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. 14 RESULTS OF OPERATIONS FOR THE YEARS ENDED AUGUST 31, 2023 AND 2022 Revenue Total revenue for the year ended August 31, 2023 increased by 0.3% to $4,034,384 compared to the revenue of $4,023,910 for the year ended August 31, 2022. Adjusted for impacts of foreign currency translation, Play MPE® revenue increased 1.9% year over year. The negative impact of foreign currency translation is attributed to the decline in the value of the Euro and the Australian dollar relative to the US dollar. The Company experienced a 6.1% growth in revenue in the second half of the year recovering from a slow start to the year. This growth came as the result expanded distribution list options, increased investments in digital marketing that commenced at the beginning of our third quarter, in-platform list selection improvements that took effect in our fourth quarter and improvements in foreign exchange rates which eliminated the negative impact to revenue experienced in the first half of the year. The Company's revenues are denominated predominantly in US Dollars, Euros and Australian Dollars. % of Total Revenue Currency 2023 2022 US Dollar 46.9% 45.6% Euro 45.2% 45.6% Australian Dollar 3.9% 4.3% Other 4.0% 4.5% Gross Margin Gross margin for the year ended August 31, 2023 was 87.2% of revenue, which represents an increase of 3.5% from the year ended August 31, 2022. 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, 2023, our gross margin increased over the comparative year predominately due to a decrease in costs associated with the hosting services and a decrease of staffing in technical and customer support departments. Operating Expenses Operating costs during the year ended August 31, 2023 decreased by 0.5% to $3,218,092 (2022 - $3,233,860). The decrease in operating costs was primarily the result of the following: Favorable foreign exchange rates reduced the overall operating costs by approximately 3.7%. The majority of our operating costs are denominated in Canadian dollars. As the US dollar strengthened on average relative to the Canadian dollar, our operating costs as expressed in US dollars declined. While total salaries and wages remained relatively consistent with the prior year, we increased the amount capitalized to capital software assets and software under development intangible asset resulting in a decrease to total operating expenses of approximately 1.6%. With the growing capitalization of salaries and wages, amortization expense grew overall expenditures by 3.0%. One-time professional fees associated with resolving outstanding litigation grew overall expenditures by 1.6%. For ease of reference the following table has been prepared to present operating results had the Company not capitalized software for fiscal years 2023 and 2022. 2023 2022 Net Income for the Year $ 335,098 $ 149,047 Capitalized Software Development (682,617 ) (626,778 ) Adjustment to Amortization of Capitalized Software 166,235 65,937 Adjusted net income (loss) for the year $ (181,284 ) $ (411,794 ) 15 General and Administrative Expenses 2023 2022 $ Change % Change Wages and benefits $ 384,213 $ 455,343 (71,130 ) (15.6%) Professional fees 240,254 145,578 94,676 65.0% Office and miscellaneous 92,157 102,124 (9,967 ) (9.8%) Shareholder relations 75,670 77,416 (1,746 ) (2.3%) Rent 49,231 59,631 (10,400 ) (17.4%) Foreign exchange loss (118,228 ) 58,299 (176,527 ) (302.8%) Telecommunications 10,882 8,391 2,491 29.7% Bad debt 3,129 44,304 (41,175 ) (92.9%) Other 32,305 29,295 3,010 10.3% Total general and administrative expenses $ 769,613 $ 980,381 (210,768 ) (21.5%) The decrease in salaries and wages can be explained by a temporary decrease in full time equivalent staffing for August 31, 2023 and one-time staff recruitment fees. Professional fees were temporarily increased due to one-time litigation expenses, which were subsequently resolved through a favorable judgment in the Company's favour. The Company was awarded costs and has only partially recognized the collection of those costs. Sales and Marketing Expenses 2023 2022 $ Change % Change Wages and benefits $ 724,297 $ 825,551 (101,254 ) (12.3%) Advertising and marketing 97,129 121,981 (24,852 ) (20.4%) Rent 41,755 57,814 (16,059 ) (27.8%) Telecommunications 9,498 5,853 3,645 62.3% Total sales and marketing expenses $ 872,679 $ 1,011,199 (138,520 ) (13.7%) The decrease in wages and benefits is the result of a temporary decrease in full time equivalent staffing for August 31, 2023. The decrease in advertising and marketing expenses is related to timing of sponsorship, advertising, and attendance at industry events in the fiscal year 2023. Product Development Expenses Product development expenses 2023 2022 $ Change % Change Wages and benefits $ 1,045,492 $ 846,737 198,755 23.5% Software services 89,131 81,615 7,516 9.2% Rent 79,690 84,991 (5,301 ) (6.2%) Telecommunications 123,132 83,592 39,540 47.3% Other - 2,683 (2,683 ) 100.0% Product development expenses $ 1,337,445 $ 1,099,618 237,827 21.6% The rise in wages and benefits can be attributed to the recruitment of additional development staff, aimed