DESTINY MEDIA TECHNOLOGIES INC 10-K

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business and financing needs, includes forward-looking statements that involve risks and uncertainties and should be read together with the "Risk Factors" section of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report and in other reports we file with the SEC, particularly those under "Risk Factors." Components of Results of Operations Service revenue The majority of the Company's 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 as the services are rendered to customers. Cost of revenue Cost of revenue primarily consists of personnel costs for our operations service and technical support employees and engineering support staff, cloud infrastructure costs, incremental transaction costs such as merchant and processing fees, and costs of external customer support software and services. In each case, personnel costs include salaries, benefits and any other compensation paid to such staff. Operating expenses Our technologies and products are developed and maintained in-house, the majority of our expenditures are contributed towards salaries, wages and benefits. Our operations are primarily conducted in Canada and therefore, 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 on its operating expenditures. General and administrative expenses consist of salaries and related personnel costs including overhead, office rent, professional fees, shareholder relations, and general office expenses. Sales and marketing expenses consist of salaries and related personnel costs including overhead, office rent, and telecommunications costs. Sales and marketing expenses also include advertising and marketing expenditures, which consist of promotional materials, online or print advertising, business development tools, and marketing or business development related travel costs, including attendance at conference or trade shows, and record label and client visits. Product development expenses consist primarily of salaries and related personnel costs including overhead and consulting fees with respect to product development and deployment. RESULTS OF OPERATIONS FOR THE YEARS ENDED AUGUST 31, 2022 AND 2021 Revenue Total revenue for the year ended August 31, 2022 decreased by approximately 3.6% to $4,023,910 compared to the revenue of $4,172,473 for the year ended August 31, 2021; however, adjusted for impacts of foreign currency translation Play MPE® revenue increased 1.1% year over year. The negative impact of the foreign currency translation can be attributed to the decline in the value of the Euro and the Australian dollar relative to the US dollar. Play MPE® revenue earned in North America and Africa during the year ended August 31, 2022, has grown by 3.4% and 208.6% year over year, respectively. Notwithstanding the negative impact of foreign currency translation, Play MPE® revenue earned in the European segment has also grown by 3.6% year over year. 19 The Company's revenues are denominated predominantly in US Dollars, Euros and Australian Dollars. % of Total Revenue Currency 2022 2021 US Dollar 45.6% 43.1% Euro 45.6% 46.4% Australian Dollar 4.3% 6.3% Other 4.5% 4.2% Gross Margin Gross margin for the year ended August 31, 2022 was 83.7% of revenue, which represents a decrease of 6.9% from the year ended August 31, 2021. 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, 2022, our gross margin decreased over the comparative year predominately due to increase in costs associated with the hosting services and increased staffing in technical and customer support departments in order to increase optimization of the service and reduce lag time in remote locations. Operating Expenses Operating costs during the year ended August 31, 2022 decreased by 4.9% to $3,233,860 (2021 - $3,400,050). The decrease in costs was primarily the result of the following three factors: An increase of $271,342 or 9.9% in wages and benefits due to additional staffing that was brought on board to support expanded development of the Play MPE® platform and additional operational staff to support expanded technical support and distribution list development. The additional staff is focused on items designed to accelerate revenue growth of Play MPE® and expand the addressable market. An increase of $96,842 or 187.2% in non-cash stock-based compensation recorded due to share-based awards granted during the year ended August 31, 2022. These increases were offset by $626,778 in capitalized wages and benefits paid to engineering and product development employees who worked on development of the new products and enhancements to the Play MPE® platform. The capitalization and inclusion of these investments in assets is done based on an assessment of their positive incremental value. Additionally, a decrease in value of the Canadian dollar relative to the US dollar added to the overall decrease in operating expenses. General and Administrative Expenses 2022 2021 $ Change % Change Wages and benefits $ 455,343 $ 246,172 209,171 85.0% Professional fees 145,578 214,971 (69,393 ) -32.3% Office and miscellaneous 102,124 80,714 21,410 26.5% Shareholder relations 77,416 64,321 13,095 20.4% Rent 59,631 22,309 37,322 167.3% Foreign exchange loss 58,299 26,069 32,230 123.6% Telecommunications 8,391 3,217 5,174 160.8% Bad debt 44,304 (4,468 ) 48,772 -1091.6% Other 29,295 13,180 16,115 122.3% Total general and administrative expenses $ 980,381 $ 666,485 313,896 47.1% The increase in salaries and wages can be explained by increased non-cash stock-based compensation due to additional share-based awards granted during the year ended August 31, 2022 and one-time staff recruitment fees. Increase in bad debt year over year was due to the Company using a more stringent policy to establish an allowance for overdue receivables. The decrease in professional fees was due to the timing of litigation proceedings in the comparative year ended August 31, 2021. 