this category and continue to maintain the momentum on the brand. So I do believe that we've kind of leveled on flour. There might be some compression on the high end in the craft flour segment, but on the value segment, I think we've sort of leveled off. You know, I could be proven wrong, but that's certainly what we see as we were able to, you know, get that price increase on shreds.

Okay, great. Thanks so much for the call. Then I'll jump back into the queue.

Your next question comes from a line of Ty Collin of 8 Capital.

Hi. Thanks for taking my question. Just looking for some additional color on the Q2 outlook. I think the language in the press release guided towards higher year-over-year sales in Q2, but not necessarily sequential growth. So just wondering if Q2 is looking flat or down. What are you seeing in terms of adult use? Some of the puts and takes there would be great. Thanks.

Perfect. Thanks for the question. So, you know, we are going into the quarter. Obviously, we have December behind us. We've had some good momentum. And we do have the incremental revenue coming from Laurentian. But the careful consideration on quarter over quarter, which, you know, could very well be growth quarter over quarter, but we do want to recognize the fact that there is seasonality to this business. The second quarter, our second quarter is usually our lowest quarter of the year because you have sort of the shutdown over Christmas, you have the shorter February month, as well as the provincial boards that year ends are in March. So we're just being cautious, recognizing that while we certainly are striving for revenue quarter over quarter, we are very clearly going to be significantly higher than the same quarter prior year. The other thing I do want to recognize, look, nobody likes to talk about this, but COVID is back out there. There are some restrictions in some of the retail stores in terms of capacity limits and in Quebec, who's allowed into the stores. There is the impact of labor shortages as people are infected with COVID. We're just being cautious on our statements for this quarter, but we certainly have momentum coming in, and we certainly have the incremental revenue coming from Laurentian that should help us deliver a great, solid quarter in Q2.

Great. Appreciate the color there. And just as my follow-up, you mentioned earlier in the call that the company still can't keep up with demand for Shred, for example. Is there any way to quantify how much sales were left on the table this quarter, and when do you expect that the supply-demand picture will start to balance out given the capacity expansions in the month in? Thank you.

Right, so good question. I mean, we certainly believe that we will be out of our supply challenges once 4C expansion is up and running. So as Derek mentioned earlier, we're focusing on, you know, 75,000 kilos of product out of the facility, and that should be able to address the needs and demand of Shred and enable us to look at, expanding the distribution to other markets on top of feeding the markets we're currently in where we're on allocation. In terms of how much demand or sales are we leaving on the table, that's a hard one to answer. We certainly know that in our conversations with the OCS, they certainly see it as a very large number. Their retailers are looking for product and it's something we can't supply. You know, every quarter, we started to see improved yields. We started to build some extra supply this past quarter, and that should help us fulfill more orders over the next quarter. As you know, there's sort of that delay between when you plant and you harvest, but we should continue to see improvements over the next couple of quarters. But I see the big unlock coming in once 4C expansion is complete, and we will have production out of those grow rooms by the end of our fiscal year.

Thanks, and congrats on the quarter.

Thank you.

Your next question comes from the line of Andrew Pothano of Staple.

Good morning. Thanks for taking my question. Maybe just starting off, With some of your products continuing on Shred, is it possible to quantify the price increases that you've made in Q1? How much more do you expect to increase it by in Q2? And as you bring Shred into new markets, are you thinking about having a standardized national price on Shred? Or could there be even further upside on on price?

Thank you, Andrew. With regard to Shred, we know that currently we're selling in the most price-compressed market, which is in Ontario, the biggest bulk of our volume, and that's just based on their margin model. We do believe that as we roll out to other markets, there's margin upside as we have some markets that have... you know, better for prices and we could get better margins on our shred. In terms of the price increase, while we were able to get the pricing through in Alberta a little bit earlier in the quarter, we were only able to get the Ontario pricing through by the end of October. So we do think that there's good upside in the next quarter as we see the full impact of the price increase in Ontario.

Is it possible to quantify the price increases?

Gareth, do you want to take that?

Yeah, I'm not sure if it's a complication. I mean, we partially benefited in the quarter, as noted just on the timing. But from here, it would be, you know, in the 5% range effective in terms of the impact to the top line sales just based on a transitional implementation on the timing during our Q1 reporting period.

