Earnings Call
Organigram Global Inc. (OGI)
Earnings Call Transcript - OGI Q3 2023
Operator, 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. Thank you. Max Schwartz, you may begin your conference.
Operator, Operator
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 when 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 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 makes seed cultivars commercially viable for extraction for derivative products containing THCV. Given that it's very difficult to grow cultivars with high concentrations of THCV, it 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 'skinny 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 clone-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 clone-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 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 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 micro-environment, 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. 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. 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 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. 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 in 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. 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 our 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. 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.
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 on 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 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 were $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, 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 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 on 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, infused pre-rolls, 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 remaining 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 in sales will result in increases in receivables, which will negatively impact cash from operating activities. The company forecasts a remaining cash CapEx spend of approximately $10 million for fiscal '23. 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
Your first question comes from the line of Tamy Chen from BMO. Your line is open.
Tamy Chen, Analyst
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. While this trend has been occurring for a while, it became more pronounced in the past year, especially over the last ten months. For instance, in the third quarter, nearly half of flower sales were from THC flower with levels above 26%. The number of SKUs with THC labeled above 26% has doubled in the last ten months, and those labeled above 30% have increased ten-fold compared to last year. Although this trend was present earlier, it has become much more visible in the past year, particularly affecting the 28-gram flower category, where SKUs above 27% THC have increased five-fold since last July. Historically, there had been no products at that potency for 28 grams. National retailers indicate that some licensed producers who previously averaged sales at around 21% to 22% THC have suddenly changed to showing sales of 28% to 32%. This shift is not merely due to advanced cultivation techniques. It appears to be a change in consumer behavior affecting the results. As we mentioned on the call, we felt this impact especially due to our focus on whole flower, particularly in the 28-gram category. We had to reduce pricing to maintain our value proposition for consumers in light of the competition, particularly from products at 27% and 28%. However, upon testing, some of these products do not actually meet those THC levels. This practice has significantly affected our results. We noticed a decline in our flower market share starting in January and took action by implementing changes in our facility to produce higher potency products. Though this had a short-term effect on our flower costs, we're striving to improve our potency responsibly through proper testing. Simultaneously, we have been engaging with key stakeholders, sending feedback to Health Canada, consulting with our Board, and discussing with other labs to find solutions to this issue, as we believe it is unfair and misleading to consumers. This is our approach to addressing the situation with a leadership perspective.
Tamy Chen, Analyst
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 mill flower, you lose tricones, and that's just not something that can 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, 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. 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. Just one more comment around pre-rolls: You're seeing it in pre-rolls as well. We had a third-party lab go out and had eight different labs testing a sample of pre-rolls for their potency. 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, Analyst
Thank you.
Operator, Operator
And your next question comes from the line of Frederico Gomes from ATB Capital Markets. Your line is open.
Frederico Gomes, Analyst
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 and 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 in THC content? And then longer term, what is your view on this sort of THC rate? Where do you think we are 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. They're sort of short term and then there are 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. 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. They are exploring it, and what's interesting is that this 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 in the legal market. There is an opportunity to force secondary certificates of analysis in the short term that might cut down on this. But interestingly, yesterday, an article came out in which Health Canada announced they are now going to start testing potencies. They are feeling the pressure because this is so widespread, and they are looking at ways to address it as well. So I think from a marketplace perspective, there are some things that could impact the short term. For us internally, we are working on new cultivars and introducing new cultivars with higher potency in our garden. 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. For example, in Q1 of this year, 25% of our flower was above 23%. In Q3, almost 50% of it is above 23%. So we're making the moves internally as well. While this is going on, our focus will really be on our gummies, our hash, bringing innovation to the market. While we have to ensure we have the right value equation for consumers, we're looking at putting in cost savings initiatives to drive our costs down to improve our margins. There’s been a lot of talk about how much capital we have invested in our facility, but we're starting to realize savings. We've identified $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 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 improve our margins in this price compressed margin. Sorry, I forgot one last thing. As you know, the Ontario Cannabis Store has changed their markup model. We expect to see that flow through in the fall. That’s something one of the Boards 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, Analyst
Thank you. And then just about your investment in seed-based production. Can you maybe provide a little bit more color about why you have decided to make this investment at this moment, given that it appears that you are one of the first movers in this regard? When should we expect to see some impact of that in your financials, and 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 seed-based production at scale? So how should we look at those risks? Thank you.
Beena Goldenberg, CEO
Right. Thanks for that question. We’re going to be rolling out our seed-based production slowly with a test and learn approach. We are not obviously going to go out and convert our whole facility. 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. When you cultivate with seeds, it requires 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 a significant number of days in the grow, which reduces significant amount of labor. It's great to be working with seed production because you don't have some of the diseases that you would get in normal clone production, such as powdery mildew. Every seed is clean and grows clean. You have more standardized flowers. The lollipopping and the leafing become more standard. There are many reasons why this is good: it's less cost, it will turn our rooms faster, and we're very excited about it. Now we are not going to change our whole production facility over; there is currently still a need to experiment with new cultivars because new is always what consumers are looking for. A portion of our garden will always be clone. You get a faster turnaround using clones as it takes a long time to produce F1 seeds that are strong and will 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 for over the next 12 to 18 months will come from the benefits of seed-based production.
Frederico Gomes, Analyst
Thank you. I’ll hop back in the queue.
Operator, Operator
And your next question comes from the line of Aaron Grey from Alliance Global Partners. Your line is open.
