Auxly Cannabis Group Inc

TSX:XLY

Earnings Call Transcript

[Operator]

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Auxly Cannabis Group's Q3 2021 Earnings Call. [Operator Instructions]Thank you. Ms. Cannon, you may begin your conference.

[Julie Cannon]

Thank you, operator, and Good morning, everyone. Thank you for joining us for Auxly Cannabis Group's Third Quarter 2021 Financial Results Conference Call. A replay of this call will be archived on the Investor Relations section of Auxly's website. We will start the call with a presentation and corporate update by our CEO, Hugo Alves, followed by a recap of our third quarter results by our CFO, Brian Schmitt, before opening the floor to questions from our financial analysts. I encourage you to follow along with the presentation slides, which are posted on our website under the Investors section under Presentation. Before I turn the call over to Hugo, I would like to remind everyone that our discussion today includes forward-looking statements that are based on assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from the views expressed today. Management can give no assurance that any forward-looking statement will prove to be correct. Forward-looking statements during this call speak only as the original date of this call, and we undertake no obligation to update or revise any of these statements, except as required by applicable law. Management refers you to the cautionary statement and risk factors included in Auxly's disclosures. I note that all references on this call are to Canadian dollars unless otherwise stated.With that, I'll turn it over to Hugo, our CEO, Hugo Alves.

[Hugo M. Alves, CEO & Director]

