LUX DIGITAL PICTURES, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that are subject to risks and uncertainties.

Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to those discussed below and elsewhere in this report, particularly in the sections entitled "Special Note Regarding Forward-Looking Statements and Industry Data" and "Risk Factors." Cautionary Statements This Form 10-K contains financial projections and other "forward-looking statements," as that term is used in federal securities laws, about our financial condition, results of operations and business. These statements include, among others, statements concerning the potential for revenues and expenses and other matters that are not historical facts. These statements may be made expressly in this Form 10-K. You can find many of these statements by looking for words such as "believes," "expects," "anticipates," "estimates," or similar expressions used in this Form 10-K. These forward-looking statements are subject to numerous assumptions, risks and uncertainties that may cause our actual results to be materially different from any future results expressed or implied by us in those statements. The most important facts that could prevent us from achieving our stated goals include, but are not limited to, the following: (a) volatility or decline of our stock price; (b) potential fluctuation in quarterly results; (c) our failure to earn revenues or profits; 14-------------------------------------------------------------------------------- (d) inadequate capital to continue the business and barriers to raising the additional capital or to obtaining the financing needed to implement our business plans; (e) failure to commercialize our technology or to make sales; (f) changes in demand for our products and services; (g) rapid and significant changes in markets; (h) litigation with or legal claims and allegations by outside parties, causing us to incur substantial losses and expenses; (i) insufficient revenues to cover operating costs; and (j) dilution in the ownership of the Company through the issuance by us of additional securities and the conversion of outstanding warrants, notes and other securities.

Opportunities, Challenges and Risks Advertising revenue constitutes the majority of our total revenue, representing 93% of total revenue for the year ended August 31, 2012. For the year ended August 31, 2012 our advertising revenue was almost entirely derived from advertising delivered on desktop, tablet and popular mobile devices. We deliver content on mobile devices through our RadioLoyaltyTM app but we do not currently generate significant mobile advertising revenues. Management believes that mobile advertising represents an opportunity for the Company in the next coming years and on an ongoing basis. We streamed content to our listeners for over 15 million hours during the fiscal year ended August 31, 2012. A total of 97.9% of these listener hours were generated by listeners through our web-based Universal PlayerTM, with the remainder of listener hours delivered on tablet computers, smartphones and other mobile devices. Management expects the mobile advertising market will grow at substantial rates in the coming years. However, many challenges exist in this market. We believe these challenges will be solved primarily with new technologies. We believe our current technologies and other technology under development will solve some of these challenges. By solving these challenges we will be able to monetize the mobile listenership we are growing today.

Key Metrics: We track listener hours because it is the best key indicator of the growth of our RadioLoyaltyTM business. Revenues from advertising through our RadioLoyaltyTM Platform represented substantially all of revenues for the year ended August 31, 2012. We also track the number of active users on our RadioLoyaltyTM web-based product as well as the RadioLoyaltyTM app as indicators of the size and quality of our audience, which are particularly important to potential advertisers. We plan to expand our internet product portfolio in the second quarter of the year ending August 31, 2013. Once these products are launched we will determine key indicators of growth for those products.

We calculate actual listener hours using our internal analytics systems. Some of our competitors do not always calculate their listener hours in the same way we do. As a result, their stated listener hours may not represent a truly comparable figure.

Player launches are defined as the number of individual times the UniversalPlayer™ was launched.

Registered users are defined as the number of users who have signed up for an account with us in order to access our broadcasters' content and to earn loyalty points. The number of registered users may overstate the number of actual unique individuals who have signed up for an account with us in order to earn loyalty points,as an individual may register for, and use, multiple accounts under unique brands or private labels.

The tables below set forth our listener hours for the year ended August 31, 2012, our player launches, and our active users as of August 31, 2012.

Listener hours (in millions) 15.3 Player launches (in millions) 10.7 Active users (in thousands) 86.5 15--------------------------------------------------------------------------------Results of Operations for the Year Ended August 31, 2012 as Compared to the Year Ended August 31, 2011 The following tables present our results of operations for the periods indicated and as a percentage of total revenue. The period-to-period comparisons of results are not necessarily indicative of results for future periods.

