DJCO 10-Q Quarter ended June 30, 2015

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2015

or

For the transition period from _______________ to _____________________

Commission File Number 0-14665

DAILY JOURNAL CORPORATION

(Exact name of registrant as specified in its charter)

(213) 229-5300

(Registrant's telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                 Yes: X                No:

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                   Yes: X                 No:

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).              Yes:                       No: X

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

DAILY JOURNAL CORPORATION

INDEX

DAILY JOURNAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying Notes to Consolidated Financial Statements

DAILY JOURNAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

DAILY JOURNAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

DAILY JOURNAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

DAILY JOURNAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Results of Operations

The Company continues to operate as two different businesses: (1) The Traditional Business, being the business of newspaper and magazine publishing and related services, and (2) Journal Technologies which supplies case management software systems and related products to courts and other justice agencies, including administrative law organizations, county governments and bar associations. The Company also generates non-operating revenues in the form of dividends and interest income, and other income and capital gains from its ownership of marketable securities.

Overall Results

During the nine months ended June 30, 2015, consolidated pretax income increased by $774,000 (137%) to $210,000 from a loss of $564,000 in the prior year period. The Traditional Business segment’s pretax income decreased by $1,276,000 (61%) to $826,000 from $2,102,000, primarily resulting from decreases in trustee sale notice and related service fee revenues of $603,000, commercial advertising revenues of $155,000 and circulation revenues of $89,000, and increased expenses of $457,000 primarily for legal and accounting fees. Journal Technologies’ business segment pretax loss decreased by $1,312,000 (28%) to $3,362,000 from $4,674,000 primarily resulting from the prior June’s accrual of $479,000 for the possible penalty associated with the Company’s uncertain and unrecognized tax benefits and this year-to-date’s additional revenues, as further discussed below. The Company’s non-operating income, net of expenses, increased by $1,186,000 (80%) to $2,676,000 primarily because of additional dividends and interest income from the Company’s marketable securities.

Additional detail about each of the Company’s reportable segments, its non-operating income and expenses, and its comprehensive income is set forth below:

At June 30, 2015, the aggregate fair market value of the Company’s marketable securities was $181,637,000. These securities had approximately $126,719,000 of unrealized gains before taxes of $49,085,000 and generated approximately $2,865,000 in dividends and interest income during the period, which lowers the Company’s effective income tax rate because of the dividends received deduction.

Consolidated revenues were $33,212,000 and $31,922,000 for the nine months ended June 30, 2015 and 2014, respectively. This increase of $1,290,000 (4%) was primarily from additional Journal Technologies licensing and maintenance and consulting revenues of $2,120,000, partially offset by the reduction in trustee sale notice and related service fee revenues of $603,000, commercial advertising revenues of $155,000 and circulation revenues of $89,000. The Company’s revenues derived from Journal Technologies’ operations constituted about 57% and 52% of the Company’s total revenues for the nine months ended June 30, 2015 and 2014, respectively. (Consolidated revenues were $10,503,000 and $11,146,000 for the three months ended June 30, 2015 and 2014, respectively.)

Consolidated operating costs and expenses increased by $1,702,000 (5%) to $35,678,000 from $33,976,000, primarily resulting from additional expenses for Journal Technologies. Total personnel costs increased by $708,000 (4%) to $19,740,000 from $19,032,000 including additional personnel costs for Journal Technologies of $703,000. Other general and administrative expenses increased by $919,000 (14%) to $7,411,000 from $6,492,000 mainly because of increased travel and business promotion expenses and additional legal and accounting fees. (Consolidated operating costs were $11,636,000 and $11,410,000 for the three months ended June 30, 2015 and 2014, respectively.)

There was net income per share of $0.70 in the nine months ended June 30, 2015, as compared with a net loss of $0.40 per share in the prior year period.