All right. Thanks, Julie. Always tough to follow such a scintillating introduction, but I'll just say, welcome, everyone, to our Q3 earnings call. Look, we're excited to host you for this call and share with you the results of what's been another record quarter for Auxly. So let's get started. I am going to turn us to Slide 6 in the presentation. We're going to do our best to keep the presentations consistent quarter-over-quarter each year so that you have a better basis upon which to assess our progress. And as you know, during the calendar 2021 year, we're trying to achieve 5 key strategic objectives: maintain our leadership in 2.0, built to leadership in dried flower and pre-rolls, become a top 5 license producer by share of market, improve our margins and grow revenues and achieve adjusted positive EBITDA. So in terms of our 2.0 market leadership, we continue to be the #1 2.0 in the company in the country. And we grew our market share this quarter to 15.6% of overall markets, up slightly from Q2. We continue to dominate in the vape segment and increased our share of market by more than a full percentage point over the quarter, we finished with 24.7% of the national vape market.And we're also making tremendous inroads into the concentrates category, one of the fastest-growing categories in the industry, where we're now the #4 -- 4th ranked license producer nationally. But the big story this quarter is really the tremendous progress that we've made to building to leadership in dried flower and pre-rolls. And look, I want to couch the discussion by saying, Auxly still building its base portfolio in flower, right? We grew our SKU count during the quarter at the OCS to a whopping 7 SKUs. And I think that's an important point for you to note because our competitors have multiples of those SKUs, right? They have flower portfolios that they've built over years that have 30, 40, in some cases, over 50 SKUs in their portfolio.So we're still building our base portfolio in dried flower. But because we've stayed keenly focused on the consumer, we've built the most efficient dried flower portfolio in the market on a sales per point of distribution basis. That means our SKUs sell more dollars per SKU than any other flower portfolio in the country. So over the quarter, on a national basis, we increased our position from 12th to the #9 LP nationally, growing our share to 2.7% of overall market. But in order to really get a flavor of how our launch has gone, you have to double-click into Ontario because Ontario is really our home, our test market, it's where we have our full SKU portfolio launched. And when you take a close look at -- to home in Ontario over the last 12 weeks ending October 30, it paints a different story.So in Ontario, we've moved into the 5th spot overall in dried flower and pre-rolls tells a similar story. Nationally, we increased our standings from the #19 producer to the #11. But in our test market of Ontario, which notably was the only market that had our Back Forty 40s product during the quarter, Auxly is now the 3rd largest supplier of pre-rolled products. So our thesis in 1.0 is working, and the results have been very encouraging.As at the end of Q3, we were not yet a top 5 license producer. We exited the quarter as the #6 LP by overall recreational cannabis market share. We grew that share from 4.9% to 5.6% as at the end of Q3, but we've continued to gain share month-over-month, and I'm very happy to report that we finished the month of October with 7.3% share of overall market, and we did move into the #5 spot. And we're confident that we're going to continue to increase share over the coming months through increased distribution of our dried flower offering, and as we recently announced on November 10, we have 18 incredible new SKUs that we're adding to our product portfolio over the course of Q4. So we remain on track to finish the year with between 7% and 9% of national market, and we're confident that we can exit the year in the #5 spot or higher.Brian, on the financial metrics, Brian is going to give you a lot more color later in the presentation, but I'll note here that we organically grew net revenues from recreational cannabis sales to $24.5 million, and we managed to keep spending relatively flat. However, we did encounter some operational challenges during the quarter, which negatively impacted our gross margin. Those challenges were related to the scale-up of dried flower and pre-roll operations and especially delays out of our control in the delivery and commissioning of key automation equipment, which resulted in lower-than-anticipated volumes and higher-than-anticipated production costs.And while we have improved and we'll continue to improve in navigating those operational challenges, we do expect some of them to persist throughout Q4 and part of Q1 2022. And regrettably, that will impact our adjusted EBITDA target. But I'm going to leave that to Brian to discuss with you in greater detail during his part of the presentation.So with that overview in mind, let's turn to Slide 8 of the presentation, where, as I've already stated, we remain the #1 LP and 2.0 product segment, and we continue to be the undisputed leaders of the vape segment, close to 25% of total market. And one point that won't show up on this paper is that unlike our flower, where we're still building a base portfolio, we have a robust portfolio of vape SKUs. In Ontario, we have 21 SKUs. But just like our flower portfolio, even where we have an increased SKU count, we still have one of the most efficient portfolios in the country, right?So even with a robust portfolio of SKUs, our portfolio is highly efficient and each SKU is very hard working. For example, in Ontario, our 21 SKUs represent 7% of the total vape category listings in Ontario, but our vapes represent 26% of all sales in the province. I think that's important to note because we're winning through quality and being consumer-centric rather than sheer quantity.At a more macro level, on the right, we exited the quarter as the #6 license producer in the country. And year-to-date, no cannabis company, in Canada, has gained more market share than Auxly. And that is a testament to our focused strategy, the tireless efforts of our people and our commitment to putting the consumer first in absolutely everything we do. And that winning formula continues to bear fruit because we continue to see increases in market share. As I mentioned, we finished the month of October with 7.3% share of overall market, and we moved into the #5 slot.And we continue to see strong consumer demand for our product. To give you a bit of color on that, most recently, in our test market of Ontario, I can tell you that Auxly has just exited this past week in Ontario as having the #1 flower SKU in the province, the #1 pre-roll SKU in the province, the #1 vape SKU in the province, the #1 overall SKU in the province and Auxly exited the week as the #1 license producer overall in Ontario. So we're heading in the right direction.Moving us to Slide 9, driving a lot of our growth is our expansion into 1.0 product formats, where our offering has enjoyed tremendous consumer success. So as I mentioned, we are paying extra close attention to our flower performance in Ontario is that as our home and test market where our entire 7 SKU portfolio is listed. And so with that in mind, if you look