ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As used in this Quarterly Report on Form 10-Q, the terms "the Company," "us," "our," the "Company" and "Salona" mean Salona Global Medical Device Corporation (a corporation incorporated under the laws of the Province of British Columbia formerly known as Brattle Street Investment Corp.) and its subsidiaries (unless the context indicates a different meaning).
Cautionary Note Regarding Forward-Looking Statements
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and related notes. This quarterly report, including, without limitation, statements under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations," includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended ("Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act"). These forward-looking statements can be identified by the use of forward-looking terminology, including the words "believes," "estimates," "anticipates," "expects," "intends," "plans," "may," "will," "potential," "projects," "predicts," "continue," or "should," or, in each case, their negative or other variations or comparable terminology. There can be no assurance that actual results will not materially differ from expectations. Such statements include, but are not limited to, economic and competitive conditions, the successful integration of its acquisitions and realization of the expected benefits of such acquisitions, regulatory changes and other uncertainties, the general expansion of its business, and other statements which are not statements of current or historical facts.
The forward-looking statements contained in this quarterly report are based on the Company's current expectations and beliefs concerning future developments and their potential effects on the Company. Future developments affecting us may not be those that the Company have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond its control) and other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors described under the heading "Risk Factors" in this Report as well as in the Company's Transition Report on Form 10-KT for the transition period ended December 31, 2022, all of which are difficult to predict. Should one or more of these risks or uncertainties materialize or should any of these assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. The Company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. These risks and others described under "Risk Factors" may not be exhaustive.
By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. The Company cautions you that forward-looking statements are not guarantees of future performance and that its actual results of operations, financial condition and liquidity, and developments in the industry in which it operates may differ materially from those made in or suggested by the forward-looking statements contained in this Report. In addition, even if the Company's results or operations, financial condition and liquidity, and developments in the industry in which it operates are consistent with the forward-looking statements contained in this Report, those results or developments may not be indicative of results or developments in subsequent periods.
Currency
Financial information presented in this Report is presented in Canadian dollars, unless otherwise indicated. Unless otherwise indicated, all references to years are to the Company's fiscal year ended on the last calendar day of December.
OVERVIEW
On March 11, 2021, the Company completed a Change of Business, as defined by the TSX Venture Exchange, to become an acquisition-oriented business focused on human performance and rehabilitative solutions with plans to achieve scale through further acquisitions and organic growth. We presently intend to operate in the recovery science market, including postoperative pain, wound care and other markets serving the aging population in the United States.
On May 21, 2021, the Company acquired South Dakota Partners Inc. ("SDP"). SDP operates a large state-of-the-art production facility located in the State of South Dakota currently producing proprietary and white label medical devices for pain management, cold and hot therapy, NMES treatment, and PEMF and ultrasound therapy.
On September 30, 2021, the Company acquired Simbex, LLC ("Simbex"), a medical device and consumer health product design and development firm. Simbex offers both engineering services and commercialization strategy consulting for the Salona subsidiaries and other companies of all sizes.
On November 29, 2021, the Company acquired the customer lists, sales orders and supply agreements, and related sales channel and intellectual property assets of ALG-Health, LLC ("ALG"), a business engaged in the selling medical devices and supplies to small, independent hospitals, group purchasing organizations, medical offices and clinics, in exchange for non-voting securities of ALG Health Plus which are exchangeable for up to a maximum of 21,000,000 nonvoting Class A shares of the Company subject to the achievement of certain revenue and EBITDA targets. In connection with the transaction, our subsidiary ALG Health Plus entered into an exclusive supply agreement with ALG.
On March 11, 2022, the Company acquired Mio-Guard, LLC, a Michigan based company engaged in the wholesale sale of sports medicine products in the mid-western, southern and central United States. Since 2009, the team at Mio-Guard has sold into the athletic training, physical therapy and orthopedics markets for sports medicine products. Mio-Guard has over 50 sales representatives in the United States with a focus on the Midwest, South and Central United States and long-standing relationships with institutions ranging from high school to college to professional athletics.
