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DIGITALTOWN, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following is a discussion of the financial condition of the Company as of August 31, 2014, and its results of operations for the three and six months ended August 31, 2014 and 2013, which should be read in conjunction with, and is qualified in its entirety by, the financial statements and notes thereto included elsewhere in this report and the audited consolidated financial statements and notes thereto included in the Company's Form 10-K for the fiscal year ended February 28, 2014. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Form 10-Q for the quarter ended August 31, 2014, contains forward-looking statements. Forward-looking statements may be identified by the use of forward-looking terminology, such as "may," "shall," "could," "expect," "estimate," "anticipate," "predict," "probable," "should," "continue," or similar terms, variations of those terms or the negative of those terms. The forward-looking statements specified in the following information have been compiled by our management and are considered by management to be reasonable. Our future operating results, however, are impossible to predict and no representation, guaranty, or warranty is to be inferred from those forward-looking statements. Company Overview DigitalTown owns and operates a nationwide social networking site of hyper-local on-line communities built around their domain names and the schools and communities they represent. In March 2013, DigitalTown filed a trademark application with the U.S. Patent and Trademark Office for the service mark "America's Prodigy". The Company is the holder of Americasprodigy.com and various other prodigy related domain names. The application lists its goods and services as entertainment services, namely, conducting contests. In February 2013, public registration began for TrustedWebmail, DigitalTown's webmail platform. TrustedWebmail features advanced monitoring controls for schools, athletic directors, youth leagues and business and will provide an easy method for monitoring emails sent and received. DigitalTown plans to launch a second tool called Trusted Cell Phone, which is a predator-averse parental/coach/teacher monitoring application which allows you to monitor all texts (SMS or MMS), phone calls, or images into or out of any android based cellular phone under your control. On July 31, 2012, DigitalTown and the National Interscholastic Athletic Administrators Association ("NIAAA") jointly announced that TrustedWebmail will be the official recommended email provider of the NIAAA for athletic administrators, coaches and athletes nationwide. On May 23, 2012, DigitalTown and The Active Network, Inc. ("Active") completed a Handoff Agreement of the technology assets supporting DigitalTown's school spirit websites and its related social networking sites. The Handoff Agreement indicates that both DigitalTown and Active agreed to mutually terminate the Strategic Alliance Agreement, initially entered between the parties on September 29, 2009, and subsequently re-entered between the parties on September 30, 2011. On May 14, 2012, DigitalTown Limited ("DTL") was incorporated under Chapter 32 of the Laws of Hong Kong. DTL is 100% owned by TSN. 17 -------------------------------------------------------------------------------- On May 3, 2012, DigitalTown created a new, wholly-owned subsidiary, The School Network, Inc. ("TSN"), under the laws of the State of Nevada. On April 4, 2012, the Company executed a Domain Sale Agreement under which it agreed to sell one of the domain names the Company currently owns. The Company received $175,000 cash in consideration of the transfer of the domain name. RESULTS OF OPERATIONS THREE MONTHS ENDED AUGUST 31, 2014 and 2013 During the three months ended August 31, 2014, the Company recorded revenues of $117 and cost of revenues of $46,953 for a negative gross profit of $(46,836) compared to revenues of $253 and cost of revenues of $78,435 for a negative gross profit of $(78,182), for the same period in 2013. For the three months ended August 31, 2014, revenue mainly consisted of commissions generated from advertising on our websites of $117. For the comparable period, revenue mainly consisted of commissions generated from advertising on our websites of $253. Cost of revenue consisted of amortization of prepaid annual domain name renewal fees of $46,943 for 2014 compared to $49,008 for 2013, server/bandwidth expense of $10 for 2014 and $2 for 2013, amortization of website development fees were $0 for 2014 and $27,342 for 2013 and direct sales expense of $0 for 2014 compared to $2,043 for 2013. Selling, general and administrative expenses for the most current three months decreased by $245,742 to $120,372 compared to a year ago. Stock compensation expense, included in selling, general and administration expenses, was $49,559 for the three months ended August 31, 2014, compared to $177,169 for the three months ended August 31, 2013, a decrease of $127,610, compared to a year ago. Excluding non-cash stock compensation expense for the two comparable periods, selling, general, and administrative expenses were $70,813 for the three months ended August 31, 2014, compared to $188,945 for the three months ended August 31, 2013. The decrease of $118,132 was primarily due to a decrease in payroll expense of $75,369 and a $23,695 decrease in professional fees. The Company's overall net loss for the current three months decreased by $282,658 to $171,564. SIX MONTHS ENDED AUGUST 31, 2014 and 2013 During the six months ended August 31, 2014, the Company recorded revenues