at the 12-week period that ended October 30, and you compare it to the previous 12-week period in Ontario, right? So pre and post kind of Auxly flower, you start to get a sense of really of the traction. So during the most recent 12-week period, the overall flower category in Ontario grew about 10%. Auxly's flower portfolio during the same period grew 188% and accounted for 42% of total category growth.So for every additional dollar in flower sales in Ontario that were incremental during the period, obviously accounted for $0.42 in that. And on a brand basis, it's equally as impressive. Back Forty is now the fastest-growing flower brand in Ontario. It's grown 191% over the last 12-week period. It's now the 4th largest flower brand by dollars in Ontario. Kolab Project, it's a bit more sluggish. It only grew 175% during that same period. It's now the 16th largest brand in Ontario. And pre-rolls tells a similar story, right? While we have launched our much awaited Forty's product in Ontario, it's again important to stress that just like dried flower, we're building our base portfolio.We currently have 4 pre-roll SKUs in Ontario. Our competitors have many more, like 2.5x to 10x our SKU count. But just like flower, we have a highly efficient portfolio. So even with the tiny SKU count in Ontario, the only province where our Forty's product was available, we're currently the third largest supplier of pre-rolls. And we believe our rankings would have been even higher, but for the operational challenges caused by equipment delays. So we do expect to see further share growth in the balance of the year as availability increases and we minimize out of stock positions.I'm going to move us to Slide 10. So this slide is intended to give you a fast visual representation of our market share progress in our chosen categories. And I want to note here that this talks about national share, right? So that you can see how we're performing across the country. And as you can see, we grew our share in every category that we participate in, except edibles, where we lost a bit of share. And I would address that by saying it's not something we're overly concerned with.Historically, we have not expanded our edibles portfolio. In fact, in Q4 of 2020, we scaled back on edible SKUs to allow us to focus on the higher-margin products like vape. But we've now turned our attention back to the edibles category with new SKUs launching late Q3, performing very well and some more SKUs launching over the balance of Q4. But we intentionally back-end loaded our edibles innovation to Q4. And that was really to allow us to focus on our flower launch and also to address chocolate seasonality issues during the summer.So we think we're going to be able to win back some share as our new edible products hit the shelves. I've already talked about flower and pre-rolls. So I won't say anything about those on this slide. I would note here on this slide that we continue to make very solid gains in concentrates, where we're now -- it's one of the fastest-growing segments in the market. We're now the 4th largest product and we feel about continued share expansion in this category. We recently launched our live terpene sticks, another first to market innovation by the Auxly team.And we're launching Caviar and live Rosin Jam over the balance of the year, and we think that those will have tremendous consumer success, just like our Kolab Diamonds product. We've also made tremendous strides in oils and capsules. We believe our Dosecann branded products are superior to similar products in the market in terms of potency, format, value and benefit. So we're quite bullish of the growth prospects for oils and capsules as we build distribution and as our consumers become more educated, right? It's now been almost 2 years in 2.0. So people are starting to get a little bit more comfortable with these formats. Look, I'm going to say a few quick words about our brand performance and our innovation pipeline, then I'm going to turn you over to Brian.Slide 12, one of our key aspirations is to build authentic connections with our consumers through our brands. We want our consumers to trust and love our brands, and we work hard to win our consumers' brand loyalty each and every day. And I'm delighted to report material progress on this front as well. From a market share perspective, all of our brands are represented in the top 10 brands of each product segment that we participate in. Our 3 vape brands are all in the top 5 brands nationally with Back Forty continuing to be the most relevant vape brand with 14% share of national market on its own.Back Forty and Kolab Project, as I mentioned, are the fastest-growing brands in dried flower and pre-rolls. And our Dosecann brand is really gaining traction as we drive distribution for our oil and capsules products. So while we believe it's still too early to draw definitive conclusions about brand health and brand relevance, we do believe that we've invested in the right capabilities to enable us to bring build meaningful brand connections with our consumers, believe our brands provide us with excellent coverage among our targeted consumer segments and that based on early signs, our brands are connecting with our consumers and building trust and loyalty.Turning to Slide 13 and our innovation capabilities. Look, I think this slide speaks volumes, not only about our innovation capabilities, but our consumer insight strength. By the end of this year, we will have launched 52 new SKUs into market. That's comprised of the 34 new SKUs already launched and then the 18 SKUs coming in Q4. That is a herculean measure by any means, but it is even more impressive when you consider the nature of the innovation. We're not just adding a new size to an existing flower SKU and calling that innovation. We're listening to our consumers and then trying to address a particular problem, need state or occasion.And when you look at these 52 SKUs that we'll have introduced by the end of year, only 14 of those are line extensions, predominantly different sized vape cartridges. 38 of the SKUs are entirely new products, a new concentrate. And 10 of those 38 SKUs are first to market innovations like our live resin gummies or live terpene sticks. And I've already noted earlier in my presentation, the efficiency of each SKU on a spend per point of distribution perspective. And when you combine those 2 things, how prolific we are at innovation plus the success that each new product enjoys when it enters the market. It's not by luck. This is the result of having a focused strategy, an obsession with our consumers and then having the right people, assets and capabilities to execute on that strategy.Slide 14. I'm not going to say much here. This is a visual representation of our product portfolio by brand, and it sets out the balance of innovations that we plan to release throughout the year. So unlike last earnings calls where we left out some more commercially sensitive innovation SKUs, this chart is now complete. I know some of our investors like to use this slide as a checklist of sorts. So I've included it here again, so they can follow it along -- follow along for the balance of the year. But I'm going to stop here and turn it over to our CFO, Brian Schmitt, to deliver the rest of the presentation. Thank you for your attention so far, and Brian, over to you.

