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DSNY > SEC Filings for DSNY > Form 10-K on 29-Nov-2012All Recent SEC Filings

Show all filings for DESTINY MEDIA TECHNOLOGIES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for DESTINY MEDIA TECHNOLOGIES INC


29-Nov-2012

Annual Report


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 later 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 YEAR ENDED AUGUST 31, 2012

Revenue

Total revenue for the declined slightly from fiscal 2011 to $3,983,789 (2011 - $4,007,230), a decrease of less than 1%. Fourth quarter revenue increased to $941,426 (fourth quarter fiscal 2011 - $933,047).

Revenue from the Play MPEŽ system currently represents 96% of our total revenues. Play MPEŽ access fee revenue was $3,819,576 (2011 - $3,831,025) for the year ended August 31, 2012. This decrease was largely attributable to the application of a one-time minimum annual fee applied during the comparative period to one customer, offset by a 20% growth in revenue from independent labels in the United States and a growth in revenues from Europe. European revenue is currently concentrated in the United Kingdom and the Scandinavian countries.

Approximately 42% of our Play MPEŽ revenue is denominated in Euros for the year ended August 31, 2012. Play MPEŽ revenue from Europe for the year ended August 31, 2012 reached $1,617,015 (2011 - $1,415,797) representing an increase of 14%. Approximately 54% of Play MPEŽ revenue is denominated in US Dollars and 4% of Play MPEŽ revenue is denominated in Australia Dollars for the year ended August 31, 2012.


Play MPEŽ is the world leader in an evolving business which is transforming the way record labels distribute pre-release music. We have seen the transition from traditional distribution methods to Play MPEŽ begin gradually and the growth seen in prior years has continued into 2012 through existing clients, and through new clients in new geographic areas and includes; a 20% increase in North American independent record label revenue and 14% growth in European revenue, of which 3% is attributable to independent record labels and the remainder is attributable to growth from our major record label clients in Europe.

While the digital distribution of pre-release music is still at an early stage, the value propositions of the Play MPEŽ system are both compelling and numerous and we have found we compete well against traditional and alternative methods of distribution in the market. Our product provides significant advantages such as reducing the costs and lead times, providing feedback on usage to the record labels, and enhanced global security, with the added appeal of reducing the impact on the environment. Play MPEŽ provides many significant advantages over competing solutions such superior sound quality, superior security, advantageous partner relationships, a network of regular users and countless added functions of the player software and total service offering.

The majority of our revenue is generated from digital media distribution service. The service is billed on usage which is based on the volume and size of distributions provided on a monthly basis ("sends") A "send" is a song, bundle of songs, album, box set, or video, authorized to be sent to a particular recipient. The revenue associated with each "send" will be on a sliding scale depending on the size of the particular send (song length for example). The system provides each label under contract to manage their own lists of recipients and directly encode and distribute their songs. This added ability provided to our clients substantially eliminates the strain on our own internal resources that can be seen in competing solutions and allows for high growth potential. All such revenues are recognized on a monthly basis as the services are delivered to customers, except where extended payment terms exist. Such revenues are only recognized when the extended payment term expires.

For customers where it is not appropriate to enter into a formal contract we provide access to the Play MPEŽ system through www.myplaympe.com or through our staff quoting system.

Real time usage statistics for Play MPEŽ are available at:
http://www.plaympe.com/v4/company/plaympestats.php

Approximately 4% of our revenues are derived from sales of our ClipstreamŽ software which declined from the previous year by 6%. This reflects a management strategy of focusing sales, marketing and support resources on MPEŽ until the new automated system for ClipstreamŽ is available.

Radio Destiny sales represents less than 0.1% of our total revenue.

Operating Expenses

Overview

As our technologies and products are developed and maintained in-house, the majority of our expenditures is on salaries and wages and associated expenses; office space, supplies and benefits. Our operations are primarily conducted in Canada. The majority of our costs are incurred in Canadian dollars while the majority of our revenue is 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 Canadian dollar to these currencies. During the year, the rise in the value of the Canadian dollar relative to the US dollar had an adverse impact on the Company.

Our total operating expenses for the year increased by 2% to $3,264,111 from $3,209,630. The majority of this increase was due to higher salaries and wages, which is due in part to additional staff for research and development, technical support, and salary adjustments.