For the Years Ended August 31, 2012 2011 Revenue Advertising $ 93 % $ - % Services 7 - Total revenue 100 - Costs of revenues Media network 35 - Colocation hosting services 15 - Broadcaster fees 9 - Other costs of sales 24 - Total costs of revenues 83 - Gross profit 17 - Operating expenses Consulting fees (1) 21 - Professional fees 10 - Product development (1) 8 Marketing and sales (1) 8 Rents 8 - Officer compensation (1) 7 - Bad debts 7 - Other expenses 15 - Total operating expenses 85 - Loss from continuing operations (68 ) - Other expenses Interest expense (5 ) - Change in fair value of derivative (3 ) - Total other expenses (8 ) - Loss from discontinued operations - (0 ) Loss before provision for income taxes (76 ) (0 ) Provision for income taxes - (0 ) Net loss (76 ) (0 ) (1) Consulting fees 5 % 0 % Product development 1 0 Marketing and sales 1 0 Officer compensation 1 0 16-------------------------------------------------------------------------------- Comparison of the Years Ended August 31, 2012 and 2011 Revenue For the Years Ended August 31, 2012 2011 Revenue Advertising Video $ 1,167,088 - Display 229,928 - Lead generation 143,312 - Other 82,857 - Total 1,623,185 - Services 119,133 - Total revenue $ 1,742,318 $ - Revenues for the year ended August 31, 2012 totaled $1,742,318. We did not operate our current business model during the year ended August 31, 2011. We generated substantial revenues from video, audio and display advertising placements utilizing our RadioLoyaltyTM Platform and the listenership from over 1,100 of our radio broadcasters. We also currently generate revenues from our services related to integration of our technology with our customer's advertising systems and related infrastructure, call center operations, list creation services and advertising. Upon the acquisition of Rightmail, we also began generating lead generation revenues. We anticipate generating additional advertising revenues from our expanding internet portfolio that is currently being integrated and should begin launching on or around the middle of the year ending August 31, 2013.

Costs of Revenue For the Years Ended August 31, 2012 2011 Costs of revenues Media network $ 615,435 - Colocation hosting services 258,971 - Broadcaster fees 151,758 - Other 421,056 - Total costs of revenue $ 1,447,220 $ - Costs of revenues for the year ended August 31, 2012 totaled $1,447,220. We did not operate our current business model during the year ended August 31, 2011. We incurred substantial media network costs associated with the distribution of our content across a variety of advertising networks. Our costs of distributing our content will proportionally decrease dramatically as we reach scale. In order to operate the RadioLoyaltyTM online broadcasting platform,RadioLoyaltyTMmobile and tablet apps and our ad-serving technologies, we require substantial computing power, hosting and streaming hosting. We operate a substantial technology center at our offices in Santa Barbara, California but also utilize a contracted facility in Los Angeles, California, to support our operations and ensure our systems and content delivery maintain our service level agreements. We refer to these costs as colocation services. Our advertising sales arrangements with over 1,100 RadioLoyaltyTM broadcasters facilitate US paying the broadcasters a monthly revenue sharing fee in exchange for advertising inventory around their content and listenership. We refer to these costs as broadcaster commissions in the event that we purchase the ad inventory. Other costs of sales include depreciation associated with the computer servers at our two colocation facilities, streaming costs, adserving costs, call center operation costs, and various application technologies that support our primary product offerings.