Thanks for that, Keller. And maybe transitioning to your R&D expenses, you know, that you had that nice outlook of accelerated profitability. You know, could you clarify specifically I believe that's excluding R&D expenses. And when thinking about R&D expenses, I believe the last time we spoke about it, you were talking about maybe $30 million over three years. Has that outlook changed at all? Could you maybe talk about cadence and and any other color you can provide on the level of R&D expenses to take into account, you know, your profitability outlook?

I would say that our R&D expenses to date have been modest just in terms of the timing the spend programs that are within the Centre of Excellence. The employees have been hired that are doing the work in terms of the Centre of Excellence. And we, of course, have our own innovation and R&D team over and above the Centre of Excellence. But I would indicate that the total program spend is the same as was originally budgeted. or originally forecasted, and that it's more or less that the timing on some of the spend on the programs has been pushed out a few months, but the aggregate of the spend would be similar. So it can get a bit lumpy, but we would see that it would start to increase from the one rate that you would have seen in Q4 and Q1 of this year in terms of the total R&D spend for the company.

Thanks. I'll get back in the queue.

Your next question comes from the line of Rahul Sarugaza of Raymond James.

Morning, Dina, Derek, Paolo. Thanks so much for taking our questions. I know we've talked a little bit about gross margins already, but I just wanted to drill down a little bit into the interplay between capacity and gross margins. We saw historically that the company was extraordinarily efficient in the early days of legalization when operating at capacity. And Derek, I think you referred to being close to capacity, if not fully at capacity right now. You know, how should we be thinking about, you know, the sort of upper end or the rate limiting step in terms of capacity and gross margins now? And then how do we see that, you know, with the expansion? And do you potentially see sort of a dip in margins as you transition to that expansion?

Yes. Firstly, I would not see any dip to our margins as we proceed to the expansion. The costs that are getting added, the operational costs that are getting added are not at the same dollar per dollar pro rata as the extra capacity it's going to generate. Just by example, when we say we're at 55,000 annualized capacity, say, that's for the month of January, but for our Q1 reporting period, It was approximately 45,000. So just in terms of volume output today and where we can get to, we would be going from 45,000 from Q1 effectively to 75,000, an increase of 30. which is significant. And our cost structure, where there is that fixed cost component, sort of tying back to a reply I gave on Tammy Chan's question earlier, is that most of the costs from here are going to be variable in nature. And as a consequence, our cost of production per unit is going to go down. as we increase every room that we increase. We've already seen that as we've increased the number of rooms available in Q1, but as compared to Q4 and Q4 over Q3, we've had these significant increases to our adjusted gross margin, again, going from a negative to a positive 18%. So we do think that there's no mathematical reason that this should not continue as we get to full capacity of 75,000.

Great. That's very helpful. And then just switching gears a little bit, we saw Organigram in particular support its investment in hyacinth. And we understand that hyacinth is starting to meet some important milestones, particularly in terms of the fermentation production of CBDA. Could you maybe give a sense for, you know, when we might start to see the incorporation of, you know, hyacinth-produced molecules into organograms products and hitting shelves, particularly given that we see a couple of years, at least one of your major competitors hit shelves with fermentation-derived cannabinoids?

Right. So thank you for that question. So at this point, we're very pleased with the IP that's come from Hyacinth, and it's why we furthered our investment. We are looking at having a contract manufacturer organization sort of agreement in place. um to help on the scale up by around q3 of 2022 that's calendar year 2022 and expect production uh sort of material revenue coming out of their their facility or that agreement by the end of calendar 2023 So it's still a little ways away before we have scaled rare cannabinoids out of that production. But we're very excited about what we've seen in terms of their technology and IP. We think we have a simplified approach that is easier to scale up than some of our competitors. And we believe that while we're talking about revenue only coming out by significant material revenue coming out by the end of calendar 2023, we do believe that the opportunities in terms of use of these products We'll take that time between now and then to work on some of the innovation and work with BAT and our product development collaboration to see where the greatest opportunities are in bringing in these products. So we'll use that time to do the right research, to do the right consumer work, and make sure that we're ready to go once the product is scaled.

Great. That's very helpful. Thanks again for taking our questions.

Your next question comes from the line of Adam Buchan of Scotiabank.

Good morning. Thanks for taking my question and congrats on the quarter. Bina, you provide some great color on the demand for Shred. I want to focus more on the sort of flower revitalization project that's been undertaken over the past year and a half. Are you able to provide some high-level detail on the contribution for sort of premium flower to overall sales versus, let's say, last quarter or versus last spring? And really, I'm just trying to get an idea about demand that you're seeing for those sort of new products that you've launched.