   General and administrative        31-Aug          31-Aug          $            %
                                      2012            2011         Change      Change
                                   (12 months)     (12 months)
        Wages and benefits       $     382,467   $     365,960      16,507        4.5%
        Rent                            36,414          40,601      (4,187 )    (10.3% )
        Telecommunications              18,136          18,757        (621 )     (3.3% )
        Bad debt                          (986 )         8,381      (9,367 )   (111.8% )
        Office and miscellaneous       368,212         221,578     146,634       66.2%


Professional fees (216,512 ) 108,595 (325,107 ) (299.4% ) $ 587,731 $ 763,872 (176,141 ) (23.1% )

Our general and administrative expenses consist primarily of salaries and related personnel costs including overhead, professional fees, and other general office expenditures.

The increase in office and miscellaneous costs is related to increased expenditures on investor relations activities.

The decrease in Professional fees is described in the following table.

                                    31-Aug          31-Aug           $            %
                                     2012            2011          Change      Change
                                  (12 months)     (12 months)
   Professional fees
        Litigation costs        $     574,329   $     528,086       46,243        8.8%
        Other professional fees        87,167         187,049      (99,882 )    (53.4% )
        Recoveries                   (878,008 )      (606,540 )   (271,468 )     44.8%
        Sub-total               $    (216,512 ) $     108,595     (325,107 )   (299.4% )

Our litigation costs primarily consisted of fees associated with an Australian claim against a former marketing representative and a wrongful dismissal claim from a former employee. Both of these legal claims were successfully resolved during the year and we expect our legal costs will dramatically decrease moving forward. Prior year costs were associated with litigation against a competitor in Canada which was also successfully resolved in fiscal 2011.

  Sales and marketing                31-Aug          31-Aug           $           %
                                      2012            2011          Change      Change
                                   (12 months)     (12 months)
       Wages and benefits        $     417,907   $     404,971       12,936       3.2%
       Rent                             38,690          43,139       (4,449 )   (10.3% )
       Telecommunications               19,269          19,929         (660 )    (3.3% )
       Meals and entertainment          12,914          11,619        1,295      11.1%
       Travel                           72,957          59,035       13,922      23.6%
       Advertising and marketing       135,987         285,036     (149,049 )    (52.3 )%
                                 $     697,724   $     823,729     (126,005 )    (15.3 )%

Sales and marketing expenses consist primarily of salaries and related personnel costs including overhead, sales commissions, advertising and promotional fees, and travel costs. The decrease in advertising and marketing is mainly due to the termination of partnership with the former marketing representative.

    Research and development          31-Aug          31-Aug           $          %
                                       2012            2011         Change      Change
                                    (12 months)     (12 months)
         Wages and benefits       $   1,637,437   $   1,340,956     296,481      22.1%
         Rent                           155,899         148,772       7,127       4.8%
         Telecommunications              77,645          68,730       8,915      13.0%
         Research and development        18,469           5,232      13,237     253.0%
                                  $   1,889,450   $   1,563,690     325,760      20.8%

Research and development costs consist primarily of salaries and related personnel costs including overhead and consulting fees with respect to product development and deployment. The increase is mainly due to increased staffing, increased salaries and wage costs, consulting requirements due to an increased ongoing investment in building out the functionality of our Play MPEŽ (which accounts for over 95% of our revenue) and the development of our cross platform streaming video prototype.


Costs associated with the above do not meet the criteria for capitalization and, thus, are charged to expense as incurred.

Depreciation and Amortization

Depreciation and amortization expense arose from fixed assets and other assets. Depreciation and amortization increased to $89,206 for the fiscal year ended August 31, 2012 from $58,339 for the fiscal year ended August 31, 2011, an increase of $30,867 or 53% as a result of the development of new Play MPEŽ applications and applications made for various patents and trademarks.

Other earnings and expenses

Other income increased to $4,458 for the year ended August 31, 2012 from $3,091 for the year ended August 31, 2011, an increase of $1,367.

Interest income increased to $48,052 for the year ended August 31, 2012 from $11,508 for the year ended August 31, 2011, an increase of $36,544. This is a result of interest income earned on the amount receivable pursuant to the litigation settlement.

Interest expense increased to $1,185 for the year ended August 31, 2012 from $691 for the year ended August 31, 2011, an increase of $494.

Income Taxes

Our provision for income tax expense for the year ended August 31, 2012 is $208,000 compared to $173,000 in 2011. The Company pays no current income tax as a result of various tax deductions available to the Company.

During the year ended August 31, 2012 the Company recorded income tax expense of $208,000 to recognize the utilization of these various tax deductions during the year to reduce taxable income. The Company realized a net increase to tax assets of $172,000 in 2012 mostly relating to the realization of input tax credits related to prior year's scientific research and development returns filed during 2012.

