Item 7. Management’s Discussion and Analysis
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, 2021 AND 2020
Revenue
Total revenue for the year ended August 31, 2021 increased by 9.1% over the same period in the prior year to $4,172,473 (2020 - $3,824,565) or by 5.4% adjusted for impacts of foreign currency fluctuations. Representing virtually all of our 2021 revenue, Play MPE® revenue increased by 9.3% year over year to $4,152,881 (2020: $3,798,317) or 5.6% adjusted for foreign currency fluctuations. The increase in Play MPE® revenue was seen from all geographic regions in which the we operate, other than Australasia.
The Company's revenues are denominated predominantly in US Dollars, Euros and Australian Dollars.
Currency
2021 % of
Total Revenue
2020 % of
Total Revenue
US Dollar
43%
44%
Euro
46%
48%
Australian
7%
7%
Other
4%
1%
Fiscal 2021 revenue growth has been a result of significant restructuring of the company's management team and business development group in 2020, refocusing on its core Play MPE® business and the commencement of seeding network use to expand territories.
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Independent record label revenue grew by 23.1% 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, 2021 was 91% of revenue, which is comparable to the year ended August 31, 2020. 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, 2021, 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 remained flat at $3,400,050 during the year ended August 31, 2021 (2020 - $3,360,953). Cost reductions in rent, marketing and various administrative costs were offset by an increase in costs generally as the Canadian rose relative to the US dollar. The Company also increased spending on business development, marketing and product development staff but this increased cost was offset by software product development costs were capitalized as the Company began significant investments into a new product designed to expand the Company's addressable market. Advertising and marketing expenses decreased by 42% 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 $155,000 in one-time restructuring costs. The Company made significant efforts to improve its business development team and add to its product design and development team. Improvements made to the business development team may have shorter term benefits to revenue but are designed to have significant improvements over the longer term as we expand to new markets.
General and administrative
31-Aug
31-Aug
2021
2020
(12 months)
(12 months)
Change
Change
$
$
$
%
Bad debt
(4,468
)
12,744
(17,212
)
-135.1%
Office and miscellaneous
152,963
151,070
1,893
1.3%
Foreign exchange
26,070
10,222
15,848
155.0%
Professional fees
214,971
243,996
(29,025
)
-11.9%
Rent
22,309
25,655
(3,346
)
-13.0%
Telecommunications
3,217
3,516
(299
)
-8.5%
Travel
5,252
6,615
(1,363
)
-20.6%
Wages and benefits
246,171
344,302
(98,131
)
-28.5%
666,485
798,120
(131,635
)
-16.5%
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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 decrease in wages and benefits relates to restructuring charges incurred in the year ended August 31, 2020.
Sales and marketing
31-Aug
31-Aug
2021
2020
(12 months)
(12 months)
Change
Change
$
$
$
%
Advertising and marketing
65,417
112,877
(47,460
)
-42.0%
Rent
128,393
111,033
17,360
15.6%
Telecommunications
20,796
16,953
3,843
22.7%
Wages and benefits
1,218,626
843,501
375,125
44.5%
1,433,232
1,084,364
348,868
32.2%
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 decrease in advertising and marketing expenses relates to reduced expenses incurred in respect of public relations initiatives, and reduced marketing and business development related travel due to the impacts of COVID-19. The increase in wages and benefits is associated with an increase in staffing in this department. We hired additional account executives and product development associates and consultants.
Product Development
31-Aug
31-Aug
2021
2020
(12 months)
(12 months)
Change
Change
$
$
$
%
Rent
87,737
118,898
(31,161
)
-26.2%
Software services
71,184
75,390
(4,206
)
-5.6%
Telecommunications
67,895
72,036
(4,141
)
-5.7%
Wages and benefits
968,160
1,076,760
(108,600
)
-10.1%
1,194,976
1,343,084
(148,108
)
-11.0%
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 decrease in wages and benefits is related to an increase in staffing in product development, offset by $167,069 capitalized as software under development in fiscal 2021, resulting in an overall increase in expenditure for the year ended August 31, 2021.
Depreciation and amortization
Depreciation and amortization arise from property and equipment and from patents and trademarks. Depreciation and amortization decreased to $105,357 for the year ended August 31, 2021 from $135,385 for the year ended August 31, 2020, a decrease of $30,028 or 22.2%.
Other earnings and expenses
Interest income decreased to $4,031 for the year ended August 31, 2021 from $24,415 for the year ended August 31, 2020, a decrease of $20,384. The decrease is related to the maturity of our one-year guaranteed investment certificates during the year.
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Net income
During the year ended August 31, 2021 we reported net income of $382,529 (2020 - $169,415). The increase in net income is attributable to a combination of (1) increased 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:
2021
2020
Net income (loss)
$
382,529
$
169,415
Interest income (net)
(4,031
)
(24,415
)
Depreciation and amortization
105,357
135,385
Stock based compensation
51,734
48,615
Deferred leasehold inducement
-
-
Adjusted EBITDA
$
535,589
$
329,000
LIQUIDITY AND FINANCIAL CONDITION
Our cash and cash equivalents and short-term investments balance increased by $129,832 during the year ended August 31, 2021 to $2,752,662 (2020 - $2,622,830). At August 31, 2021, we held $2,752,662 (August 31, 2020 - $1,841,340) in cash and cash equivalents and $nil (2020 - $781,490) in short term investments consisting of one-year Guaranteed Investment Certificates held through a major Canadian financial institution.
At August 31, 2021, we had working capital of $2,561,480 compared to $2,423,774 as at August 31, 2020. The increase in our working capital was primarily due our increased cash and cash equivalents at August 31, 2021.
At August 31, 2021, $2,367,337 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.
Cash Flows
Net cash provided in operating activities was $528,922 for the year ended August 31, 2021, compared to $272,213 for the year ended August 31, 2020. The increase is mainly attributable to the timing of receipts from our customers.
The cash provided by investing activities was $590,885 for the year ended August 31, 2021, compared to cash used in investing activities of $433,859 for the year ended August 31, 2020. The increase in cash provided by investing activities is a result of the maturity of short-term investments, consisting of one-year Guaranteed Investment Certificates, prior to August 31, 2021, offset by an investment in new capital assets and internally developed software.
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Cash used in financing activities was $260,405 for the year ended August 31, 2021, consisting of the repurchase of common stock of the company for retirement under the normal course issuer bid announced in January 2021. Cash used in financing activities during each of the fiscal year ended August 31, 2020, was $533,223.
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.
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.
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Research and Development Expense for Software Products
Our software solutions are offered to our customers through software as a service delivery models. Development costs associated with the certain solutions offered exclusively through a software as a service model are accounted for in accordance with ASC 350-40. Internal-Use Software. All other client solution development costs, which represent a significant majority of development costs, are accounted for in accordance with ASC 985-20. Costs of Software to be Sold, Leased or Marketed.
Under ASC 985-20, software development costs incurred in creating computer software solutions are expensed until technological feasibility has been established upon completion of a detailed program design. Thereafter, all software development costs incurred through the -software's general release date are capitalized and subsequently recorded at the lower of amortized cost or net realizable value. Capitalized costs are amortized based on current and expected future revenue for each software solution with minimum annual amortization equal to the straight-line amortization over the estimated economic life of the solution. We amortize capitalized costs over five years.
Under ASC 350-40, software development costs related to preliminary project activities and post-implementation and maintenance activities are expensed as incurred. We capitalize direct costs related to application development activities that are probable to result in additional functionality. Capitalized costs are amortized on a straight-line basis over five years. We test for impairment whenever events or changes in circumstances that could impact recoverability 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.
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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.