[Brian Schmitt, Chief Financial Officer]

Thank you, Hugo, and good morning, everyone. If I could get everyone to turn to Slide 16, I'd like to start with an overview of our revenues from continuing operations, where we are again excited to report another record quarter for Auxly, achieving $24.5 million in net revenue, an increase of 95% year-over-year and 17% from the previous quarter. In Q3, we saw another significant jump in our cannabis 1.0 sales, which accounted for approximately 31% of our total revenue, up from 20% the previous year as a result of our expansion initiatives into dried flower and pre-roll categories, while maintaining our leadership position in cannabis 2.0 sales, which accounted for approximately 69% of our revenues. The next slide captures our gross margin, adjusted EBITDA and net losses for the third quarter. Our gross margin declined to 19% in the quarter, which included an impairment charge related to packaging materials no longer in use. Year-to-date gross margins were 27%, an improvement over 2020 and in line with our gross margin target of 30%. There were a number of factors impacting gross margin during the quarter, including product mix changes, higher costs associated with delayed automation and additional efforts to commission certain machinery, resulting in lower realized sales volumes and costs associated with new product production, including greater percentage of units falling below finished goods specifications and additional labor charges per unit sold.While cannabis 1.0 product margins were nominal during the quarter, we anticipate improvements in gross profit from dried flower and pre-rolled products as automation is implemented and volumes increase over the next few quarters. And adjusted EBITDA loss of $6.5 million improved nominally over the same period in 2020 as a result of increased profits, partially offset by higher SG&A.SG&A, excluding noncash share-based compensation, increased over the previous quarter by approximately $400,000, which included additional selling expenditures to support store openings and higher health Canada fees directly attributable to increased revenues. Net losses for the quarter improved by $4.2 million as compared to the same period in 2020. In addition to previous comments regarding adjusted EBITDA, total other losses were lower in 2021, primarily as a result of nominal losses on the settlement of assets and liabilities and other expenses and a gain of $1.4 million related to the disposition of curative following the application of proceeds against the remaining net assets after impairment charges reflected in the second quarter.Next Slide 18 outlines our 7 quarters of progress made since the company commenced cannabis sales, showing an ongoing strong positive trend in the share of market that is a key indicator of the company's performance. With an adult-use recreational focus, Auxly's revenues ultimately follow our success as represented by share of market. However, they are influenced by our wholesale partners buying patterns. Our share of market for 2020 was 3.1%, which increased to 5.6% for the third quarter. And in October, Auxly share market improved again to 7.3%. While adjusted EBITDA has been more volatile on a quarterly basis, continued revenue growth supported by increased automation, scale and operational efficiencies will also lead to further meaningful improvements over time.As we turn to Slide 19, we updated the company's revenue multiple relative to its immediate peers and continue to see an opportunity for multiple expansions as the company increases share of market through continued execution against our plan. While revenue multiples may be influenced by other factors, the Canadian adult recreational space has seen some dramatic changes in share and market over the past few quarters, and Auxly is one of the winners.Auxly has successfully retained its leadership position and maintained its share of market in 2.0 products with a greater than 15% market share and has increased sales in cannabis 1.0 products, with a total of just 11 flower and pre-roll SKUs to capture an additional 0.7% total market share in the third quarter. As we close out the year with continued product expansion and innovation that has proven to resonate with our target consumers, we believe we will continue to see gains in our market share in both cannabis 1.0 and 2.0 categories, leading to higher adult-use recreational sales that accelerate our revenues, securing our top 5 LP position and leading to meaningful share appreciation and multiple expansion.With that, I'll turn it back over to Hugo for closing comments.

[Hugo M. Alves, CEO & Director]

Yes. Thanks, Brian. Look, I'm going to bring things to conclusion here and then open up the floor for Q&A. We hope we've been able to give you a clearer picture of the way we see our business in the market and most importantly, why we're excited and confident about our future. At a high level, this was a very encouraging quarter. We demonstrated the advantages of having a focused strategy. We demonstrated that by leveraging the same capabilities that have made us the leader in 2.0, we can quickly build to leadership in 1.0, and that's exactly what we've done this quarter. By staying focused on our consumer, we've entered the dried flower and pre-rolled segment. And in a few short months, with a tiny SKU portfolio, we've been able to outperform and capture more market share than our larger competitors, all of whom have been in the 1.0 segment since day 1. And we still have lots of room for improvement, lots of ways that we can get better and more efficient, but that in part drives our optimism and excitement about the future. We know we're on the right path. We know that as we continue to invest in and refine our asset base and capabilities, we're going to increase throughput and availability. We're going to optimize costs, increase profitability and build deeper brand loyalty. And we know that as our operations scale, coupled with our focused strategy that we can be the #1 cannabis country -- company in the country. As I mentioned, in Ontario, our home market, we exited last week, #1 flower SKU, #1 vape SKU, #1 pre-roll SKU and as the #1 license producer overall. And that ability to win in our home market is very encouraging sign to us.So that concludes our earnings call. And I'm now going to turn it over to Julie to open up the floor for Q&A. But before I do that, I want to take 1 second to thank the entire Auxly team for their tireless efforts over the quarter and also a massive thank you to our customers, our partners, our shareholders and especially our consumers. Over to you, Julie.