The Traditional Business

The Traditional Business segment advertising revenues, which declined by $666,000 (8%) to $7,954,000 from $8,620,000, are very much dependent on the number of California and Arizona foreclosures for which public notice advertising is required by law. The number of foreclosure notices published by the Company decreased by 20% during the nine months ended June 30, 2015 as compared to the prior year period and accounted for almost all of the decline in revenues. Because this slowing is expected to continue, there will be fewer foreclosure notice advertisements and declining revenues in fiscal 2015, and the Company’s print-based earnings will also decline significantly because it will be impractical for the Company to offset all revenue loss by expense reduction. The Company's smaller newspapers, those other than the Los Angeles and San Francisco Daily Journals ("The Daily Journals"), accounted for about 92% of the total public notice advertising revenues in the nine months ended June 30, 2015. Public notice advertising revenues and related advertising and other service fees constituted about 22% of the Company's total revenues during such period. Because of this concentration, the Company’s revenues would be significantly affected if California (and to a lesser extent Arizona) eliminated the legal requirement to publish public notices in adjudicated newspapers of general circulation, as has been proposed from time to time. Also, if the adjudication of one or more of the Company’s newspapers was challenged and revoked, those newspapers would no longer be eligible to publish public notice advertising, and it could have a material adverse effect on the Company’s revenues.

Commercial advertising decreased by $155,000 (5%) to $2,730,000 from $2,885,000 because of the continuing challenges in the commercial advertising business. The Daily Journals accounted for about 86% of the Company's total circulation revenues, which declined by $89,000 (2%) to $4,429,000 from $4,518,000. The court rule and judicial profile services generated about 10% of the total circulation revenues, with the other newspapers and services accounting for the balance. Advertising service fees and other are Traditional Business segment revenues, which include primarily (i) agency commissions received from outside newspapers in which the advertising is placed and (ii) fees generated when filing notices with government agencies.

The Traditional Business segment operating expenses increased by $457,000 (3%) to $13,597,000 from $13,140,000 primarily due to additional legal and accounting fees.

Journal Technologies

Journal Technologies’ revenues increased by $2,109,000 (13%) to $18,789,000 from $16,680,000 in the prior year period. Licensing and maintenance fees increased by $1,434,000 (15%) to $10,752,000 from $9,318,000. Consulting fees increased by $686,000 (25%) to $3,401,000 from $2,715,000. (Consulting fees were $791,000 and $1,189,000 for the three months ended June 30, 2015 and 2014, respectively . ) In most cases, revenues from new installation projects will only be recognized, if at all, upon completion and acceptance of the services by the various customers. Deferred revenues on installation contracts primarily represent the fair value of advances from customers of Journal Technologies for software licenses and installation services. After a customer’s acceptance of the completed project, the advances are generally no longer at risk of refund and are therefore considered earned. Deferred revenues on license and maintenance contracts represent prepayments of annual license and maintenance fees.

Journal Technologies’ operating expenses, which included the amortization of intangible assets of $3,671,000 and $3,642,000 in the nine-month periods ended June 30, 2015 and 2014, respectively, increased by $1,245,000 (6%) to $22,081,000 from $20,836,000 primarily due to increased personnel costs of $703,000 and travel expenses of $436,000. Identifiable intangible assets, including customer relationships and developed technology, are being amortized on a straight-line basis over five years due to the short life cycle of technology that customer relationships depend on and over 15 years for tax purposes. Goodwill, which is not amortized for financial statement purposes, is amortized over a 15-year period for tax purposes. Goodwill represents the expected synergies in expanding the Company’s software business. Goodwill is evaluated for impairment annually, or whenever events or changes in circumstances indicate that the value may not be recoverable. Considered factors for potential goodwill impairment evaluation include the current year’s business profitability before intangible amortization, fluctuations of revenues, changes in the market place, the status of installation contracts and new business, among other things. The Company is continuing to update and upgrade its software products. These costs are expensed as incurred and will impact earnings at least through the foreseeable future.