of $317 and cost of revenues of $92,576 for a negative gross profit of $(92,259) compared to revenues of $562 and cost of revenues of $159,632 for a negative gross profit of $(159,070), for the same period in 2013. For the six months ended August 31, 2014, revenue mainly consisted of commissions generated from advertising on our websites of $317. For the comparable period, revenue mainly consisted of commissions generated from advertising on our websites of $562. Cost of revenue consisted of amortization of prepaid annual domain name renewal fees of $92,556 for 2014 compared to $98,055 for 2013, server/bandwidth expense of $20 for 2014 and $1,396 for 2013, amortization of website development fees were $0 for 2014 and $54,685 for 2013 and direct sales expense of $0 for 2014 compared to $5,497 for 2013. Selling, general and administrative expenses for the most current six months decreased by $679,061 to $255,238 compared to a year ago. Stock compensation expense, included in selling, general and administration expenses, was $108,976 for the six months ended August 31, 2014, compared to $560,957 for the six months ended August 31, 2013, a decrease of $451,981, compared to a year ago. Excluding non-cash stock compensation expense for the two comparable periods, selling, general, and administrative expenses were 18 -------------------------------------------------------------------------------- $146,262 for the six months ended August 31, 2014, compared to $373,342 for the six months ended August 31, 2013. The decrease of $227,080 was primarily due to a decrease in payroll expense of $140,004, a decrease in professional fees of $37,267 and a $25,141 decrease in benefits expense. The Company's overall net loss for the current six months decreased by $766,907 to $351,801. LIQUIDITY AND CAPITAL RESOURCES SIX MONTHS ENDED AUGUST 31, 2014 The Company's cash position at August 31, 2014, was $1,539, a decrease of $49,050 from $50,589 at February 28, 2014. Net cash used in operating activities during the six months ended August 31, 2014 and 2013, was $162,250 and $331,015, respectively. When comparing the two periods, the decrease in cash used in operating activities of $168,765 is mainly due to a decrease of $224,212 in cash operating expenses and an increase in related party accounts payable of $39,803 offset by a decrease in deferred officer compensation of 78,826. Net cash used in investing activities for the six months ended August 31, 2014 was $0 as compared to net cash used of $3,974 for the six months ended August 31, 2013, of which $3,486 was used for the cost of website development and $488 for the purchase of domain names. Net cash provided by financing activities for the six months ended August 31, 2014 was $113,200 which consisted of proceeds from related parties payable of $80,000, payments received on stockholder subscription receivables of $13,200 and proceeds from the issuance of stock of $20,000. For the comparable period ended August 31, 2013, the Company had net cash provided by financing activities of $305,650 which consisted of proceeds from note payable of $150,000, payments received on stockholder subscription receivables of $157,000 offset by payments of $1,350 on loan from related party. Monthly cash operating expenses for the six months ended August 31, 2014, were approximately $40,000 per month. Based on current projections, the Company's monthly cash operating expenses going forward should remain at approximately $40,000 per month which includes the monthly cost for the renew of the existing domain names of approximately $15,000. In addition to the normal monthly operating expenses, the Company's committed cash requirements for the twelve months ending February 28, 2015 include the balance due of $30,000 for expenses pertaining to the Company's Strategic Partnership Agreement with the NIAAA and $22,500 pertaining to the Company's software development maintenance agreement. From September 1, 2014 to October 15, 2014, the Company has not received any cash proceeds from stock subscription receivables. As of August 31, 2014, the Company has the following stock subscription agreements outstanding: 2007 Agreements On October 5, 2007, the Company received subscriptions for 1,300,000 restricted common shares at $2.50 per share (total value of $3,250,000). Significant terms of the original subscription agreement are as follows: · The price per share of $2.50 was based on the closing price on October 4, 2007. · At 24 months, 1/36 payments are due monthly. · The Company, at its option, may call up to 1/12 of the gross receivable per month if the preceding 30 day average trading price is at or above $7.00 a share with minimum trading volume of 5,000 shares per day. 19 -------------------------------------------------------------------------------- · If the purchaser sells these common shares, the purchaser shall be entitled to an amount equal to 200% of the original purchase price of each share and the Company shall be entitled to 50% of any additional net sales proceeds from the stock sale. On February 25, 2010, due to the economic downturn and the market value decline of the Company's stock, which was trading below $2.50 per share, the Company amended the pricing terms of the subscription agreements received by the Company on October 5, 2007. The amendment changed the following significant terms of the subscription agreement: The parties agree that the Initial Pricing terms in the Confidential Binding Term Sheet dated October 5, 2007 of the Agreement will be amended to state as follows: 2. The Subscriber offers to purchase shares of the Company for $0.75 per share. After the price adjustment, the revised