On September 23, 2022, the Company acquired DaMar Plastics, Inc, a California based company that manufactures custom plastics. In addition to providing plastic injection molding parts to their customers, DaMar Plastics also offers several ancillary services, including but not limited to assembly, packaging and mold making. This business capability matches well with the electromedical, and assembly services offered by South Dakota Partners (SDP).
RECENT DEVELOPMENTS
On March 15, 2023, the Company entered into a stock purchase agreement providing for the acquisition of all of the capital stock of Biodex Medical Systems, Inc., which consists principally of the Biodex Physical Medicine business. The Purchase Agreement replaces the previously disclosed asset purchase agreement covering the same business that was first announced on August 15, 2022. The Company completed the Acquisition on April 3, 2023. The purchase agreement provides that the Company shall purchase all of the capital stock of Biodex in consideration for a total of US $8 million in cash, minus indebtedness, transaction expenses and plus or minus a working capital adjustment, payable as follows: (i) a closing payment to the Sellers of US $1,000,000 in cash, and (ii) three installment payments totaling US $7 million, plus or minus the post-closing adjustment, as follows: US $2 million on July 1, 2023, US $3 million on October 1, 2023, plus or minus the Post-Closing Adjustment, and US $2 million on January 1, 2024. The payment of the installment payments is guaranteed by the Company and is secured by the pledge of the Biodex capital stock as security to Seller, pursuant to the terms of a promissory note.
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On May 15, 2023, the Company entered into and completed the acquisition pursuant to a Stock Purchase Agreement with the owner of Arrowhead Medical, LLC ("Arrowhead") providing for the acquisition of all of the ownership interests of Arrowhead. The purchase price consideration consists of the issuance at closing of one million (1,000,000) shares of the Company's Class A common stock, which is convertible into the Company's Common Shares, subject to limitations on conversion which prevent conversion of Class A shares if the holder owns more than 500,000 shares of the Company's Common Shares, or if the holder owns more than 9,9% of the outstanding Common Shares of the Company. The purchase price also includes the assumption by the Company of approximately $250,000 in bank debt under Arrowhead's asset based line of credit, and a contingent earnout payment equal to one share of Class A common stock for each one dollar (US $1.00) of EBITDA generated by the Arrowhead business over the two-year period following the closing date, up to a maximum of 2 million Class A shares.
In April 2023, pursuant to the earnout provisions of the acquisition agreement, the Company issued the Simbex sellers a total of 6,383,954 shares of common stock in the Simbex acquisition parent subsidiary, exchangeable for shares of the Company’s Class A common stock. The shares of Class A common stock are convertible into the Company’s Common Shares, subject to certain limits on conversion based on the number or percentage of Common Shares owned by each holder. As of May 15, 2023, the $4.4 million cash portion of the earnout consideration has not been paid by the Company. Under the terms of the Simbex acquisition agreement, the unpaid cash earnout payment accrues interest at the rate of 8% per annum.
REVENUE AND EXPENSE COMPONENTS
The following is a description of the primary components of our revenue and expenses:
Revenue. We derive our revenue primarily from the sale of goods and services provided to the Company's contracted customers and sales-based royalties charged by the Company to licensees of the Intellectual Property (IP) developed by the Company. Currently, most of our business is conducted with customers within markets in which we have experience, and with payment terms that are customary to our business.
Cost of revenue. Cost of revenue consists primarily of direct labor expended in the manufacturing of products and the delivery of services, the cost of raw materials and finished goods, and other overhead costs attributable to the manufacture of products or delivery of services.
Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of salaries and related employee benefits, sales commissions, stock-based compensation, insurance expense, professional service fees, information technology expenses and other administrative expenses.
Depreciation of property and equipment. Depreciation of property and equipment consists primarily of manufacturing equipment and information technology assets expensed over their useful lives.
Amortization of right-of-use assets. The right-of-use asset is a lessee's right to use an asset and is amortized over the life of the lease.
Amortization of acquired intangible assets. Amortization of acquired intangible assets reflects the amortization of intangible assets such as trademarks, non-compete agreements, intellectual property and customer base.
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Interest expense. Interest expense consists primarily of the interest charged in connection with the line of credit facility, the term note, and the finance leases.