Taxes

Because a small change in ordinary income produces a significant change in the annual effective rate due to significant permanent book and tax differences, primarily for the dividends received deduction, it was impractical for the Company to compute a reliable estimate using the annual effective rate method. As such, the Company computed its estimate of income taxes on each component of taxable income; ordinary income, the dividends received deduction and other permanent book and tax differences, and recorded each in the period in which it occurred.

For the nine months ended June 30, 2015, the Company recorded an income tax benefit of $760,000 on pretax income of $210,000. The effective tax rate was lower than the statutory rate primarily due to the dividends received deduction, the domestic production activity deduction and a discrete benefit of about $400,000 related to the California Enterprise Zone credits.  On pretax loss of $564,000 for the nine months ended June 30, 2014, the Company recorded a tax benefit of $15,000 which was the net result from applying the effective tax rate anticipated for fiscal 2014 to pretax loss for the first three quarters of fiscal 2014. The Company’s effective tax rate was -362% and 3% for the nine months ended June 30, 2015 and 2014, respectively. (Income tax benefits were $60,000 for the three months ended June 30, 2015 and $25,000 for the three months ended June 30, 2014.) The Company files federal income tax returns in the United States and with various state jurisdictions and is no longer subject to examinations for fiscal years before fiscal 2011 with regard to federal income taxes and fiscal 2010 for state income taxes.

At June 30, 2015, the Company had an accrued liability of approximately $3,059,000 for uncertain and unrecognized tax benefits relating to an acquisition in fiscal 2013. The Company does not anticipate a significant increase or decrease in this liability in the next twelve months.   If recognized, it is expected that these unrecognized tax benefits would not have a significant impact on the Company’s effective tax rate.  During the nine months ended June 30, 2015, interest expense of approximately $70,000 was recorded as “interest and penalty expense accrued for uncertain and unrecognized tax benefits” in the statement of Comprehensive Income (Loss).

The Company has presented the above analysis to discuss the material changes occurred between the periods presented in the unaudited interim consolidated financial statements.  We believe the causes of material changes for the nine-month and the three-month periods are identical in substance and thus combine our analysis and discussion for these periods with parenthesis quantitative disclosure of changes in the three-month period where necessary.

Liquidity and Capital Resources

During the nine months ended June 30, 2015, the Company's cash and cash equivalents and marketable security positions increased by $5,124,000 to $194,210,000. After selling marketable securities for $4,044,000 and realizing a pretax gain of approximately $4,000, cash and cash equivalents were used primarily for the purchase of other marketable securities of $10,977,000 and capital assets, including computer software and office equipment of about $433,000. The investments in marketable securities, which had an adjusted cost basis of approximately $54,918,000 and had a market value of about $181,637,000 at June 30, 2015, generated approximately $2,865,000 in dividends and interest income, which lowers the Company’s effective income tax rate because of the dividends received deduction. As of June 30, 2015, there were unrealized investment pretax gains of $126,719,000 as compared to $125,700,000 as of September 30, 2014. Most of the unrealized gains were in the common stocks of three U.S. financial institutions.

The cash provided by operating activities of $4,529,000 included decreases in deferred installation contracts and license and maintenance agreements of $4,612,000, partially offset by increases in deferred subscriptions of $543,000. Cash flows from operating activities increased by $714,000 during the nine months ended June 30, 2015 as compared to the prior year period primarily resulting from increases in net income of $1,519,000.

As of June 30, 2015, the Company had working capital of $131,661,000, including the liabilities for deferred subscriptions and deferred installation contracts and license and maintenance agreements of $16,822,000, which are scheduled to be earned within one year, and the deferred tax liability of $49,085,000 for the unrealized gains described above.

The Company believes that it will be able to fund its operations for the foreseeable future through its cash flows from operating activities and its current working capital and expects that any such cash flows will be invested in its businesses. The Company may or may not have the ability to borrow against its marketable securities on favorable terms as it did for prior acquisitions. The Company also may entertain additional business acquisition opportunities. Any excess cash flows could be used to reduce the investment margin account liability or invested as management and the Board of Directors deem appropriate at the time.