17 -------------------------------------------------------------------------------- Operating Expenses For the Years Ended August 31, 2012 2011 Operating expenses Consulting fees $ 367,147 - Professional fees 166,287 - Product development 147,541 - Marketing and sales 145,334 Rents 139,120 Officer compensation 130,187 Bad debt 117,408 Other 261,917 - Total operating expenses $ 1,474,941 $ - Operating expenses for the year ended August 31, 2012 totaled $1,474,941. We did not operate our current business model during the year ended August 31, 2011. We incurred substantial consulting fees during the year ended August 31, 2012 associated with business development efforts and financial advisory services. We have a broad-based business strategy to acquire more broadcasters directly, enter into joint ventures, revenue sharing arrangements or similar contracts with internet radio station guides (aggregators), and consider mergers and acquisition targets on an ongoing basis. We previously used outside consultants to execute these elements of our business strategy. Recently, we added personnel in order to focus on these efforts internally. We incurred substantial professional fees in order to complete the transaction between Lux Digital Pictures, Inc. and RadioLoyalty, Inc. Product development costs were associated with continuing improvements to the software and related infrastructure for our primary product offering as well as development work on our online product portfolio and the WatchThisTM technology. We expect these costs to increase in the current fiscal year. Marketing and sales costs included compensation for our sales staff and various internet marketing-related costs. Rents were primarily related to four leases we are obligated under for our Santa Barbara, California office. Officer compensation related to a variety of payments to the two primary executives that operate our business and $10,000 in stock compensation associated with the initial shares of RL that were issued upon the incorporation of RL. Bad debts were substantial primarily because of a $72,000 reserve for potentially uncollectible accounts we recorded in order to reserve against substantial balances that were over 90 days delinquent as of August 31, 2012.

Other operating costs include telecom, depreciation, utilities, travel and entertainment and various other costs of doing business.

Other Expenses For the Years Ended August 31, 2012 2011 Other expenses Interest expense $ 93,278 $ - Change in fair value of derivative 50,761 - Total interest expenses $ 144,039 $ - Other expenses for the year ended August 31, 2012 totaled $144,039. We did not operate our current business model during the year ended August 31, 2011. We incurred interest expense calculated on our convertible promissory notes and fees charged by the provider of our factoring line of credit. We also recorded the accretion of various debt discounts associated with our convertible promissory notes. The accretion is a result of the amortization of debt discounts to the convertible promissory notes over the term of the convertible promissory notes. Debt discounts recorded during the year ended August 31, 2012 represented the beneficial conversion feature, warrants to purchase stock, and derivative liability associated with the convertible promissory notes. The original value of the derivative liability was recorded as a debt discount. As a result of the derivative classification, the debt discount had to be re-measured as of the reporting date. The re-measurement resulted in an increase to the derivative liability of $50,761. If the convertible promissory notes issued to the Creditor remain outstanding at any time subsequent to the six-month anniversary of the date the convertible promissory notes were issued, a derivative liability exists and will have to be measured as of each reporting date.

18--------------------------------------------------------------------------------Provision for Income Taxes We did not generate profits for the year ended August 31, 2012. As a result, no provision for income taxes was recorded. For the year ended August 31, 2011, we recorded a $53,585 charge to adjust the balance of our deferred tax assets.

Net Loss Attributable to Common Shareholders For the Years Ended August 31, 2012 2011 Net loss attributable to common shareholders Net loss $ (1,323,882 ) $ (205,620 ) Deemed dividends (200,647 ) - Net loss attributable to common shareholders $ (1,524,529 ) $ (205,620 ) We generated a net loss of $1,323,882 for the year ended August 31, 2012 for the reasons set forth above. We did not operate our current business model during the year ended August 31, 2011. We also recorded a deemed dividend of $83,020 to account for the distribution of assets to the former Chief Executive Officer of RL. A deemed dividend of $117,627 was also recorded to account for the excess value over historical costs of various financial instruments issued to the entity that originally owned the WatchThisTM technology. We do not expect dividends in any form will be issued or recorded during the year ending August 31, 2013.

Liquidity and Capital Resources As of August 31, 2012 we had cash totaling $227,435, which consisted of cash funds held at major financial institutions. We had net a working capital deficit of $950,012 as of August 31, 2012, compared to a net working capital of $458,212 as of August 31, 2011. Our principal uses of cash during the fiscal year ending August 31, 2012 were funding our operations as described below.