[Julie Cannon]

Thanks, Hugo. Operator, we're ready for Q&A.

[Operator]

[Operator Instructions] And your first question will be from Rahul Sarugaser at Raymond James.

[Rahul Sarugaser]

Congratulations on the quarter, really well done on the revenue ramp. So my first question is, given that much of that strong revenue has come from flower and you recognize that the margin impact was driven by sort of some scaling of dried flower and automation, as you mentioned, Hugo. But given that input costs of the flower are relatively higher as a proportion of total cost relative to your historical potentially or your cannabis 2.0 products, which have historically driven pretty strong margins. How do you see your blended margin profile moving going forward, particularly, as flower grows as a proportion of sales? And then, of course, it has the input cost of that flower are relatively higher?

[Hugo M. Alves, CEO & Director]

Yes. Great question, Rahul and I'm going to let Brian answer that. But I mean, before, I would just add the color, like our target is 30% blended gross margin. That hasn't changed because of the sort of the mix. Just like we launched our 2.0 products, demand has been really, really strong, but these are new people, new processes, new products. So it takes a while for the gears to click in from an operational perspective, and we were really impacted by delays in the shipment of equipment, which is just part of the sort of global supply chain issues that are happening currently. So I think, look, we know that from a production manufacturing perspective, we'll get a lot more efficient. From a cost of input perspective, our Sunens facility is now -- it's firing. It will only get better. We're still really at kind of like half ramp there, but the facility is doing great. It's growing incredible product. There is no flower that's in higher demand than our Wedding Pie strain. So we feel really good about our ability to drive low production cost. This is a purpose built, highly automated facility. So no reason why we can't have similar cost profiles to some of the larger cultivators that have been in production for a while, but I'll turn it over to Brian to give more color.

[Brian Schmitt, Chief Financial Officer]

Thank you, Hugo. I would just add that certainly, when we created our objectives for the year, certainly, the automated machinery was in our plan for the third quarter. And consequently, we sought out those listings early on. So unfortunately, as Hugo has indicated, it hasn't gone perfectly with respect to the equipment. So that has caused some pressure in the short-term with respect to our gross margins. Some of the equipment, to be a little more specific, is essentially delayed 6 months. So some of the equipment that we expected in July and then moved to August, September is now effectively going to be commissioned in January. So in Q1. So we do expect net-net a little extra pressure, if you will, on gross margin in the short term. But coming out of Q1, we would anticipate improvement once that additional automated machinery is up and running in the first quarter.

[Rahul Sarugaser]

Great. Hugo, Brian, that's great color. And now just sort of moving to SG&A. You had trimmed those SG&A costs sort of end of last year, beginning of this year. And they've sort of climbed a little bit my assumption is that because that is sort of commensurate with your rapidly ramping revenue and market share. So how should we be thinking about SG&A going forward, specifically as you earn balance and relative to ramping revenue?

[Hugo M. Alves, CEO & Director]

Brian, go ahead. Actually, this is in your wheelhouse here.

[Brian Schmitt, Chief Financial Officer]

For sure. So Rahul, I think what we're seeing here is if you look at the detailed notes of the financial statements, the ramp is really in the selling and expenditure category. We've spent a little more resources this year in respect of store opening related marketing initiatives, point-of-sale materials as stores open, we launch new SKUs. And then, in our case, we classify the flat Health Canada fee under selling expenses, so that one is directly proportional to our revenue increases. We will provide additional guidance with our Q4s in respect of 2022. But for the fourth quarter, I would anticipate a similar SG&A number as Q3.

[Rahul Sarugaser]

Terrific. If you wouldn't mind at all, just one more question then. Given that really strong market share profile that we're seeing in Canada, punching well above your weight, could you maybe give us a little bit -- give us some insight into your international view and how you plan to sort of leverage what you've learned in Canada and your ability to drive revenue market share here in other markets?