Right, so a couple of points on that question. So we have, you know, seen from a flower standpoint, we've seen the growth obviously in our shred demand, but also in our big bag of buds. So that's our 28-gram format, you know, unique strains. And again, we have limited distribution as we work through our capacity challenges, but we're seeing some growth in that format as well. Our Edison brand, we've seen it's been sustained market share on an Edison brand. We expect to see some growth on our Edison flower in the back half of this year as we start introducing some of our newer genetics behind that brand, higher THC, higher terpene offerings on Edison, which is consistent with the consumer demand for more premium brands. So that is coming. In the interim, we continue to focus on building out our portfolio behind Edison with our vapes. We have some live resin vapes under packs that will be coming out to market. We have our Edison Jolts, which I talked about briefly in the script, that really was you know a great intro into a sort of high potency lozenge category and we're seeing you know additional skews coming out in that space because because of the demand so we'll margin up outside a flower through some of our derivatives We launched our Bonjour offering, which is CBD-infused soft chews. And again, a larger format CBD offering. There's not very many in the marketplace. You know, good margin for us, a great offering for consumers, an opportunity to build that distribution. So I think there's going to be margin improvement as we continue to build out our portfolio. And then, you know, as I said earlier, I think with Edison, it's just a matter of some of the new products gaining some traction. And we did see that with our Edison pinners, which were our pre-rolls this past quarter. So I hope that answers that question.

Yeah, no, it certainly does. Thanks for the color. So second, I just wanted to kind of touch on Israel again. And I'm just wondering if your partner, CanDoc, has shared any sort of commentary on what they expect for forward competitive dynamics in the market. You know, it seems basically right now that Israel will eat sort of anything Canadians put on the table. But, you know, of course, there are many LPs looking to get into that market given the attractive demand and margins, right? So is there anything you can share on that front in terms of what you expect on a four basis? I know you said, you know, sort of sequential one order every quarter, but, you know, anything on that front would be helpful.

um right so i i think what became clear in our discussions with can doc is what they're looking at what is really gaining the the best premium prices in the israeli market is canadian indoor grown um flowers so what i think um provides us with a unique uh opportunity is that we're one of the largest indoor grown facility um supplying that marketplace um you know they've said that as soon as they put product out there um you know with with our brand and identify it as canadian indoor grown it just flies off the shelf so it's really seen as you know premium quality product in that marketplace so while i think there will be you know some uh competition from israeli drones this uh certainly um think that uh we feel pretty strongly about uh our performance in the market and you know can doc has is very pleased with the products and you know they were uh certainly you know told us how quickly that that some of our new strains that we introduced um you know, sold out in the marketplace. So I'm feeling good about that relationship and continuing to build from there.

Great. Thanks, Dr. Keller. And congrats on the quarter again.

Thank you.

Your next question comes from the line of Douglas Mim of RBC Capital Markets.

Good morning. A couple questions. First question just has to do with the illicit market. Maybe what you could do is walk us through you know, where you see the pricing in that market, particularly in larger provinces, and the price differential between your Shred, Big Bag of Buds product, and the type of differential that you need to maintain in terms of pricing, like how far in price can you take before you're not able to take share from the illicit market? Just want to start with that.

Right, okay, so thank you for that question. I think we've actually crossed that market in terms of pricing with the illicit market. If you look at price per gram, you know, we've seen overall in the market where the price per gram in the legal market and some of the value offerings has actually fallen below the price per gram on the illicit market. Now, it's hard to say whether that's a level playing field. You have differences in, obviously, strains and THC, but I feel like the increase in our demand on Shred has sort of indicated that we're there. We're getting that crossover from the illicit market into the legal market, and we're at the right price there that we continue to see growth. And I believe it's come across that right now the legal market is now 53% of sales versus 47% of the illicit market. I mean, there's still a long way to go to get more of that illicit market over. But in terms of price per gram on flour, I think we've kind of crossed that. And I think that gave us the opportunity to take a little bit of pricing on Shred. Obviously, the market dynamics are a little bit different depending on the province you're in. But generally speaking, I think we've already hit that mark.

Okay. That's fair. The second question I wanted to ask was about... You see that you're selling into Israel, but there are going to be a couple other markets that open up in Europe in the next little while, perhaps in the next 12 to 24 months. What's your thinking or the company's thinking for international expansion outside of Canada and what you're doing in Israel?