Such investments may include additional securities of the companies in which the Company has already invested, securities of other companies, government securities (including U.S. Treasury Notes and Bills) or other instruments. The decision as to particular investments will be driven by the Company’s belief about the risk/reward profile of the various investment choices at the time, and it may utilize government securities as a default if attractive opportunities for a better return are not available. The Company’s Chairman of the Board, Charles Munger, is also the vice chairman of Berkshire Hathaway Inc., which maintains a substantial investment portfolio. The Company’s Board of Directors has utilized his judgment and suggestions, as well as those of J.P. Guerin, the Company’s vice chairman, when selecting investments, and both of them will continue to play an important role in monitoring existing investments and selecting any future investments.

As of June 30, 2015, the investments were concentrated in just seven companies. Accordingly, a significant decline in the market value of one or more of the Company’s investments may not be offset by the hypothetically better performance of other investments, and that could result in a large decrease in the Company’s shareholders’ equity and, under certain circumstances, in the recognition of impairment losses in the Company’s income statement.

Critical Accounting Policies and Estimates

The Company’s financial statements and accompanying notes are prepared in accordance with U.S. generally accepted accounting principles. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions are affected by management’s application of accounting policies. Management believes that revenue recognition, accounting for software costs, fair value measurement and disclosures (including for the long-term Incentive Plan liabilities), accounting for business combinations, testing for goodwill impairment and income taxes are critical accounting policies and estimates.

The Company’s critical accounting policies are detailed in its Annual Report on Form 10-K for the year ended September 30, 2014. The above discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in this report.

Disclosure Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Certain statements contained in this document, including but not limited to those in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, are “forward-looking” statements that involve risks and uncertainties that may cause actual future events or results to differ materially from those described in the forward-looking statements. Words such as “expects,” “intends,” “anticipates,” “should,” “believes,” “will,” “plans,” “estimates,” “may,” variations of such words and similar expressions are intended to identify such forward-looking statements. We disclaim any intention or obligation to revise any forward-looking statements whether as a result of new information, future developments, or otherwise. There are many factors that could cause actual results to differ materially from those contained in the forward-looking statements. These factors include, among others: risks associated with software development and implementation efforts; Journal Technologies’ reliance on professional services engagements with justice agencies, including California courts, for a substantial portion of its revenues; material changes in the costs of postage and paper; possible changes in the law, particularly changes limiting or eliminating the requirements for public notice advertising; possible loss of the adjudicated status of the Company’s newspapers and their legal authority to publish public notice advertising; a further decline in public notice advertising revenues because of fewer foreclosures; a further decline in subscriber and commercial advertising revenues; possible security breaches of the Company’s software or websites; the Company’s reliance on its president and chief executive officer; changes in accounting guidance; material weaknesses in the Company’s internal control over financial reporting, and its decision to restate its Form 10-Q for the third quarter of fiscal 2014; and declines in the market prices of the Company’s investments. In addition, such statements could be affected by general industry and market conditions, general economic conditions (particularly in California) and other factors. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in this Form 10-Q, including in conjunction with the forward-looking statements themselves. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time to time in documents filed by the Company with the Securities and Exchange Commission, including in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2014.

For information regarding the Company’s market risk, refer to Item 7A – Quantitative and Qualitative Disclosures about Market Risk in the Company’s Form 10-K for the fiscal year ended September 30, 2014. There have been no material changes to the Company’s market risk exposures since September 30, 2014.

In light of the material weaknesses in the Company’s internal control over financial reporting discussed in the Company’s Form 10-K for the fiscal year ended September 30, 2014, management concluded that the Company’s disclosure controls and procedures were not effective as of June 30, 2015. While the Company has been analyzing possible remedial steps, there were still material weaknesses existing as of June 30, 2015, and there were no material changes in the company’s internal control over financial reporting or in other factors reasonably likely to affect its internal control over financial reporting during the nine months ended June 30, 2015.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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