The Company is subject to United States federal and state income taxes at an approximate rate of 34% (2011 - 34%) and to Canadian federal and British Columbia provincial taxes in Canada at an approximate rate of 25.5% (2010- 27.3%). The effective tax rate of 27.0% in 2012 is slightly higher than our expected blended tax rate of 26% due to an increase in certain expenses in Canada that are not deductible for Canadian income tax purposes. Our effective tax rate could fluctuate due to the valuation of our deferred tax assets, or by changes in tax laws, regulations, and accounting principles.

As at August 31, 2012 the Company had deferred tax assets of $947,000 (August 31, 2011 - $1,155,000) which includes the value of benefits from deductions associated with non-capital losses, depreciable assets, and investment tax credits. The Company will continue to evaluate the realizability of deferred tax assets yearly by assessing the need for and amount of a valuation allowance.

Income

During the year ended August 31, 2012, operating income decreased by 10% to $719,678 (August 31, 2011 -$797,600). Net income was $563,003 (August 31, 2011 -$638,508). We had a 7% decrease in North American revenues, mostly due the application of a one-time minimum annual fee applied in the prior year to one of our major record label clients. This was mostly offset by a 20% increase in North American independent record label revenue, and a 14% growth in European revenues, including a 3% increase in European independent record label clients.

During the year, there was a net recovery of litigation costs of approximately $304,000, compared to a net recovery of approximately $78,000 in 2011.


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 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 us. Adjusted EBITDA has limitations as a profitability measure in that it does not include the interest expense on our debts, our provisions for income taxes, the effect of our expenditures for 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:

                                                     31-Aug       31-Aug
                                                      2012         2011
           Net income                             $  563,003   $  638,508
           Interest income and expenses              (46,867 )    (10,817 )
           Deferred income tax expense (recovery)    208,000      173,000
           Depreciation and amortization              89,206       58,339
           Stock based compensation                   42,797        8,983
           Adjusted EBITDA                        $  856,139   $  868,013

LIQUIDITY AND FINANCIAL CONDITION

We had cash of $1,275,423 as at August 31, 2012 compared to cash of $1,238,173 as at August 31, 2011. We had a working capital surplus of $1,641,032 as at August 31, 2012 compared to $1,354,115 as at August 31, 2011. The increase in our working capital was mainly due to increased accounts receivable balance and an increase in the current portion of the long term receivable associated with the settlement of litigation during the year.

Cash Flows

Net cash generated in operating activities was $22,612 for the year ended August 31, 2012, compared to $1,139,070 for the year ended August 31, 2011. Although our revenue was consistent with 2011, the decrease is mainly due to an increase accounts receivable, a decrease in accounts payable, and an increase in a long term receivable arising from the settlement of litigation during the year, the proceeds of which are being received over a period of several years. As of the date of this report, we have collected approximately 90% of the accounts receivable balance at August 31, 2012.

The cash used in investing activities was $231,581 for the year ended August 31, 2012, compared to $63,289 for the year ended August 31, 2011. The increase is attributable to the development of new Play MPEŽ applications and applications made for various patents and trademarks related to our cross platform streaming video prototype.

Net cash provided by financing activities was $255,760 for the year ended August 31, 2012 compared to net cash used of $362,305 for the year ended August 31, 2011. The increase is mainly the result of proceeds received from the exercise of warrants and the halt of the share buyback program in fiscal 2012.

We expect our current cash balance as well as cash expected to be generated from operations during fiscal 2013 will provide sufficient funds during the fiscal year end of August 31, 2013. We are encouraged by our revenue growth in fiscal 2012 relating to independent labels in North America and or revenue growth in Europe as new and existing record label clients incorporate Play MPEŽ into their work flow.

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

We recognize revenue in accordance with Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") 985-605, Revenue Recognition. Accordingly, revenue is recognized when there is persuasive evidence of an arrangement, delivery to the customer has occurred, the fee is fixed and determinable, and collectability is considered probable.

The majority of our revenue is generated from digital media distribution service. The service is billed on usage which is based on the volume and size of distributions provided on a monthly basis. All revenues are recognized on a monthly basis as the services are delivered to customers, except where extended payment terms exist. Such revenues are only recognized when the extended payment term expires.

At present, the Company does not have yet have a standard business practice for contracts that contain extended payment terms, and therefore recognizes revenue from such contracts when the payment terms lapse and all other revenue criteria have been met.

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.

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 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 carry-forwards 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 partially 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 up to the carrying value of the deferred income tax balance of $947,000.

Contingencies

As discussed in Part I, Item 3 of this Form 10-K under the heading "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.

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 . . .

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