total value of this subscription agreement is $975,000. The following other provisions of the Initial Pricing and Final Pricing terms in the Confidential Binding Term Sheet dated October 5, 2007 of the Agreement will be deleted, and are not enforceable by either party: · Beginning October 5, 2009, and 1/36 payments are due each month thereafter on the 5th of every month. · The Company at its option may call up to 1/12 of the (gross) receivable note per month if the preceding 30 day average trading price is at or above $7.00 a share. Minimum trading volume must be 5,000 shares a day. · As total consideration for the purchase and sale of the Company's stock, purchaser shall ultimately pay to the Company the following amount (the "Purchase Price"): D. Purchaser shall first be entitled to an amount equal to 200% of the face amount of each share. E. After the purchaser receives the amount in A above, the Company shall be entitled to 50% of any additional net sales proceeds of the stock. Net sales proceeds shall mean the gross proceeds received from the sale of the stock, less reasonable brokerage commissions. F. Final adjusted net sales proceeds will be wired to the Company within 7 days from the final settlement of the sale of stock sold. The outstanding balance owed on the revised 2007 subscription agreements at August 31, 2014 is $328,195. 2010 Agreement Material terms of the subscription agreement received by the Company on June 22, 2010, for 400,000 restricted common shares at $0.75 per share (total value of $300,000) are as follows: · Payment is due in full in 60 months. · At 24 months, the Company can demand at its option, monthly 1/36 payments on the subscription agreement. · The Company has the option to charge simple annual interest of up to 4%. · The Company will provide downside protection of up to 30% of the stock price upon conversion. The outstanding balance owed on the 2010 subscription agreement at August 31, 2014 is $300,000. 20 -------------------------------------------------------------------------------- Summary For the six months ended August 31, 2014, the Company received stock subscription payments of $13,200 and as of August 31, 2014, the Company had related party stock subscriptions receivable aggregating $628,195 for the 2007 and 2010 agreements. The following table summarizes the stock subscription receivable, by quarter, at August 31, 2014: Participatory Rights in the Amount of New Proceeds of Downside Total Amount Subscription the Resales Protection Quarter Ended Total Balance Due Collected Agreements Collected Provided February 28, 2013 978,854 - - - - May 31, 2013 910,854 68,000 - - - August 31, 2013 821,854 89,000 - - - November 30, 2013 679,354 142,500 - - - February 28, 2014 641,395 37,959 - - - May 31, 2014 636,395 5,000 - - - August 31, 2014 628,195 8,200 - - - In summary, we believe our current cash reserves, the amounts we expect to collect on our outstanding stock subscription receivables, future proceeds from the issuance of our common stock and proceeds from the sale of current domain names should be sufficient to enable us to operate for the next 12 months. In the event that we are unable to collect our stock subscription receivables as needed or raise additional capital through the sale of our common stock or sell additional domain names on acceptable terms, we would be forced to reduce operating expenses and/or cease operations altogether. Critical Accounting Policies The discussion and analysis of DigitalTown, Inc.'s financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosure of contingent assets and liabilities. Management reviews its estimates on an ongoing basis. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. While DigitalTown Inc.'s significant accounting policies are described in more detail in Note 2 to its financial statements, management believes the following accounting policies to be critical to the judgments and estimates used in the preparation of its financial statements: Intangible Assets - Domain Names/Website Development Costs Domain name costs are accounted for in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC 350-50) guidance pertaining to Intangibles-Goodwill and Other, Website Development Costs. Certain modules and components of the Company's overall website development are ready for their intended use and the Company's resulting websites are currently operational. Accordingly, the annual domain name renewal fees are currently being amortized over one 21 -------------------------------------------------------------------------------- year and the purchase of any new domain names are the only amounts being capitalized. Previously, during the infrastructure development stage of its websites, the Company capitalized the purchase of new domain names and the annual domain name renewal fees. Additionally, since the ownership of each domain name can be renewed for a nominal renewal fee each year prior to their expiration date, the useful lives of the domain names are deemed to be indefinite and no amortization of the capitalized costs for the domain names will be recorded. Website development costs are accounted for in accordance with the FASB Accounting Standards Codification (ASC 350-40) guidance pertaining to Intangibles-Goodwill and Other, Internal-Use Software which requires that all internal and external costs incurred to develop the internal-use software necessary to operate the websites be capitalized. The guidance further states, amortization should begin when an individual module or component of the overall internal-use software is ready for its intended use. The cost of such module or component will be amortized on a