Right, so first of all, we also have a partnership with Canatrack out in Australia. We had shipped them a while ago and we have re-engaged with them and are looking to expand our export shipments to Australia as well. So that in addition to Israel, our current businesses that we'll certainly look at fulfilling in this fiscal year. In terms of other markets, certainly we're all watching Germany and trying to understand legalization there and other available markets in Europe. What we're doing in the short term, we're evaluating how to get some EU GMP or GMP status in our Moncton facility, how to build out some capacity to be able to take advantage of that market as well. The facilities are designed to get to EUGMP, that's our derivatives facility in Winnipeg, as well as our Moncton facility. We don't have the certification yet, but it's something that we'll look at over the course of the next 12 months as we consider those export markets in Europe that become another opportunity for us.

Okay, thanks very much.

Thank you. Your next question comes from the line of Andrew Bond of Jefferies.

Morning. Andrew Bond on the line for Owen Bennett. Thank you for taking our questions. I understand it's late in the call, so I'll keep it to one. Just around U.S. strategy for federal legalization, understanding that timing remains uncertain, we've seen several different approaches and transaction types from other LPs like optionality agreements and structured agreements with MSOs, as well as CPG-oriented brand plays. Obviously, Organigram has shown great traction based on market share data. So just curious what specifically you're thinking about as you develop an approach to the eventual U.S. THC market. Thank you.

Great. Well, thank you. So we've been looking at the U.S. market, and obviously it's something that we – I apologize. Hold on just a second. Sorry about that. So we have looked at the U.S. market, and I don't believe necessarily that the options that some of our competitors have done is the right approach. We know how significantly this market has changed over the course of two years, and I'm not sure if you put in an option now, you know what you're going to be getting in two years' time, given the rapidly changing market dynamics. We as a company will continue to look at the market and track regulation changes to make sure that we understand when the opportunities really develop in the U.S. for us. We'll explore CBD offerings in the U.S. and other adjacencies, so those are things that we'll look at. But we're going to do it when it's the right move for us. The short-term goal in the last year six months has been to build out the foundation in our Canadian marketplace. We added EIC, which got us into a dummies market very quickly. We've just added Laurentian, which bolsters our presence in Quebec and gets us both into Kraft flour and into concentrates in a bigger way with the Tremblant hash. So I think that was our priority. As we continue to look and as we've built out our base in Canada, we'll start to look. And I'm not sure if the U.S. is the first marketer we'll look at, you know, outside of the U.S., but we will look at expanding internationally as we, you know, see the right opportunities come for us.

Great. Thanks for that, Carla. Congrats on the quarter.

Thank you. Your next question comes from the line of Frederico Gomes of ATB Capital Markets.

Hi, good morning. Thank you for taking my question. In terms of your market share, so you guys have a good momentum going there, but, you know, the market is still very competitive for demand. So just going forward, we just expect to continue to gain share of the market. Now, is there any target you guys have in mind in terms of how much share you can take organically? Or, you know, would you expect to have that market share curve to kind of flatline until the market consolidates? Thanks.

Thanks for the question. I think what we've said so far is obviously we're not taking full advantage of our shred offering because we are capacity constrained. So we do believe as we build out our capacity, there is more upside to gain on our shred as well as our big bag of buds or our 28-gram format. As we build out our capacity, we do believe there's more market share to grab from those offerings. And we do have, you know, a derivatives business that we continue to build out. So we have more offerings coming in our gummy lineup. We have yet to really see the full benefit of our new launch behind our Bonjour brand. You know, we have some new innovation on, you know, pre-rolls more more dual pack pinners coming out and more vapes coming out which we are underdeveloped in the vape category but we have some new vapes coming out both under our shred brand and our Edison brand so I think that the answer is we do think that there's opportunities to gain market share And I'll also say that while Quebec is a challenging market to take a good read on because of the limited data coming out of that marketplace, we certainly believe we'll have a larger market share simply through the benefit of the acquisition of Laurentian.

Great. Thank you very much.

This concludes today's Q&A session. I will now turn the call back to Bina.

Thank you, everyone, for listening this morning, and thank you for some great questions. We're very excited about the momentum we have on the business, and I look forward to updating you again soon. Thanks for joining the call.

Thank you for participating in today's call. You may now disconnect.