Foreign exchange gains and losses. Foreign exchange gains and losses result from the currency fluctuations as the Company's operations are primarily in the United States in US dollars, and its reporting currency used throughout this report is in Canadian dollars.
Change in fair value of earn-out and contingent consideration. The change in fair value of earn-out and contingent consideration represents the change in earned and potential future obligations that are contingent on an acquired entity's business achieving certain milestones.
Transaction-related expenses. Transaction-related expenses include legal, financial, audit, US and Canadian regulatory expenses and other fees incurred in connection with the Change of Business transaction, the multiple acquisitions, due diligence of acquisition targets, financing costs, US regulatory costs, and associated accounting and other costs. While these costs are necessary to the change of our line of business, they are not operational expenses of the business.
Income tax provision. The Company accounts for income taxes in accordance with ASC Topic 740, Income Taxes, which requires a company to use the asset and liability method of accounting for income taxes, whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences.
RESULTS OF OPERATIONS
Revenue
| | | Three Months Ended March 31, | | | Change | |
| | | 2023 | | | 2022 | | | $ | | | % | |
| Revenue | $ | 10,683,229 | | $ | 8,668,415 | | $ | 2,014,814 | | | 23% | |
Revenue increased by $2.0 million, or 23%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. Sales increased $2.8 million as a result of acquisitions made since the three months ended March 31, 2022, and was offset by a decrease in sales in the ALG sales channel of $0.5 million and a reduction in the contract services businesses of $0.8 million. A favorable impact related to changes in foreign exchange rates increased sales by $0.5 million.
Cost of revenue
| | | Three months ended March 31, | | | Change | |
| | | 2023 | | | 2022 | | | $ | | | % | |
| Cost of revenue: | | | | | | | | | | | | |
| Direct service personnel | $ | 1,825,755 | | $ | 1,430,939 | | $ | 394,816 | | | 28% | |
| Direct material costs | $ | 4,426,091 | | $ | 3,715,608 | | $ | 710,483 | | | 19% | |
| Other direct costs | $ | 335,524 | | $ | 295,008 | | $ | 40,516 | | | 14% | |
| Total cost of revenue | | 6,587,370 | | | 5,441,555 | | | 1,145,815 | | | 21% | |
Total cost of revenue increased by $1.1 million, or 21%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was primarily due to an increase in the sales volume driven by acquisitions made since the three months ended March 31, 2022.
Operating expenses
| | | Three months ended March 31, | | | Change | |
| | | 2023 | | | 2022 | | | $ | | | % | |
| Operating expenses: | | | | | | | | | | | | |
| Selling, general and administrative | $ | 3,875,214 | | $ | 2,573,552 | | $ | 1,301,662 | | | 51% | |
| Depreciation of property and equipment | | 184,264 | | | 69,123 | | | 115,141 | | | 167% | |
| Amortization of right-of-use assets | | 381,833 | | | 86,425 | | | 295,408 | | | 342% | |
| Amortization of intangible assets | | 350,546 | | | 214,981 | | | 135,565 | | | 63% | |
| Total operating expenses | $ | 4,791,857 | | $ | 2,944,081 | | $ | 1,847,776 | | | 63% | |
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Selling, general and administrative increased by $1.3 million, or 51%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. Expenses increased $0.7 million due to acquisitions made since the three months ended March 31, 2022, $0.5 million for an increase in infrastructure for the consolidated business operations, and $0.1 million for severance expense.
Depreciation of property and equipment increased by $0.1 million, or 167%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was primarily due to the addition of assets from acquired businesses.
Amortization of right-of-use assets increased by $0.3 million, or 342%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was primarily due to the addition of building leases resulting from acquired businesses.
Amortization of intangible assets increased by $0.1 million, or 63%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was primarily due to the addition of assets resulting from acquired businesses.