Sources of Funds We believe, based on our current operating plan, that our existing cash will not be sufficient to meet our anticipated cash needs for at least the next 12 months. We will explore additional financing sources and means to lower our cost of capital, which could include equity, equity-linked and debt financing. In addition, in connection with any future acquisitions, we may require additional funding which may be provided in the form of additional debt, equity or equity-linked financing or a combination thereof. There can be no assurance that any additional financing will be available to us on acceptable terms.

Our Indebtedness As of August 31, 2012, we had issued a total of $650,500 in convertible promissory notes that remained outstanding as of that date. We also entered into an additional $250,000 convertible promissory note in September 2012 and have executed a term sheet for an additional $100,000 as of December 12, 2012. We also owe significant balances under a factoring agreement, a lease agreement for computer servers, and significant balances are owed to the two primary executives that operate our business.

19 --------------------------------------------------------------------------------Capital Expenditures Based on current estimates, we believe that our anticipated capital expenditures will be adequate to implement our current plans.

Historical Trends The following table summarizes our cash flow data for the years ended August 31, 2012 and 2011.

Fiscal Year Ended August 31, 2012 2011 Net cash provided by used in operating activities of continuing operations $ (259,970 ) $ - Net cash used in investing activities of continuing operations (8,450 ) - Net cash provided by financing activities of continuing operations 668,427 - Net cash provided by discontinued operations (172,572 ) 205,620 Cash flow used by operating activities of continuing operations totaled $259,970 for the year ended August 31, 2012, compared to $0 used for the year ended August 31, 2011. We did not operate our current business model during the year ended August 31, 2011.Operating cash flow was negative during the year ended August 31, 2012 as we began operations and continued the expansion of our advertising within the RadioLoyaltyTM and WatchThis™ Platforms.

Cash flow used by investing activities of continuing operations totaled $8,450 for the year ended August 31, 2012, as compared to $0 used in the year ended August 31, 2011. We did not operate our current business model during the year ended August 31, 2011. We invested in several computers during the year ended August 31, 2012.

Cash flow provided by financing activities of continuing operations totaled $668,427 for the year ended August 31, 2012, compared to $0 used for the year ended August 31, 2011. We did not operate our current business model during the year ended August 31, 2011. We raised substantial capital through the issuance of convertible promissory notes during the year ended August 31, 2012.

Cash flow used in discontinued operations totaled $172,572 for the year ended August 31, 2012, compared to cashflows provided by discontinued operations of $205,620 for the year ended August 31, 2011. We did not operate our current business model during the year ended August 31, 2011. We closed the prior business down during the year ended August 31, 2012.

Contractual Obligations and Commitments The following summarizes our contractual obligations as of August 31, 2012: Payments Due by Period Less Than More Than Total 1 Year 1-3 Years 4-5 Years 5 Year (in thousands) Operating lease obligations $ 308,587 $ 180,636 $ 127,951 $ - $ - Computer servers lease obligation 128,535 $ 128,535 $ - $ - $ - Total $ 437,122 $ 309,171 $ 127,951 $ - $ - 20--------------------------------------------------------------------------------Off-Balance Sheet Arrangements As of August 31, 2012 and 2011, we did not have any off-balance sheet arrangements.

Quarterly Trends Our operating results fluctuate from quarter to quarter as a result of a variety of factors. We expect our operating results to continue to fluctuate in future quarters.

Our results may reflect the effects of some seasonal trends in listener behavior due to increased internet usage and sales of media-streaming devices during vacation and holiday periods. For example, we expect to experience increased usage during the fourth quarter of each calendar year due to the holiday season, and in the first quarter of each calendar year due to the use of media-streaming devices received as gifts during the holiday season. We may also experience higher advertising sales during the fourth quarter of each calendar year due to greater advertiser demand during the holiday season and lower advertising sales during the first quarter of each calendar year results from a generally decreased advertising demand. While we believe these seasonal trends have affected and will continue to affect our operating results, our lack of operating history provides for less insight into the effect of these factors. We believe that our business may become more seasonal in the future. Seasonal variations in listener behavior may result in fluctuations in our financial results.