straight-line basis over its estimated useful life, as determined by the Company, after taking into account the effects of obsolescence, technology, competition and other economic factors. The Company has components of its website development that are operational and are being amortized on a straight-line basis over a three year life. Stock-Based Compensation The Company measures and recognizes compensation expense for all stock-based payment awards made to employees and directors on a straight-line basis over the respective vesting period of the awards. The compensation expense for the Company's stock-based payments is based on estimated fair values at the time of the grant of the portion of stock-based payment awards that are ultimately expected to vest. The Company estimates the fair value of stock-based payment awards on the date of grant using the Black-Scholes option pricing model. This option pricing model involves a number of assumptions, including the expected lives of stock options, the volatility of the public market price for the Company's common stock and interest rates. Recently Issued Accounting Pronouncements: In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The new guidance requires that share-based compensation that require a specific performance target to be achieved in order for employees to become eligible to vest in the awards and that could be achieved after an employee completes the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation costs should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This new guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all 22 -------------------------------------------------------------------------------- awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The adoption of ASU 2014-12 is not expected to have a material impact on our financial position or results of operations. In June 2014, the FASB issued ASU No. 2014-10: Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation, to improve financial reporting by reducing the cost and complexity associated with the incremental reporting requirements of development stage entities. The amendments in this update remove all incremental financial reporting requirements from U.S. GAAP for development stage entities, thereby improving financial reporting by eliminating the cost and complexity associated with providing that information. The amendments in this Update also eliminate an exception provided to development stage entities in Topic 810, Consolidation, for determining whether an entity is a variable interest entity on the basis of the amount of investment equity that is at risk. The amendments to eliminate that exception simplify U.S. GAAP by reducing avoidable complexity in existing accounting literature and improve the relevance of information provided to financial statement users by requiring the application of the same consolidation guidance by all reporting entities. The elimination of the exception may change the consolidation analysis, consolidation decision, and disclosure requirements for a reporting entity that has an interest in an entity in the development stage. The amendments related to the elimination of inception-to-date information and the other remaining disclosure requirements of Topic 915 should be applied retrospectively except for the clarification to Topic 275, which shall be applied prospectively. For public companies, those amendments are effective for annual reporting periods beginning after December 15, 2014, and interim periods therein. Early adoption is permitted. The adoption of ASU 2014-10 is not expected to have a material impact on our financial position or results of operations. In July 2013, the FASB issued ASU No. 2013-11: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists. The new guidance requires that unrecognized tax benefits be presented on a net basis with the deferred tax assets for such carry-forwards. This new guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2013. We do not expect the adoption of the new provisions to have a material impact on our financial condition or results of operations. In February 2013, FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to: -Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period; and 23 -------------------------------------------------------------------------------- -Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense. The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. Early adoption is permitted. The adoption of ASU No. 2013-02 did not have a material impact on our financial position or results of operations. In January 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements originally established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial statement users. In choosing to narrow the scope of the offsetting disclosures, the Board determined that it could make them more operable and cost effective for preparers while still giving financial statement users sufficient information to analyze the most significant presentation differences between financial statements prepared in accordance with U.S. GAAP and those prepared under IFRSs. Like ASU 2011-11, the amendments in this update will be effective for fiscal periods beginning on, or after January 1, 2013. The adoption of ASU 2013-01 did not have a material impact on our financial position or results of operations. FORWARD-LOOKING INFORMATION Any statements contained herein related to future events are forward-looking statements. Readers are cautioned not to place undue reliance on forward-looking statements. DigitalTown, Inc. undertakes no obligation to update any such statements to reflect actual events. |