20 Sales and Marketing Expenses 2022 2021 $ Change % Change Wages and benefits $ 825,551 $ 1,218,626 (393,075 ) -32.3% Advertising and marketing 121,981 65,417 56,564 86.5% Rent 57,814 128,393 (70,579 ) -55.0% Telecommunications 5,853 20,796 (14,943 ) -71.9% Total sales and marketing expenses $ 1,011,199 $ 1,433,232 (422,033 ) -29.4% The decrease in wages and benefits is the result of restructuring costs in the prior year and adjustments in staff allocation. The increase in advertising and marketing expenses is related to increased sponsorship, advertising, and attendance at industry events in the fiscal year 2022 compared to the fiscal 2021, where COVID-19 restrictions severely impacted public activities and travel. Product Development Expenses 2022 2021 $ Change % Change Wages and benefits $ 846,737 $ 968,160 (121,423 ) -12.5% Software services 81,615 71,184 10,431 14.7% Rent 84,991 87,737 (2,746 ) -3.1% Telecommunications 83,592 67,895 15,697 23.1% Other 2,683 - 2,683 100.0% Product development expenses $ 1,099,618 $ 1,194,976 (95,358 ) -8.0% During the year ended August 31, 2022, the Company increased development staffing to accelerate new additions to the product roadmap designed to increase the addressable market and facilitate faster market acquisition. The decrease in wages and benefits reflects the capitalization of a portion of these costs. During the year ended August 31, 2022, $626,778 in wages and benefits paid to engineering and product development staff were capitalized to software under development intangible assets and $269,777 of the capitalized wages and benefits was subsequently reclassified to computer software fixed assets as the products were completed. Depreciation and Amortization Depreciation and amortization expense increased to $142,662 for the year ended August 31, 2022 from $105,357 for the year ended August 31, 2021, an increase of 35.4% was due to depreciation of additionally capitalized software development costs associated with Play MPE® recipient player applications during the year. Other Income Interest income earned on the Company's Guaranteed Investment Certificates was $9,153 for the year ended August 31, 2022 (2021 - $4,031). The interest income more than doubled year over year due to increased interest rates in Canada. Additionally, the Company terminated its lease agreement for the office space on January 31, 2022. Upon termination the Company disposed of leasehold fixtures and fittings and recorded a gain on lease termination of $11,018. Net Income For the year ended August 31, 2022, we reported a net income of $149,074 (2021 - $382,529). For the year ended August 31, 2022, adjusted EBITDA was $435,507 (2021 - $535,589). Adjusted EBITDA is not defined under U.S. 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 our 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 non-cash 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, this stock-based compensation expense does not result in cash payments by the Company. Adjusted EBITDA has limitations as a profitability measure in that it does not include provisions for income taxes, the effect of our expenditures on capital assets, the effect of non-cash stock-based compensation expense and the effect of asset impairments. The following is a reconciliation of net income from operations to Adjusted EBITDA: 21 2022 2021 Net income $ 149,074 $ 382,529 Current income tax 4,348 - Stock-based compensation 148,576 51,734 Depreciation, amortization and deferred leasehold inducements 142,662 105,357 Interest income (9,153 ) (4,031 ) Adjusted EBITDA $ 435,507 $ 535,589 LIQUIDITY, FINANCIAL CONDITION As of August 31, 2022, we held $2,095,928 (2021 - $2,752,662) in cash and cash equivalents. Our cash equivalents consisted of one-year Guaranteed Investment Certificates held through a major Canadian financial institution and had reached their maturity. On August 31, 2022, we had working capital of $2,268,778 compared to $2,561,480 as at August 31, 2021. The decrease in our working capital was primarily due to the decrease in cash and cash equivalents as a result of timing of customer receipts and trade payments. Cash Flows The following table sets forth a summary of the net cash flow activity for each of the years indicated: Net cash and cash equivalents provided by (used in) 2022 2021 $ Change % Change Operating activities $ 307,198 $ 528,922 (221,724 ) -41.9% Investing activities (692,846 ) 590,885 (1,283,731 ) -217.3% Financing activities (190,676 ) (260,405 ) 69,729 -26.8% Effect of foreign exchange rate changes on cash (80,410 ) 51,920 (132,330 ) -254.9% Net increase (decrease) in cash and cash equivalents $ (656,734 ) $ 911,322 (1,568,056 ) -172.1% Operating Activities Net cash provided by operating activities during the year ended August 31, 2022 was $307,198 (2021 - $528,922). The primary reason for the decrease in cash flows from operating activities was the timing of receipts from our customers. Investing Activities Net cash used in investing activities for the year ended August 31, 2022 was $692,846, compared to cash provided by investing activities of $590,885 for the year ended August 31, 2021. During the fiscal 2021, $805,017 was received on the maturity of our GICs. During the fiscal year 2022, the contributions made towards investing activities was cash spent on new capital assets and internally developed computer software. Financing Activities Net cash used in financing activities during the year ended August 31, 2022 was $190,676 (2021 - $260,405) - this cash was used to repurchase and retire 143,100 shares of common stock (2021 - 185,285 shares of common stock) of the Company under the Normal Course Issuer Bid ("NCIB") and to repurchase stock options. CAPITAL RESOURCES The Company does not have any material commitments for capital expenditures and the Company is able to meet current and expected growth with current capital investments. OFF-BALANCE SHEET ARRANGEMENTS As of August 31, 2022, the Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 22 CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGEMENTS AND ESTIMATES Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities in our financial statements and accompanying notes. We evaluate these estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are more fully described in Note 2 to our financial statements, we believe that the following accounting policies are the most critical for fully understanding and evaluating our financial condition and results of operations: 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. 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 two 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. We test for impairment whenever events or changes in circumstances that could impact recoverability occur. 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 rates is based primarily on our historical experience. The estimated forfeiture rates may differ from actual forfeiture rates which would affect the amount of expense recognized during the period. 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. 23 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 carryforwards 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 7 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. 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. Contingencies As discussed under "Item 3. Legal Proceedings" and in Note 8 - "Commitments and 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 can be reasonably estimated. 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. 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. New Accounting Pronouncements See Note 2 to the Financial Statements included in Item 8 of this Annual Report.