[Hugo M. Alves, CEO & Director]

Yes. Look, why don't I take that one, Brian. I would say that until you win in your home market, hard to find the case as to why you think you're going to win in an international market. So we're focused on winning in our home market, Ontario, Canada, winning nationally, and then when we go international, then we have something that has value, right? We have brand equity. We have -- that's proven to resonate with consumers. We have product formulations and know-how that are proven to address consumer segment need. And the other thing that I think doesn't get a lot of play in international circuits is we have a full -- like we have an open market in Canada. There's no single -- there's no limited license state. There's no regulatory moat where we control an entire ecosystem or 2 or 3 companies control an entire ecosystem. This is open market competition at its finest. So we'll also have the proven ability to not only win share, but then protect share in a highly competitive environment. So we're focused on winning in Canada. We're focused on building brands that our consumers love and trust, selling more products to recreational consumers in Canada than any other company.We have defined entry plans into other jurisdictions, but that -- those are the type of things that we will leverage, right? We'll leverage the strength and results that we've achieved at home from a brand equity perspective from an IP and know-now perspective and from a sort of operational perspective, but we're not planning to go and buy assets in other jurisdictions. Brian, I don't know if you have anything else to add, but if you do, go ahead.

[Brian Schmitt, Chief Financial Officer]

No. I think you touched on. We're obviously exploring other jurisdictions and staying on top of legalization as legislation changes.

[Operator]

Next question is from Frederico Gomes at ATB Capital Markets.

[Frederico Yokota Choucair Gomes, VP & Analyst]

So first, just on your adjusted EBITDA, maybe could you clarify your guidance there. You guys mentioned that you're having difficulties reaching that target. But I think that in your MD&A in your PR, you mentioned achieving positive EBITDA by the end of this year. So that is still part of your outlook, that's still the case?

[Hugo M. Alves, CEO & Director]

Yes. Look, Brian, you can take this. It's part of our -- it's still part of what we're trying to achieve, Frederico, for sure. But we want to be transparent with you and with community where we're having temporary operational challenges that it's -- I don't want to say it's a good problem to have, I would much rather not be having them. But the consumer demand for our product has been tremendous. Our quarter could have been much better had we been able to fill all of the demand. So we're just going to work really hard, get through the operational challenges, improve every day as we have been to try and increase volumes and availability. But until we can get out of this much more manual type of process, it is going to impact gross margin. So that ties into our adjusted EBITDA, obviously. So we want to be upfront with people to say we're experiencing some challenges. We're going to work really hard to still try and achieve that goal, but it is at risk. Brian, over to you.

[Brian Schmitt, Chief Financial Officer]

Yes. I would add, our goals, we kept them the same. So our goals are not changing. So that caused some confusion in the MD&A. We apologize for that. We attempted to add some color below our goals. So our goals have been consistent quarter-over-quarter. As Hugo's indicated and as I indicated in respect to the last question, our equipment is delayed at least 6 months from the original expected delivery date. As I indicated, it's in Q1 at this point. We're also not sure what's going to happen here in Q1 with sales. Obviously, all of the LPs last year experienced as substantial drops from Q4 -- calendar Q4 into calendar Q1. We're not sure what's going to happen here with some of the provincial boards that have March 31 year-end inventory counts. We monitor our sales on hand, our inventory levels on hand. And we're hopeful that there will be no significant pullback given our inventory levels, particularly since we launched new SKUs, there shouldn't be really a holdback or pullback in Q1. But we're not sure where Q1 is going to end up. So we are sort of targeting the first half of 2022 for an adjusted EBITDA target to be positive at this point.

[Frederico Yokota Choucair Gomes, VP & Analyst]

Okay. No, that's helpful. And then your -- maybe can we get an update on your efforts to enter Quebec? So today, we had a competitor LP announcing in a position there. Just wondering would you guys consider doing something similar, acquiring a player in Quebec to enter that market faster?

[Hugo M. Alves, CEO & Director]

That's -- yes, I'll take that one, Frederico. So we did see the announcement today. We know both parties, obviously, but look, like getting into Quebec is a strategic objective for next year. We have sort of timeline as to when we would like to launch product there. We have been in discussions with the SQDC now for a year. We have lots of activity in Quebec, lots of people that we're talking to, and we're confident that we can enter the Quebec market. It's how we enter the Quebec market that we want to make sure we do it the right way. We are going to watch how this Pure Sunfarms acquisition of Rose plays out and what it means for Pure Sunfarms product in the province. But we're committed to engaging policymakers in the province to understand their objectives by not allowing 2.0 products. We're continuing to meet with the SQDC to understand how we can bring value to their assortment and we've engaged local on those efforts. And we do feel that we need to be in Quebec in the near term. So that is one of our key objectives. Would we consider buying a facility in Quebec? We would consider it, under the right circumstances, but I've done lots of business in Quebec over my professional life and going in and buying a facility and thinking you're from Quebec isn't, in my view, the successful way to go about it. So we will likely partner with people in Quebec to bring our product to market, and you can expect to see that in 2022.