Interest and other income and (expense)
| | | Three months ended March 31, | | | Change | |
| | | 2023 | | | 2022 | | | $ | | | % | |
| Interest expense | | (278,086 | ) | | (120,454 | ) | | (157,632 | ) | | 131% | |
| Foreign exchange gain (loss) | | 1,528 | | | (4,173 | ) | | 5,701 | | | 137% | |
| Other income | | 133 | | | 45 | | | 88 | | | 196% | |
| Provision for impairment | | - | | | (5,520,522 | ) | | 5,520,522 | | | -100% | |
| Change in fair value of contingent consideration | | (195,300 | ) | | 5,853,701 | | | (6,049,001 | ) | | -103% | |
| Transaction costs | | (458,771 | ) | | (1,199,120 | ) | | 740,349 | | | -62% | |
Interest expense increased by $0.2 million, or 131%, for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The increase was primarily due to additional lease liabilities related to acquired businesses.
Foreign exchange gain reduced by $0.0 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022.
Other income increased by $0.0 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022.
Provision for impairment decreased by $5.5 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. There was no provision for impairment in the three months ended March 31, 2023.
Change in fair value of contingent consideration decreased by $6.0 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The decrease is due to changes in the likelihood of the acquisitions achieving certain earnout milestones and changes in the stock price for the stock component of the earnout payments.
Transaction costs decreased by $0.7 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The decrease is a result of a reduction in costs associated with acquisitions, potential acquisitions and US and Canadian regulatory activity.
Income Tax Provision
| | | Three months ended March 31, | | | Change | |
| | | 2023 | | | 2022 | | | $ | | | % | |
| Income tax (provision) recovery | $ | (36,250 | ) | $ | 114,110 | | $ | (150,360 | ) | | (132%) | |
The Income tax benefit decreased by $0.2 million for the three months ended March 31, 2023, compared to the three months ended March 31, 2022. The provision of $0.04M for the quarter ended March 31, 2023, represents the anticipated state income tax obligations for the Company for the 2023 tax year.
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Liquidity and Capital Resources
Our principal sources of liquidity are our existing cash and cash equivalents, our line of credit facility, and cash from operations. Our liquidity and capital structure are evaluated regularly within the context of our annual operating and strategic planning process. We consider the liquidity necessary to fund our operations, which includes working capital needs. Our future capital requirements will depend on many factors including our rate of revenue growth, property and equipment to expand manufacturing capacity, the timing and extent of spending to support development efforts, the expansion of sales and administrative activities, the timing of introductions of new products and enhancements to existing products, and the satisfaction of earn-outs and other contingent liabilities related to acquisitions.
If we are required to access the debt markets, we expect to be able to secure borrowing rates consistent with the market at that time. As part of our liquidity strategy, we will continue to monitor our current level of spending and cash use as well as our ability to secure additional credit facilities, term loans, or other similar arrangements in light of our spending levels and general financial market conditions.
Cash and cash equivalents including restricted cash were $3.7 million and $1.9 million as of March 31, 2023, and December 31, 2022, respectively. Restricted cash on March 31, 2023, consisted of $1.4 million (US $1 million) of cash held in escrow in connection with the anticipated acquisition of Biodex Medical Systems, Inc. (“Biodex”), as discussed in more detail in Notes 1 and 19. On April 3, 2023, the cash was released when the acquisition of Biodex closed.
Summary of Cash Flows
The following is a summary of our cash provided by (used in) operating, investing and financing activities, the effect of exchange rate changes on cash and cash equivalents, and the net change in cash and cash equivalents:
| | | Three Months ended
March 31, 2023 | | | March 31, 2022 | |
| Net cash used in operating activities | $ | (823,904 | ) | $ | (1,224,698 | ) |
| Net cash used in investing activities | | (93,232 | ) | | (592,237 | ) |
| Net cash provided by financing activities | | 2,577,566 | | | 4,551,984 | |
| Net increase in cash and cash equivalents and restricted cash | $ | 1,660,430 | | $ | 2,735,049 | |
Operating Activities
We used net cash of $0.8 million for operating activities for the three months ended March 31, 2023. This cash flow was primarily used to ensure continued operation of the Company and capital-raising expenses.
Investing Activities
We used net cash of $.1 million for investing activities for the three months ended March 31, 2023. This decrease in cash flow reflects the funds used to acquire manufacturing equipment.
Financing Activities
We generated net cash of $2.6 million from financing activities for the three months ended March 31, 2023. The increase in cash was from net debt proceeds of $2.9 million, offset by lease payments of $0.3 million.
We have never paid a cash dividend on our capital stock. Any future determination to pay cash dividends will be at the discretion of our Board of Directors (the "Board") and will depend upon our financial condition, operating results, capital requirements and such other factors as our Board deems relevant.
Debt and Commitments
Our contractual obligations as of March 31, 2023, include debt of $0.7 million, a line of credit facility of $8.1 million, and lease obligations of $7.0 million reflecting the minimum commitments for our office and warehouse spaces. See Notes 11 and 12 to our unaudited interim condensed consolidated financial statements included elsewhere in this report for more information on our debt and lease obligations, respectively, including the scheduled maturities and timing of cash payments related to these obligations.
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There are obligations as of March 31, 2023, for future earnout consideration associated with completed acquisitions. As of March 31, 2023, these obligations are estimated to be settled with $2.9 million in stock and $4.4 million in cash payments. The Simbex earnout was due to be paid with stock of the Simbex acquisition parent subsidiary and cash in the month of April 2023. In April 2023, the Company issued the sellers a total of 6,383,954 shares of common stock in the Simbex acquisition parent subsidiary, exchangeable for shares of the Company’s Class A common stock. The shares of Class A common stock are convertible into the Company’s Common Shares, subject to certain limits on conversion based on the number or percentage of Common Shares owned by each holder. As of May 15, 2023, the $4.4 million cash portion of the earnout consideration has not been paid by the Company. Under the terms of the Simbex acquisition agreement, the unpaid cash earnout payment accrues interest at the rate of 8% per annum. Although management has been in discussions with the Simbex sellers to modify and extend the payment date for the cash earnout payment, there can be no assurances that any agreement will be reached in this regard or that the Simbex sellers may not take legal action to collect this obligation, which could result in significant legal costs and efforts to defend such claims. See Note 4 to our unaudited interim condensed consolidated financial statements included elsewhere in this report for more information regarding acquisitions, and “Recent Developments” above.
On March 15, 2023, the Company entered into a stock purchase agreement providing for the acquisition of Biodex Medical Systems, Inc., which consists principally of the Biodex Physical Medicine business. The purchase agreement provided for the purchase of all of the capital stock of Biodex in consideration for a total of US $8 million in cash, minus indebtedness, transaction expenses and plus or minus a working capital adjustment, payable as follows: (i) the closing payment to the Sellers of US $1 million in cash was made on April 3, 2023, and (ii) three installment payments totaling US $7 million, plus or minus the post-closing adjustment, as follows: US $2 million on July 1, 2023, US $3 million on October 1, 2023, plus or minus the Post-Closing Adjustment, and US $2 million on January 1, 2024. The payment of the installment payments is guaranteed by the Company and is secured by the pledge of the Biodex capital stock as security to Seller, pursuant to the terms of a promissory note.
The Company has been in discussions to raise funds through equity and debt financings . As the Company's funding activities are ongoing, there can be no assurances that the Company will be able to secure funding on terms that are acceptable to the Company or at all. These conditions raise substantial doubt about the Company's ability to continue as a going concern within one year after the date the unaudited interim condensed consolidated financial statements are issued. While management has developed and is in process to implement plans that management believes could alleviate in the future the substantial doubt that was raised, management concluded at the date of the issuance of the unaudited interim condensed consolidated financial statements that substantial doubt exists as those plans are not completely within the control of management.
Off-Balance Sheet Arrangements
As of March 31, 2023, we did not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our unaudited interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these unaudited interim condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. On an on-going basis, we evaluate our estimates and assumptions, including those related to useful lives of non-current assets, impairment of non-current assets, including goodwill and intangible assets, valuation of stock-based compensation, allowance for doubtful accounts, provisions for inventory and valuation allowance for deferred tax assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumption conditions.
See Note 3 to our unaudited interim condensed consolidated financial statements included elsewhere in this report for additional details regarding the accounting policies we believe to be critical to the judgments and estimates used in the preparation of our unaudited interim condensed consolidated financial statements.
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Recent Accounting Pronouncements
See Note 3 to our unaudited interim condensed consolidated financial statements included elsewhere in this report for additional details regarding recent accounting pronouncements.