at accelerating the implementation of new additions to the product roadmap. Additionally, for the year ended August 31, 2023, the Company increased the amount of capitalized product development wages, reflecting a continued significant investment in product development to expand its addressable market. The increase in telecommunications costs is directly associated with the expansion of product development activities. Depreciation and Amortization Depreciation and amortization expense increased to $238,355 for the year ended August 31, 2023 from $142,662 for the year ended August 31, 2022, an increase of 67.1% 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 $36,498 for the year ended August 31, 2023 (2022 - $9,153). The interest income more than doubled year over year due to increased interest rates in Canada. 16 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 for the year ended August 31, 2022. Net Income For the year ended August 31, 2023, we reported a net income of $335,098 (2022 - $149,074). For the year ended August 31, 2023, adjusted EBITDA was $687,463 (2022 - $435,507). 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: 2023 2022 Net income $ 335,098 $ 149,074 Current income tax 2,576 4,348 Stock-based compensation 147,932 148,576 Depreciation and amortization 238,355 142,662 Interest income (36,498 ) (9,153 ) Adjusted EBITDA $ 687,463 $ 435,507 LIQUIDITY, FINANCIAL CONDITION As of August 31, 2023, we held $2,002,769 (2022 - $2,095,928) in cash and cash equivalents. The Company's cash equivalents consist of investments in mutual funds with a major Canadian financial institution that earn interest at variable interest rates ranging from 4.55% - 4.90%. On August 31, 2023, we had working capital of $2,185,960 compared to $2,268,778 as at August 31, 2022. The decrease in our working capital was primarily due to operating results. 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) 2023 2022 $ Change % Change Operating activities $ 705,634 $ 307,198 398,436 129.7% Investing activities (716,024 ) (692,846 ) (23,178 ) 3.3% Financing activities (21,135 ) (190,676 ) 169,541 (88.9%) Effect of foreign exchange rate changes on cash (61,634 ) (80,410 ) 18,776 (23.4%) Net increase (decrease) in cash and cash equivalents $ (93,159 ) $ (656,734 ) 563,575 (85.8%) Operating Activities Net cash provided by operating activities during the year ended August 31, 2023 was $705,634 (2022 - $307,198). The cash used in operating activities for the year ended August 31, 2023 was due to approximately $2.3 million spent on salaries and wages, $0.2 million in professional expenses, $0.15 million on telephone communications and cloud infrastructure, and approximately $0.1 million spent on research and development. The net cash used in operating activities for the year ended August 31, 2022 was due to approximately $2.4 million spent on salaries and wages, $0.1 million in professional expenses, $0.1 million on office expenses, $0.1 million on telephone communications and cloud infrastructure, and approximately $0.08 million spent on research and development. In 2023, the notable rise in net cash provided by operating activities compared to 2022 can be attributed primarily to the increased revenue of the Company and its proactive efforts to optimize and rightsize expenses. 17 Investing Activities Net cash used in investing activities for the year ended August 31, 2023 was $716,024, compared to cash used by investing activities of $692,846 for the year ended August 31, 2022. The year-over-year increase was mainly driven by the higher proportion of software development salaries and wages being capitalized this year. Financing Activities Net cash used in financing activities during the year ended August 31, 2023 was $21,135 (2022 - $190,676) - this cash was used to repurchase and retire 25,651 shares of common stock (2022 - 143,100 shares of common stock) of the Company under the Normal Course Issuer Bid ("NCIB") and to repurchase stock options. The decrease in net cash used in financing activities was driven by the lower number of shares repurchased in the year. 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 income from operations. OFF-BALANCE SHEET ARRANGEMENTS As of August 31, 2023, 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. 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. 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. 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. 18 Stock-Based Compensation We recognize the costs of employee services received in stock-based payment transactions according to the fair value provisions of the current stock-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 stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions which determine the fair value of stock-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. 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. 19 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. Intangible assets that are not subject to amortization are tested for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. 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.