DJCO 10-Q Quarter ended June 30, 2016

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2016

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 (LOSS) INCOME

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

DAILY JOURNAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(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

Results of Operations

The Company continues to operate as two different businesses: (1) The Traditional Business, being the business of newspaper publishing and related services that the Company had before 1999 when it purchased a software development company, and (2) Journal Technologies, Inc. (“Journal Technologies”), a wholly-owned subsidiary which supplies case management software systems and related products to courts, prosecutor and public defender offices, probation departments and other justice agencies, including administrative law organizations, city and county governments and bar associations.

Comparable nine-month periods ended June 30, 2016 and June 30, 2015

Consolidated revenues were $32,595,000 and $33,209,000 for the nine months ended June 30, 2016 and 2015, respectively. This decrease of $614,000 (2%) was primarily from the reduction in The Traditional Business’s trustee sale notice and related service fee revenues of $429,000 and commercial advertising revenues of $427,000 (primarily due to the discontinuance of publishing the California Lawyer magazine), and Journal Technologies’ public service fees of $1,089,000 primarily due to a reduction in the number of traffic tickets processed on a website for the public to pay traffic citations online and an Amnesty Program that reduces traffic ticket fines, partially offset by increased Journal Technologies’ license and maintenance fees of $681,000 and consulting fees of $387,000. The Company’s revenues derived from Journal Technologies’ operations constituted about 58% and 57% of the Company’s total revenues for the nine months ended June 30, 2016 and 2015, respectively.

Consolidated operating costs and expenses increased by $234,000 to $35,915,000 from $35,681,000, primarily resulting from additional expenses for Journal Technologies, partially offset by reduced expenses for the Traditional Business. Total personnel costs increased by $797,000 (4%) to $20,537,000 from $19,740,000 primarily resulting from added personnel for Journal Technologies. Postage and delivery expenses decreased by $133,000 (13%) to $857,000 from $990,000, and newsprint and printing expenses decreased by $256,000 (27%) to $679,000 from $935,000 primarily because of the discontinuance of publishing the California Lawyer magazine effective October 1, 2015. Other general and administrative expenses decreased by $450,000 (6%) to $6,964,000 from $7,414,000 mainly because of decreased legal, accounting and other professional service fees, partially offset by increased travel costs for installation services and selling expenses for Journal Technologies. Depreciation and amortization costs, which included primarily the amortization of Journal Technologies’ intangible assets of $3,777,000 and $3,671,000 for the nine-month periods ended June 30, 2016 and 2015, respectively, increased by $195,000 (5%) to $4,288,000 from $4,093,000 mainly resulting from the additional depreciation expense for the recently acquired Logan, Utah office building.

The Company’s non-operating income, net of expenses, increased by $32,000 to $2,714,000 from $2,682,000 primarily because of more dividend income, partially offset by increased interest rate for the two acquisition loans and additional interest expenses for the Company’s real estate loan. During the nine months ended June 30, 2016, consolidated pretax loss was $606,000 as compared with pretax income of $210,000 in the prior year period.

There was net loss of $81,000 (-$0.06 per share) for the nine months ended June 30, 2016 as compared with net income of $970,000 ($0.70 per share) in the prior year period.

At June 30, 2016, the aggregate fair market value of the Company’s marketable securities was $161,250,000. These securities had approximately $102,868,000 of unrealized gains before taxes of $40,000,000 and generated approximately $3,013,000 in dividends and interest income during the nine months ended June 30, 2016, which lowers the Company’s effective income tax rate because of the dividends received deduction. Most of the unrealized gains were in the common stocks of three U.S. financial institutions.

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

The Traditional Business

The Traditional Business segment’s pretax income increased by $71,000 (9%) to $891,000 from $820,000.

Advertising revenues decreased by $572,000 (7%) to $7,382,000 from $7,954,000 primarily resulting from the declines in commercial advertising revenues and trustee sale notice advertising revenues. Commercial advertising revenues decreased by $427,000 (16%) to $2,303,000 from $2,730,000 primarily due to the discontinuance of publishing the California Lawyer magazine and the continuing challenges in the commercial advertising business from internet sites devoted to online recruitments and steady consolidation of companies serving the legal marketplace resulting in an ever-smaller group of companies placing display advertising.