Aaron Grey, Analyst
Hi. Great. Thanks for the question. Just one for me. So just in terms of your commentary regarding 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, and actually more of a shift to people saying that we need shakeouts. What are you seeing that gives you more confidence that we might start to see that now? You talked about some of the payments in arrears and some of the taxes. Do you think there's going to be a greater portion of that? Can you just talk about some things in the industry, why that market might start to come to fruition?
Beena Goldenberg, CEO
Sure. Thanks. 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. The 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 who aren't paying. Think about it this way: If companies aren't paying their excise taxes and are using that 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. We’ve had word from CRA; the Health Canada stat just came out in an article last week that the number of 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 next 12 months. The capital markets are very tight. People can’t raise money, and their runway is going to run out. We’re just there, watching it, understanding it, and we're going to go after listings where a company that has gone into some form of restructuring is likely not going to continue to replenish at that level. If we have competitive products, we’re using our data looking at where the listings are, how do we gain that market share, and continue to strengthen our business as this turbulence continues through our industry? I think your comment is right: We need to see consolidation in the industry; it is way too fragmented. I think the dynamics in the market will see that happen over the next 12 months.
Aaron Grey, Analyst
Okay. Great. Thank you very much for the commentary. I’ll jump back in the queue.
Operator, Operator
And your next question comes from the line of Andrew Partheniou from Stifel. Your line is open.
Andrew Partheniou, Analyst
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 were just a delay and higher production costs from lower yields, among some other things. But these seem to be the main causes of the lower EBITDA. Both of these things seem to be quickly reversible, and you're guiding for positive EBITDA next quarter. There could be a rather large international shipment in Q4, which could bring your sales back to levels we saw in prior quarters in the low $40 million range. That all suggests a pretty quick rebound. 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: If you could talk a little bit more about that, it would be helpful.
Derrick West, CFO
Thanks, Andrew. I’ll start first with EBITDA and the churn that we would see. 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 the facility to get improved THC. This increased our cost of cultivation quite significantly and quickly, which becomes part of our cost of goods sold this quarter. 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. Cost of cultivation is the main driver for flower margins, which accounts for 70% of our revenues. This 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 B2B sales were lower in Q3 than one would be on a normalized quarter for us. Those tend to be a higher margin category for us. So we do see a pickup there for Q4. Also, we have other cost initiatives that we have done that Beena spoke to, and more automation allows for throughput. 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. I will not provide specific guidance on the research and development costs, as I think we're getting too detailed. 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 was primarily driven by two factors: one, Canada's share prices being so low for us and others compared to what that means for our market cap versus our carrying value. So that becomes an indicator that there has to be a review. Secondly, when you consider our Q3 operational results were below our internal expectations, the close conditions of the two combined together require us to do a detailed analysis and review. As we did this review, we were starting at a lower point than we were when we did this in the past, in the sense that there is an ongoing headwind from THC inflation. All this somewhat impacts the modeling as we look out. As well, the discount rate increases; interest rates have gone up, and the risk factor for cannabis companies and forecasting is higher. This analysis resulted in the recognition of an impairment loss of $191 million. A 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. We do expect a 5-point improvement in our margin rate as this fully flows through the P&L.
Andrew Partheniou, Analyst
Okay. Thanks for that. And then maybe talking a little more about your yield. You talked about changes to your growing conditions, which lowered yield, but it increased THC potency, and 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? 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. 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 the plants. 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 without establishing the right conditions. We saw a drop in our yields as we grew those plants. When you make those changes, you kind of have to wait three 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—and now we’re starting to see the yields bounce back. The THC did come back; the yields did come—our THC came up, and the yields did come back. So I think the lesson here was to move a little slower. 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, Analyst
Thanks for that additional color. Glad to hear that everything is back on track now.
Operator, Operator
And your next question comes from the line of Ty Collin from Eight Capital. Your line is open.
Ty Collin, Analyst
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 products and new innovations start 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. We did start looking at price adjustments, 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. The biggest impact for us was really around the 28-gram value equation that Beena referenced. We looked to do a price increase on our Big Bag O' Buds in early spring. In some cases, we took a price decrease of about 20%. We were retailing at about $142 originally, went down to $119. And as THC levels continued to go up, our value equation was imbalanced. So we had to lower our price even further, going down to the floor for our Big Bag O' Buds, about $99 per ounce in Ontario. Some other products might not have seen the same degree of adjustment. It wasn't across the board, but we had to make some changes in certain provinces to ensure that our value equation was balanced. If we look at the overall market right now, volume growth is going up in flower; the last six months versus the previous six months, we're seeing volume up about 10%. Meanwhile, sales dollars have decreased by about 3.5%. So there is price compression in the market, and it's largely due to most competitors in the market making adjustments to balance off that value equation or the price-to-THC ratio. In our case, we have made adjustments as deep as 20%, but in some cases, it hasn't been that deep.
Beena Goldenberg, CEO
Right. Good question. We do continue to keep interest in the U.S. market; it's an interesting market for us. But while it remains illegal federally, we have to protect our TSX and NASDAQ listings. We’re watching it carefully. I’m not sure SAFE Banking makes a big change, but certainly, the de-scheduling is something that we are looking at to understand our opportunities. When you think about what we did with Phylos, we dipped our toe into this U.S. market with that investment through a convertible loan. We found a way to do that kind of investment and still stay compliant with our listings. We will continue to look at opportunities. The market is depressed right now; there are assets in the U.S. that are depressed as well and there are opportunities out there. We have the balance sheet and a strategic investor in BAT. We’ll continue to look at ways to take advantage of the market conditions while we focus on strengthening our business in Canada.
Ty Collin, Analyst
Great. Thanks, Beena.
Operator, 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
Thank you, everybody for joining today. We’re really playing the long game here at Organigram. We’re focusing on doing what's right 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, Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect.