DESTINY MEDIA TECHNOLOGIES INC 10-K

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion of our results of operations and financial condition should be read together with the consolidated financial statements and related notes that are included in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors. RESULTS OF OPERATIONS FOR THE YEARS ENDED AUGUST 31, 2020 AND 2019 Revenue Total revenue for the year ended August 31, 2020 increased by 0.4% over the same period in the prior year to $3,824,565 (2019 - $3,809,092) or by 1.8% adjusted for negative impacts of foreign currency fluctuations. Representing virtually all of our 2020 revenue, Play MPE® revenue increased by 1.2% year over year to $3,795,317 (2019: $3,752,715) or 2.7% adjusted for unfavorable foreign currency fluctuations. The increase in Play MPE® revenue was seen from all geographic regions in which the we operate. The relative strength of the US dollar observed earlier in the fiscal year and in the prior year reversed as the US dollar declined in Q4. Play MPE® revenue grew by 7.1% in Q4 or 5.1% when adjusted for the favorable foreign currency fluctuations observed in Q4. The Company's revenues are denominated predominantly in US Dollars, Euros and Australian Dollars. Currency 2020 % of Total Revenue 2019 % of Total Revenue US Dollar 44% 44% Euro 48% 47% Australian 7% 8% Other 1% 1% 17 Revenue growth has been modest as the Company has undergone significant restructuring of its management team and business development group, refocused on its core Play MPE® business and has commenced seeding network use to expand territories. 2020 represents the Company's fourth year of revenue growth as it makes investments for larger revenue growth. Negative impacts on pricing and use with one of our Major Label customers were offset by large increases in independent record label revenue. Through the first three quarters of the year, independent record label grew by 7.8%. In Q4, that segment grew by 42.5% for a total increase for the year of 16.3% for the year. The majority of growth in this segment came from an increase in leads, lead conversion and average revenue per sale within existing territories where Play MPE® has well established use. Also contributing to this growth is independent record label revenue in new territories as the Company has established sufficient use to begin to attract paid use. These new territories include the UK, Jazz globally, South Africa, newer genres of music in the US, and Canada. Gross Margin Gross margin for the year ended August 31, 2020 was 92%, which is comparable to the year ended August 31, 2019. The Company's cost of revenue consists of data hosting and processing charges, third party transaction related costs, and engineering, technical and customer support costs. These costs are driven by the size and volume of customer transactions processed, as well as the relative proportion of 'full service' versus 'self-service' revenue. Our self-service sales are derived from customers who have been provided with a customer account to access our encoder to independently upload and publish releases. Our full-service revenue is derived from customers who are fully serviced by our internal staff, who prepare and publish releases on their behalf. During the year ended August 31, 2020, our gross margin remained consistent over the prior year, as we saw service revenue grow from both customer types. Operating Expenses Overview As our technologies and products are developed and maintained in-house, the majority of our expenditures are on salaries and wages and other associated expenses such as office space, office supplies and employee benefits. Our operations are primarily conducted in Canada and our costs are primarily incurred in Canadian dollars while our revenues are primarily denominated in Euros and US Dollars. Thus, operating expenses and the results of operations are impacted, to the extent they are not hedged, by the rise and fall of the relative values of the Canadian dollar to these currencies. The Company maintains a large portion of its financial reserves in Canadian dollars to mitigate the downside risk of adverse exchange rates. Overall operating costs increased by 15.2% to $3,360,953 (2019 - $2,917,935) during the year ended August 31, 2020, largely driven by an increase in staffing costs, and an increase in marketing, business development and promotional expenses. Overall staffing costs increased by 17.1% as a result of the addition of sales and marketing staff and product development staff. Advertising and marketing expenses decreased by 20.7% as a result of decreased public relations efforts as a result of the covid-19 pandemic, as more fully described below. Included in overall operating expenditures is approximately $272,000 in costs associated with one-time restructuring. The Company made significant efforts to improve its business development and software engineering teams. Also included in overall operating costs are expenses invested in improvements in the Play MPE® platform and business relationships designed to result in longer term sustained revenue growth. Neither of these costs have an immediate impact on revenue but are designed to have a long lasting and sustained improvement in revenue as the Company expands, adds territories and expands its addressable market. 18 General and administrative 31-Aug 31-Aug 2020 2019 (12 months) (12 months) Change Change $ $ $ % Bad debt 12,744 4,719 8,025 170.1% Office and miscellaneous 161,292 161,610 (318 ) (0.2%) Professional fees 243,996 164,562 79,434 48.3% Rent 25,655 29,339 (3,684 ) (12.6%) Telecommunications 3,516 2,651 865 32.6% Travel 6,615 5,702 913 16.0% Wages and benefits 344,302 402,175 (57,873 ) (14.4%) 798,120 770,758 27,362 3.6% Our general and administrative expenses consist of salaries and related personnel costs including overhead, office rent, and general office supplies. General and administrative costs also include professional fees and general and administrative travel expenditures. The increase in office and miscellaneous expense relates to transitionary expenses associated with changes in office services and an increase in realized foreign exchange losses as a result of fluctuating foreign currency exchange rates. Sales and marketing 31-Aug 31-Aug 2020 2019 (12 months) (12 months) Change Change $ $ $ % Advertising and marketing 112,877 142,412 (29,535 ) (20.7%) Rent 111,033 97,264 13,769 14.2% Telecommunications 16,953 9,887 7,066 71.5% Wages and benefits 843,501 659,388 184,113 27.9% 1,084,364 908,951 175,413 19.3% Sales and marketing expenses consist of salaries and related personnel costs including overhead, office rent, and telecommunications costs. Sales and marketing also includes advertising and marketing expenses, which consists of promotional materials, online or print advertising, business development tools, and marketing or business development related travel costs including attendance at conferences and trade shows, and label visits. The increase in advertising and marketing expenses relates to additional expenses incurred in respect of public relations initiatives, and increased marketing and business development related travel. The increase in wages and benefits is associated with an increase in staffing in this department. We hired a marketing manager, and additional inside and outside business development associates and consultants. Product Development 31-Aug 31-Aug 2020 2019 (12 months) (12 months) Change Change $ $ $ % Rent 118,898 118,389 509 0.4% Software services 75,389 70,581 4,808 6.8% Telecommunications 72,036 80,860 (8,824 ) (10.9%) Wages and benefits 1,076,761 871,550 205,211 23.5% 1,343,084 1,141,380 201,704 17.7% Product Development costs consist of product and software development related salaries and personnel costs including overhead, office rent and telecommunications. Product development also includes consulting fees with respect to product development and deployment. The increase in wages and benefits is attributable to overall increased staffing with respect to product development and software development. The decrease in telecommunications and software services is associated with the characterization of certain costs to operations and savings resulting from changes in services and providers. 19 Depreciation and amortization Depreciation and amortization arise from property and equipment and from patents and trademarks. Depreciation and amortization increased to $135,385 for the year ended August 31, 2020 from $96,846 for the year ended August 31, 2019, an increase of $38,539 or 39.8% from a combination of an overall increase in the capital asset balances subject to amortization. Other earnings and expenses Interest income decreased to $24,415 for the year ended August 31, 2020 from $27,188 for the year ended August 31, 2019, a decrease of $2,773. The decrease is related to the maturity of certain one-year guaranteed investment certificates during the year. Net income During the year ended August 31, 2020 we reported net income of $169,415 (2019 - $610,778). The decrease in net income is attributable to a combination of (1) negative foreign exchange fluctuations on our reported revenues and (2) an increase in certain operating expenses such as salaries and wages and marketing, as more fully described above. Adjusted EBITDA is not defined under generally accepted accounting principles ("GAAP") and it may not be comparable to similarly titled measures reported by other companies. We used Adjusted EBITDA, along with other GAAP measures, as a measure of profitability because Adjusted EBITDA helps us to compare our performance on a consistent basis by removing from our operating results the impact of our capital structure, the effect of operating in different tax jurisdictions, the impact of our asset base, which can differ depending on the book value of assets, the accounting methods used to compute depreciation and amortization, the existence or timing of asset impairments and the effect of non-cash stock-based compensation expense. We believe Adjusted EBITDA is useful to investors as it is a widely used measure of performance and, the adjustments we make to Adjusted EBITDA, provide further clarity on our profitability. We remove the effect of noncash stock-based compensation from our earnings, which can vary based on share price, share price volatility and expected life of the equity instruments we grant. In addition, these stock-based compensation expenses do not result in cash payments by the Company. Adjusted EBITDA has limitations as a profitability measure in that it does not include interest expense on our debt, our provisions for income taxes and amortization, the effect of deferred leasehold inducement, the effect of noncash stock-based compensation expense and the effect of asset impairment. The following is a reconciliation of net income from operations to Adjusted EBITDA: 2020 2019 2018 Net income (loss) $ 169,415 $ 610,778 $ 656,270 Interest income (net) (24,415 ) (27,188 ) (10,597 ) Depreciation and amortization 135,385 96,846 105,869 Stock based compensation 48,615 41,675 54,452 Deferred leasehold inducement - (4,150 ) 5,606 Adjusted EBITDA $ 329,000 $ 717,961 $ 811,600 LIQUIDITY AND FINANCIAL CONDITION Our cash and cash equivalents and short-term investments balance decreased by $269,364 during the year ended August 31, 2020 to $2,622,830 (2019 - $2,892,194). At August 31, 2020, we held $1,841,340 (August 31, 2019 - $2,512,138) in cash and cash equivalents and $781,490 (2019 - $380,056) in short term investments consisting of one-year Guaranteed Investment Certificates held through a major Canadian financial institution. At August 31, 2020, we had working capital of $2,423,774 compared to $2,809,689 as at August 31, 2019. The decrease in our working capital was primarily due the adoption of ASU 842 - Leases on September 1, 2019. At August 31, 2020, $2,205,924 in cash and short-term investments were held outside of the United States. At this time, we have no intention to repatriate this cash. However should we decide to repatriate in the future, taxes may need to be accrued and paid. 20 Cash Flows Net cash provided in operating activities was $272,213 for the year ended August 31, 2020, compared to $804,534 for the year ended August 31, 2019. The decrease is mainly attributable to the timing of receipts from our customers. The cash used by investing activities was $433,859 for the year ended August 31, 2020, compared to cash utilized in investing activities of $591,621 for the year ended August 31, 2019. The increase in cash provided by investing activities is a result of the purchase of short-term investments, consisting of one-year Guaranteed Investment Certificates, at August 31, 2020, offset by an investment in new capital assets and internally developed software. Cash used in financing activities was $533,223 for the year ended August 31, 2020, consisting of the repurchase of common stock of the company for retirement under the normal course issuer bid announced in September 2019. Cash used in or provided by financing activities during each of the fiscal year ended August 31, 2019, was $2,005. CAPITAL RESOURCES The Company does not have any material commitments for capital expenditures and the Company is able to meet current and expected growth and increase in growth in revenue with current capital investments. MATERIAL OFF-BALANCE SHEET ARRANGEMENTS None. CRITICAL ACCOUNTING ESTIMATES We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and make estimates and assumptions that affect our reported amounts of assets, liabilities, revenue and expenses, and the related disclosures of contingent liabilities. We base our estimates on historical experience and other assumptions that we believe are reasonable in the circumstances. Actual results may differ from these estimates. The following critical accounting policies affect our more significant estimates and assumptions used in preparing our consolidated financial statements. Revenue Recognition The Company's revenue is derived from software as a service (SaaS) arrangements. The Company accounts for revenue in accordance with ASC 606, which the Company adopted on September 1, 2018 using the modified retrospective method. The core principle of ASC 606 is to recognize revenue upon the transfer of products or services to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those products or services. ASC 606 prescribes a five-step model for recognizing revenue from contracts with customers: (1) identify the contract(s) with customers; (2) identify the separate performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the separate performance obligations in the contract; and (5) recognize revenue when (or as) the performance obligations are satisfied. The majority of our revenue is generated from digital media distribution service. The service is billed either based on usage or on a fixed fee which is based on the volume and size of distributions provided. All revenues are recognized on a monthly basis as the services are delivered to customers. Significant management judgments and estimates must be made in connection with determination of the revenue to be recognized in any accounting period. If we made different judgments or utilized different estimates for any period material differences in the amount and timing of revenue recognized could result. Stock-Based Compensation We recognize the costs of employee services received in share-based payment transactions according to the fair value provisions of the current share-based payment guidance. The fair value of employee services received in stock-based payment transactions is estimated at the grant date and recognized over the requisite service period. Determining the appropriate fair value model and calculating the fair value of stock-based awards requires judgment, including estimating stock price volatility, forfeiture rates and expected life. 21 We selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value of our share-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of share-based awards, including the option's expected term and the price volatility of the underlying stock. Our current estimate of volatility is based on historical and market-based implied volatilities of our stock price. To the extent volatility of our stock price increases in the future, our estimates of the fair value of options granted in the future could increase, thereby increasing stock-based compensation cost recognized in future periods. We derive the expected term assumption primarily based on our historical settlement experience, while giving consideration to options that have not yet completed a full life cycle. Stock-based compensation cost is recognized only for awards ultimately expected to vest. Our estimate of the forfeiture rate is based primarily on our historical experience. To the extent we revise this estimate in the future, our share-based compensation cost could be materially impacted in the quarter of revision, as well as in the following quarters. In the future, as empirical evidence regarding these input estimates is available to provide more directionally predictive results, we may change or refine our approach of deriving these input estimates. Research and Development Expense for Software Products Research and development expense includes costs incurred to develop intellectual property. The costs for the development of new software and substantial enhancements to existing software within the scope of ASC 985-20 Software - Costs of Software to be Sold, Leased or Marketed are expensed as incurred until technological feasibility has been established, at which time any additional costs would be capitalized. We have determined that technological feasibility is established at the time a working model of software is completed. Because we believe our current process for developing software will be essentially completed concurrently with the establishment of technological feasibility, no costs have been capitalized to date. Significant management judgments and estimates must be made in connection with determination of any amounts identified for capitalization as software development costs in any accounting period. If we made different judgments or utilized different estimates for any period material differences in the amount and timing of capitalized development costs could occur. Accounts Receivable and Allowance for Doubtful Accounts We extend credit to our customers based on evaluation of an individual customer's financial condition and collateral is generally not required. Accounts outstanding beyond the contractual payment terms are considered past due. We determine our allowance for doubtful accounts by considering a number of factors, including the length of time accounts receivable are beyond the contractual payment terms, our previous loss history, and a customer's current ability to pay its obligation to us. We write-off accounts receivable when they are identified as uncollectible. All outstanding accounts receivable accounts are periodically reviewed for collectability on an individual basis. Income Taxes Deferred income tax assets and liabilities are computed based on differences between the carrying amount of assets and liabilities on the balance sheet and their corresponding tax values using the enacted income tax rates by tax jurisdiction at each balance sheet date. Deferred income tax assets also result from unused loss carryforwards and other deductions. The valuation of deferred income tax assets is reviewed annually and adjusted, if necessary, by use of a valuation allowance to reflect the estimated realizable amount. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We evaluate all available evidence, such as recent and expected future operating results by tax jurisdiction, and current and enacted tax legislation and other temporary differences between book and tax accounting to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized. There is a risk that management estimates for operating results could vary significantly from actual results, which could materially affect the valuation of the future income tax asset. Although the Company has tax loss carry-forwards and other deferred income tax assets, management has determined certain of these deferred tax assets do not meet the more likely than not criteria, and accordingly, these deferred income tax asset amounts have been completely offset by a valuation allowance as disclosed in Note 6 of our consolidated financial statements. If management's estimates of the cash flows or operating results do not materialize due to errors in estimates or unforeseen changes to the economic conditions affecting the Company, it could result in an impairment adjustment in future periods. Contingencies As discussed under "Item 3. Legal Proceedings" and in Note 9 "Contingencies" in Notes to Consolidated Financial Statements, the Company is subject to various legal proceedings and claims that arise in the ordinary course of business. In accordance with US GAAP, the Company records a liability when it is probable that a loss has been incurred and the amount is reasonably estimable. There is significant judgment required in both the probability determination and as to whether an exposure can be reasonably estimated. In management's opinion, the Company does not have a potential liability related to any current legal proceedings and claims that would individually or in the aggregate materially adversely affect its financial condition or operating results. However, the outcomes of legal proceedings and claims brought against the Company are subject to significant uncertainty. Should the Company fail to prevail in any of these legal matters or should several of these legal matters be resolved against the Company in the same reporting period, the operating results of a particular reporting period could be materially adversely affected. 22 Impairment of Long-Lived Assets We evaluate the recoverability of our long-lived assets including tangible assets in accordance with authoritative guidance. When events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable, we recognize such impairment in the event the carrying amount of such assets exceeds the future undiscounted cash flows attributable to such assets. We have not recorded any impairment losses to date. RECENT ACCOUNTING PRONOUNCEMENTS For a discussion of recent accounting pronouncements and their possible effect on our financial statements, please see Note 2 to our Consolidated Financial Statements found elsewhere in this Annual Report.