Trustee sale notices 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 14% during the nine months ended June 30, 2016 as compared to the prior year period and accounted for about a reduction of $429,000 in trustee sale notice and related service fee revenues. Because this slowing is expected to continue, the Company expects there will be fewer foreclosure notice advertisements and declining revenues in fiscal 2016, and the Company’s print-based earnings will also likely 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, 2016. Public notice advertising revenues and related advertising and other service fees constituted about 22% of the Company's total revenues for both the nine months ended June 30, 2016 and 2015. Because of this concentration, the Company’s revenues would be significantly adversely 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.

The Daily Journals accounted for about 86% of The Traditional Business' total circulation revenues, which increased by $2,000 to $4,431,000 from $4,429,000. The court rule and judicial profile services generated about 9% 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 decreased by $689,000 (5%) to $12,911,000 from $13,600,000 primarily due to decreased legal, accounting and other professional service fees of $620,000.

Journal Technologies

Journal Technologies’ business segment pretax loss increased by $949,000 (28%) to $4,311,000 from $3,362,000 and included the amortization costs of intangible assets of $3,671,000 for both the nine-month periods ended June 30, 2016 and 2015.

Revenues decreased by $21,000 to $18,768,000 from $18,789,000 in the prior year period. Licensing and maintenance fees increased by $681,000 (6%) to $11,433,000 from $10,752,000. Consulting fees increased by $387,000 (11%) to $3,788,000 from $3,401,000. 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 and are recognized ratably over the maintenance period. Other public service fees decreased by $1,089,000 (23%) to $3,547,000 from $4,636,000 primarily due to a reduction in the number of traffic tickets processed on a website for the public to pay traffic citations online and an Amnesty Program that reduces traffic ticket fines.

Operating expenses increased by $923,000 (4%) to $23,004,000 from $22,081,000 primarily due to increased personnel costs and travel expenses which are expected to continue to increase in the foreseeable future.

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. Journal Technologies 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

For the nine months ended June 30, 2016, the Company recorded an income tax benefit of $525,000 on pretax loss of $606,000. The income tax benefit was the result of applying the effective tax rate anticipated for fiscal 2016 to pretax income for the nine-month period ended June 30, 2016. The effective tax rate was lower than the statutory rate primarily due to the dividends received deduction.  On pretax income of $210,000 for the nine months ended June 30, 2015, the Company recorded an income tax benefit of $760,000 which was the net result of applying the effective tax rate anticipated for fiscal 2015 to pretax income for the nine months ended June 30, 2015.   The Company’s effective tax rate was 87% and -362% for the nine months ended June 30, 2016 and 2015, respectively.  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 2013 with regard to federal income taxes and fiscal 2012 for state income taxes. Recently, the Internal Revenue Service has commenced a review of the Company’s fiscal 2014 federal income tax.

At June 30, 2016, the Company had an accrued liability of approximately $2,805,000 for uncertain and unrecognized tax benefits relating to an acquisition in fiscal 2013, after a reduction of $439,000 resulting from the recognition of deferred revenues and from the amortization of goodwill for tax purposes. 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 to the Company’s effective tax rate.  During the nine-month periods ended June 30, 2016 and 2015, interest expenses of approximately $75,000 and $70,000, respectively, were recorded as “interest expense accrued for uncertain and unrecognized tax benefits” in the Consolidated Statements of Comprehensive (Loss) Income.

Comprehensive (Loss) Income

Comprehensive (loss) income includes net income and unrealized net losses on investments, net of taxes, as summarized below:

Comparable three-month periods ended June 30, 2016 and June 30, 2015

Consolidated revenues were $10,338,000 and $10,494,000 for the three months ended June 30, 2016 and 2015, respectively. This decrease of $156,000 (1%) was primarily from decreases in Journal Technologies’ public service fees of $531,000 mainly because of a reduction in the number of traffic tickets processed on a website for the public to pay traffic citations online and an Amnesty Program that reduces traffic ticket fines, partially offset by increased Journal Technologies’ license and maintenance fees of $364,000. The Company’s revenues derived from Journal Technologies’ operations constituted about 53% and 54% of the Company’s total revenues for the three months ended June 30, 2016 and 2015, respectively.