[Operator]

Your next question will be from John Chu at Desjardins.

[John Chu, Analyst]

So maybe just on the gross margin. It looks like you're going to have 18 new SKUs being introduced into the quarter. Can you remind me how many you had in the third quarter? I'm just trying to understand how much of a headwind introducing new SKUs can be for the fourth quarter?

[Hugo M. Alves, CEO & Director]

Yes. Sure. So look, I'll take that one. I think there is kind of new SKUs that are 2.0 SKUs. And I think if you look at -- John, if you look at our press release of 20 -- November 10, you'll see that it's kind of a lot of edible SKUs, concentrate SKUs and then some flower SKUs. A lot of the automation challenges really come around the pre-roll segment and in dried flower packaging. And it's really in pre-rolls where automation makes a big difference, right? Like there's a lot of volume that goes through. So not having a piece of automated equipment really impacts the operations. We wouldn't anticipate Q4 like on our concentrate SKUs, on our vape SKUs, on our edible SKUs to really have any headwinds, right? On our dried flower SKUs, these are not new pre-roll SKUs. These are kind of flower that's being grown at Sunens and then a couple of different sizes of existing SKUs, right? So our Wedding Pie and our Animal Mints, we have them in 28-gram formats in Ontario. This is just giving us the 3.5-gram size. So we would expect those operational challenges to be limited really to just the normal pressures you feel from increased volumes. So we really don't see a worsening of the operational challenges. In fact, we see improvement every day, right? It's like anything else. So we don't have a piece of automated equipment. So people step in to fill the void and then they get better at what they do, more efficient, you can start to pull out some of the other costs. So we don't see a worsening of the headwinds. We see kind of the headwinds reducing, but they're still being kind of a persistent breeze, if you will, as we wait for our automated equipment and get it commissioned.

[John Chu, Analyst]

Okay. And are you able to quantify the impact that these operational challenges had to your #1 to your sales and then secondly, to the margins? On the sales side, it sounded like you were sold out of some SKUs as a result and you weren't able to meet the demand. So can you quantify that? And then obviously, if you had the automation, what were your expectations on what margins could have been? Just trying to know that the jump from end margins from last quarter to this quarter was pretty large, I'm just trying to understand maybe to get a sense of what it could have been?

[Hugo M. Alves, CEO & Director]

Yes. Look, Brian can address the margin point. In terms of what orders you're left on the table, that is almost impossible to quantify because it has a knock-on effect, right? So there is the -- I got a purchase order. They want a lot of product, and I can't fill it all. So that part you can quantify, right? Like how much of the purchase order didn't you fill? But what you can't quantify is the fact that you're not getting the reorder, right? So the longer you wait to fill an order, the longer it takes for you to get your reorders. And like that part, you can't really quantify, like what would have been the reorder timeline, what would have been the reorder cadence, et cetera. So that's a bit harder. Look, I think the way we develop products, the way we launch products is we let scale lag sales, right? We could have spent $20 million to build out like a shiny spaceship, thinking that this format we're going to launch is going to have the type of demand that it's enjoyed. But if we got it wrong, then there'd be all the problems with spending big before sales are big, et cetera, and you'd have like all these impairment charges, right? Like I think that chapter in the cannabis industry is probably over. So we've let scale lag sales and we'll keep driving forward to get better and increase availability and fill. Brian, over to you on the margin point.

[Brian Schmitt, Chief Financial Officer]

Yes. John, on the margin, like, look, I think we've tried to articulate that our target margins were obviously predicated on the equipment being here. So I think our goal would still be to have a blended 30% margin in the short term. Obviously, if flower sales ultimately flipped to 75% of our portfolio, we will provide some further guidance in that respect. In the short term, there's going to be additional pressure as we've discussed until that automation is fully deployed.

[John Chu, Analyst]

Okay. So the last question with especially in Ontario with the store is opening up the foot traffic back in, I guess, it was June, there's always been the view that for the 2.0 products, especially the customer really needed to need a bud tender to really understand those products. Are you finding that reopening and that increased foot traffic and then being able to talk to about tender, is that really starting to push up the 2.0 sales? And is that something that you're seeing?