In addition, expenditures by advertisers tend to be cyclical and discretionary in nature, reflecting overall economic conditions, the economic prospects of specific advertisers or industries, budgeting constraints, buying patterns and a variety of other factors. Many of these market conditions are not possible for us to control.

Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

We believe that the assumptions and estimates associated with our revenue recognition, costs of revenues, stock based compensation and accounting for income taxes have the greatest potential impact on our financial statements.

Therefore, we consider these to be our critical accounting policies and estimates.

Revenue Recognition The Company's revenue is principally derived from advertising services.

The Company recognizes revenue when: (1) persuasive evidence exists of an arrangement with the customer reflecting the terms and conditions under which products or services will be provided; (2) delivery has occurred or services have been provided; (3) the fee is fixed or determinable; and (4) collection is reasonably assured. For all revenue transactions, the Company considers a signed agreement, a binding insertion order or other similar documentation to be persuasive evidence of an arrangement.

21 -------------------------------------------------------------------------------- Advertising Revenue. The Company generates advertising revenue primarily from display and video advertising. The Company generates the majority of its advertising revenue through the delivery of advertising impressions sold on a cost per thousand, or CPM, basis. Currently, advertising revenues are generated through our proprietary technologies from internet-based content. The Company does not currently generate significant revenues from mobile advertising. In determining whether an arrangement exists, the Company ensures that a binding arrangement, such as an insertion order or a fully executed customer-specific agreement, is in place. The Company generally recognizes revenue based on delivery information from its campaign trafficking systems.

The Company also generates advertising revenue pursuant to arrangements with advertising agencies and brokers. Under these arrangements, the Company provides the agencies and brokers the ability to sell advertising inventory on the Company's service directly to advertisers. The Company reports this revenue net of amounts due to agencies and brokers because the Company is not the primary obligor under these arrangements, the Company does not set the pricing, and does not establish or maintain the relationship with the advertisers.

Services Revenue. The Company generated services revenues for the period from December 1, 2011 through November 30, 2012. These revenues related to the provision of data and streaming hosting services to two customers. The Company no longer generates significant services revenues of this nature but does anticipate project-oriented service revenues associated with the integration and private-branding of the Company's technologies with both current and potential business partners and customers, respectively.

Deferred Revenue. Deferred revenue consists of both prepaid unrecognized revenues and advertising fees received or billed in advance of the delivery or completion of the services or in instances when revenue recognition criteria have not been met. Deferred revenue is recognized when the services are provided and all revenue recognition criteria have been met.

Multiple-Element Arrangements. The Company could potentially enter into arrangements with customers to sell advertising packages that include different media placements or ad services that are delivered at the same time, or within close proximity of one another. The Company uses the prospective method for all arrangements entered into or materially modified from the date of adoption that involve multiple element arrangements. Under this new guidance, the Company allocates arrangement consideration in multiple-deliverable revenue arrangements at the inception of an arrangement to all deliverables or those packages in which all components of the package are delivered at the same time, based on the relative selling price method in accordance with the selling price hierarchy, which includes: (1) vendor-specific objective evidence ("VSOE") if available; (2) third-party evidence ("TPE") if VSOE is not available; and (3) best estimate of selling price ("BESP") if neither VSOE nor TPE is available.

VSOE . The Company determines VSOE based on its historical pricing and discounting practices for the specific product or service when sold separately.

In determining VSOE, the Company requires that a substantial majority of the selling prices for these services fall within a reasonably narrow pricing range.

The Company has not historically priced its advertising products within a narrow range. As a result, the Company has not been able to establish VSOE for any of its advertising products.

TPE . When VSOE cannot be established for deliverables in multiple element arrangements, the Company applies judgment with respect to whether it can establish a selling price based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, the Company's go-to-market strategy differs from that of its peers and its offerings contain a significant level of differentiation such that the comparable pricing of services cannot be obtained. Furthermore, the Company is unable to reliably determine what similar competitor services' selling prices are on a stand-alone basis. As a result, the Company has not been able to establish selling price based on TPE.