Consolidated operating costs and expenses increased by $481,000 (4%) to $12,120,000 from $11,639,000 mainly resulting from additional expenses for Journal Technologies. Total personnel costs increased by $503,000 (8%) to $6,860,000 from $6,357,000 primarily resulting from added personnel for Journal Technologies. Postage and delivery expenses decreased by $67,000 (19%) to $279,000 from $346,000, and newsprint and printing expenses decreased by $92,000 (27%) to $243,000 from $335,000 primarily because of the discontinuance of publishing the California Lawyer magazine effective October 1, 2015. Other general and administrative expenses decreased by $28,000 (1%) to $2,380,000 from $2,408,000 mainly because of decreased legal, accounting and other professional service fees, partially offset by increased travel costs for installation services and selling expenses for Journal Technologies. Depreciation and amortization costs, which included the amortization of Journal Technologies’ intangible assets of $1,224,000 for both the three-month periods ended June 30, 2016 and 2015, increased by $79,000 (6%) to $1,445,000 from $1,366,000 mainly resulting from the additional depreciation expense for the recently acquired Logan, Utah office building.

The Company’s non-operating income, net of expenses, decreased by $41,000 to $1,159,000 from $1,118,000 primarily because of increased interest rate for the two acquisition loans and additional interest expenses for the Company’s real estate loan. During the three months ended June 30, 2016, consolidated pretax loss was $623,000 as compared with $27,000 in the prior year period.

There was net loss of $338,000 (-$0.25 per share) for the three months ended June 30, 2016 as compared with net income of $33,000 ($0.02 per share) in the prior year period.

Liquidity and Capital Resources

During the nine months ended June 30, 2016, the Company's cash and cash equivalents and marketable security positions decreased by $10,046,000 to $171,612,000. Cash and cash equivalents were used primarily for the purchase of marketable securities of $3,838,000 and capital assets of $3,670,000, including $3,500,000 for the Logan, Utah building. The investments in marketable securities, which had an adjusted cost basis of approximately $58,382,000 and a market value of about $161,250,000 at June 30, 2016, generated approximately $3,013,000 in dividends and interest income.

Cash flows from operating activities decreased by $4,484,000 during the nine months ended June 30, 2016 as compared to prior year period primarily resulting from (i) decreases in net income of $1,051,000 and accounts payable and accrued liabilities of $1,511,000 as more liabilities were paid and (ii) increases in accounts receivable of $1,969,000 primarily due to more billings. The net cash provided by operating activities of $45,000 included decreases in deferred installation contracts and maintenance agreements of $2,248,000.

As of June 30, 2016, the Company had working capital of $117,159,000, including the liabilities for deferred subscriptions and deferred installation contracts and deferred maintenance agreements and others of $16,411,000, which are scheduled to be earned within one year, and the deferred tax liability of $40,000,000 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 note payable collateralized by real estate 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, 2016, 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 (such as the other-than-temporary impairment losses of $376,000 recognized during fiscal 2015, $1,719,000 recognized in fiscal 2013 and $2,855,000 recognized in fiscal 2012).

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, 2015. 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 declines in the market prices of the securities owned by the Company. 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, 2015.

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, 2015. There have been no material changes to the Company’s market risk exposures since September 30, 2015.

In conjunction to the adoption of the 2013 COSO framework during this fiscal year, the Company has made significant changes to its internal controls to rectify those previously identified material weaknesses mentioned in its Form 10-K for the fiscal year ended September 30, 2015. Based on the evaluation performed under the 2013 COSO framework and applicable Securities and Exchange Commission rules as of June 30, 2016 , management believes that its internal controls over financial reporting is effective.

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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