[Hugo M. Alves, CEO & Director]

Look, I think it depends on format and products, right? Like flower, people understand flower. I think where it does help is specifically 2.0 sales, especially you've seen like in our presentation, we had a marked increase in our oils in capsules formats, right? These are still formats where consumers have questions, how do you use it, how many drops, how many capsules do I take a day and being able to go in, talk to an educated bud tender and get some guidance is very helpful. So yes, we do see it being helpful in 2.0 formats.

[Operator]

[Operator Instructions] And your next question will be from Pablo Zuanic at Cantor Fitzgerald.

[Pablo Ernesto Zuanic, Research Analyst]

Hugo, maybe this question is a bit simplistic, but in the past, we saw other companies gain share in flower very quickly. I mean Aurora back in the day with a value format and then Canopy with DWD, right? So we saw companies gain share aggressively because we're selling 28g formats or pack sizes or very low prices. On the other hand, we see other companies like Village Farms gain on the strength of a single strain, good quality, good price. I mean help to maybe the [indiscernible] observer characterize your market share gain in flower and pre-rolls. I mean you don't share volumes, we can't really ascertain price points. But if I go through High Fire everything in detail, I can see what's driving it, but it would be good from your side, you can tell us what's driving -- are you gaining a specific price segments? Are you gaining specific pack sizes? And why is the consumer responding to your flower? I mean the question really just understand, is this a temporary jump or is it sustainable?

[Hugo M. Alves, CEO & Director]

Yes. Yes, that's a great question. So I would say when some of those companies captured all their market share, there was no competition, right? And they haven't been able to maintain it. So we're not value priced, we're every day premium priced, right? We focus -- look, why are we winning? We're here because we're here for the consumer, right? We want to give them a great product at a great value that never disappoints their expectations so that they can build loyalty and trust in our brand. We are the same price as the Pure Sunfarms product. What we have is we pick the right genetics driven by consumer insights, and we have the right mix of potency and pricing. And the result is the product it was made for consumers, with their needs in mind, at the quality that they demand and the value that they want, and it's resonating. So I go back to the efficiency of each SKU, Pablo. And you can go to High Fire and you can cut up the data, it's pretty easy to do. We have 7 SKUs, no one sells more on a per SKU basis than we do. And like I said, I think that's a testament to our insight, right, to being able to put out a product on the market that we've -- we're putting it out for a reason. And the reason is, well, that's what we're growing or that's what we could buy. We're putting it out. We specifically select the genetics to meet the profile that we want. We test it. We refine it and then we grow what's been proven. And I think that's the key to our success, is we can put out a product-driven by insights that we have a high degree of confidence is going to get traction. And then we work really, really hard to ensure consistency, fill and great customer service.

[Pablo Ernesto Zuanic, Research Analyst]

Right. And on that point, and again, some of these questions are maybe from the [indiscernible] observer and maybe too high level. But on the one hand, we hear some companies say, look, we've been farmers for 30 years, hence, we can produce well, good quality, good price. And then we see other companies that are new to again, 3 year seen still struggling, right? So again, to understand the endurance of this platform, maybe more color on the cultivation side, what is it that you guys are doing so great, if you can share some color there? Again, the question comes from the angle of trying to understand why others are failing over the last 3 years and why are you guys doing so well on the cultivation side?

[Hugo M. Alves, CEO & Director]

Well, look, I don't think it should be lost that our greenhouse was designed, built, operation have been started by someone who is every big sort of titan in the industry in the produce industry as Pure Sunfarms, right? So Nature Fresh Farms is as big or bigger than Village Farms. They're kind of ones on the East Coast, one's on the West Coast. So I would say from a cultivation know-how perspective and a facility that's been purpose-built to produce high-quality cannabis at like really consistent and low-cost per gram basis, we have one of the top facilities in the world.So yes, cultivation is very important as is your genetics. So we're confident that this product is not a flash in the pan. We've got an amazing facility. We've made huge investments in genetics and automation. We're only 1 year into Sunens operation, and like I said, the Wedding Pie flower is the #1 flower SKU in Ontario. Our Wedding Pie pre-rolls are the #1 pre-roll SKU in Ontario and our Wedding Pie 28 grams, the #1 SKU overall in Ontario. So it's going in the right direction.

[Operator]

Thank you. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.