22-------------------------------------------------------------------------------- BESP . When it is unable to establish selling price using VSOE or TPE, the Company uses BESP in its allocation of arrangement consideration. The objective of BESP is to determine the price at which the Company would transact a sale if the service were sold on a stand-alone basis. BESP is generally used to allocate the selling price to deliverables in the Company's multiple element arrangements. The Company determines BESP for deliverables by considering multiple factors including, but not limited to, prices it charges for similar offerings, market conditions, competitive landscape and pricing practices. The Company limits the amount of allocable arrangement consideration to amounts that are fixed or determinable and that are not contingent on future performance or future deliverables. The Company regularly reviews BESP. Changes in assumptions or judgments or changes to the elements in the arrangement may cause an increase or decrease in the amount of revenue that the Company reports in a particular period.

The Company recognizes the relative fair value of the media placements or ad services as they are delivered assuming all other revenue recognition criteria are met.

Cost of Revenue Cost of revenue consists of the revenue-sharing amounts paid to broadcasters who provide us with their content and listenership, infrastructure costs related to content streaming, costs related to creating and serving advertisements through our proprietary ad serving technology as well as third party ad serving technology providers and a commission payable to the original owner of the RadioLoyaltyTM technology. The Company makes payments to third-party ad servers for the period the advertising impressions or click-through actions are delivered or occur, and accordingly, the Company records this as a cost of revenue in the related period.

Stock-Based Compensation Stock-based payments made to employees, including grants of restricted stock units and employee stock options, are recognized in the statements of operations based on their fair values. The Company has previously issued restricted stock units and has not issued any employee stock options to date. The Company recognizes stock-based compensation for awards granted that are expected to vest, on a straight-line basis using the single-option attribution method over the service period of the award, which is generally three years. Because the restricted stock units vest on a daily basis, the Company has estimated the forfeiture rate of these stock awards to be 0%. Should the Company issue stock-based compensation in the form of employee stock options, the resulting expense recognized in the statements of operations may been reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The forfeiture rates used for valuing stock-based compensation payments would be estimated based on historical experience. The Company would estimate the fair value of employee stock options using the Black-Scholes valuation model. The determination of the fair value of a stock-based award is affected by the deemed fair value of the underlying stock price on the grant date, as well as other assumptions including the risk-free interest rate, the estimated volatility of the Company's stock price over the term of the award, the estimated period of time that the Company expects employees to hold their stock options and the expected dividend rate.

The Company has elected to use the "with and without" approach as described in Accounting Standards Codification 740 Tax Provisions in determining the order in which tax attributes are utilized. As a result, the Company will only recognize a tax benefit from stock-based awards in additional paid-in capital if an incremental tax benefit is realized after all other tax attributes currently available to the Company have been utilized. In addition, the Company has elected to account for the indirect effects of stock-based awards on other tax attributes, such as the research tax credit, through the statement of operations.

23 --------------------------------------------------------------------------------Income Taxes The Company accounts for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the financial statements or in the Company's tax returns. Deferred income taxes are recognized for differences between financial reporting and tax bases of assets and liabilities at the enacted statutory tax rates in effect for the years in which the temporary differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The Company evaluates the realizability of deferred tax assets and valuation allowances are provided when necessary to reduce net deferred tax assets to the amounts expected to be realized.

The Company recognizes a tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. The Company will recognize interest and penalties related to unrecognized tax benefits in the income tax provision in the accompanying statement of operations.

The Company calculates the current and deferred income tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed income tax returns are recorded when identified. The amount of income taxes paid is subject to examination by U.S. federal and state tax authorities. The estimate of the potential outcome of any uncertain tax issue is subject to management's assessment of relevant risks, facts and circumstances existing at that time. To the extent that the assessment of such tax positions change, the change in estimate is recorded in the period in which the determination is made.

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