DJCO 10-Q Quarter ended June 30, 2017

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2017

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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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

Page Nos.

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 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. These organizations use the Journal Technologies family of products to help manage cases and information electronically, to interface with other critical justice partners and to extend electronic services to bar members and the public, including a website to pay traffic citations online. These products are licensed to more than 500 organizations in 42 states and internationally.

Comprehensive Income (Loss)

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

Comparable nine-month periods ended June 30 , 2017 and 2016

Consolidated revenues were $30,470,000 and $32,595,000 for the nine months ended June 30, 2017 and 2016, respectively. This decrease of $2,125,000 (7%) was primarily from the reduction in (i) The Traditional Business’s trustee sale notice and its related service fee revenues of $527,000 and (ii) Journal Technologies’ consulting fees of $761,000 and public service fees of $1,070,000 primarily due to a reduction in the number of traffic tickets processed online for the public to pay traffic citations, partially offset by increased Journal Technologies’ license and maintenance fees of $331,000. The Company’s revenues derived from Journal Technologies’ operations constituted about 57% and 58% of the Company’s total revenues for the nine months ended June 30, 2017 and 2016, respectively.

Consolidated operating expenses increased by $4,307,000 (12%) to $40,222,000 from $35,915,000, primarily resulting from additional personnel costs and services for Journal Technologies. Total personnel costs increased by $3,327,000 (16%) to $23,864,000 from $20,537,000. Outside services increased by $593,000 (23%) to $3,183,000 from $2,590,000. Depreciation and amortization costs, which included primarily the amortization of Journal Technologies’ intangible assets of $3,671,000 for both fiscal periods, decreased by $84,000 to $4,204,000 from $4,288,000.

The Company’s non-operating income, net of expenses, increased by $1,180,000 (43%) to $3,894,000 from $2,714,000 primarily because of the interest and penalty expense reversal of $743,000 for uncertain and unrecognized tax benefits and more dividend income, partially offset by increases in the interest rate on the two acquisition margin loans and additional interest expense for the Company’s real estate loan.

During the nine months ended June 30, 2017, consolidated pretax loss was $5,858,000 after recording the interest and penalty expense reversal of $743,000 for uncertain and unrecognized tax benefits as compared with $606,000 in the prior year period. There was net income of $157,000 ($0.11 per share) for the nine months ended June 30, 2017, primarily because of the reversal of the tax liability for uncertain and unrecognized tax benefits, as compared with a net loss of $81,000 (-$0.06 per share) in the prior year period. (See Taxes .)

At June 30, 2017, the aggregate fair market value of the Company’s marketable securities was $210,553,000. These securities had approximately $147,161,000 of unrealized gains before taxes of $57,240,000 and generated approximately $3,491,000 in dividends and interest income during the nine months ended June 30, 2017 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 decreased by $1,037,000 to a pretax loss of $146,000 from pretax income of $891,000.

Advertising revenues decreased by $549,000 to $6,833,000 from $7,382,000 primarily resulting from the declines in trustee sale notice advertising and its related service fee revenues of $527,000.

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 27% during the nine months ended June 30, 2017 as compared to the prior year period. Because this slowing is expected to continue, the Company expects there will be fewer foreclosure notice and other public notice advertisements and declining revenues in fiscal 2017, and the Company’s print-based earnings will also likely decline significantly because it will be impractical for the Company to offset all revenue losses 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 89% of the total public notice advertising revenues in the nine months ended June 30, 2017. Public notice advertising revenues and related advertising and other service fees constituted about 22% of the Company’s total revenues for both of the nine-month periods ended June 30, 2017 and 2016. Because of this concentration, the Company’s revenues would be significantly adversely affected if California and Arizona eliminated the legal requirement to publish public notices in adjudicated newspapers of general circulation, as had been recently implemented in Arizona for one notice type with approximately $500,000 in annual revenues. 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 87% of The Traditional Business’ total circulation revenues, which declined by $173,000 to $4,258,000 from $4,431,000. 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 increased by $384,000 (3%) to $13,295,000 from $12,911,000.

Journal Technologies

Journal Technologies’ business segment pretax loss increased by $4,605,000 (107%) to $8,916,000 from $4,311,000 after recording the interest and penalty expense reversal of $743,000 for uncertain and unrecognized tax benefits in March 2017 and including the amortization costs of intangible assets of $3,671,000 for both of the nine-month periods ended June 30, 2017 and 2016. (See Taxes .)

Revenues decreased by $1,500,000 (8%) to $17,268,000 from $18,768,000 in the prior year period. Licensing and maintenance fees increased by $331,000 (3%) to $11,764,000 from $11,433,000. Consulting fees decreased by $761,000 (20%) to $3,027,000 from $3,788,000. Consulting revenues from installations projects will only be recognized, if at all, upon completion and acceptance of the services by customers. Deferred revenues on installation contracts primarily represent the fair value of advances from customers of Journal Technologies for installation services. Only upon completion and a customer’s acceptance does the customer realize value, and any 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 $1,070,000 (30%) to $2,477,000 from $3,547,000 primarily due to a reduction in the number of traffic tickets processed online for the public to pay traffic citations.

Operating expenses increased by $3,923,000 (17%) to $26,927,000 from $23,004,000 primarily due to increased personnel costs.

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 15 years 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, 2017, the Company recorded an income tax benefit of $6,015,000 on pretax loss of $5,858,000.

The Company had an accrued liability of approximately $2,655,000 for uncertain and unrecognized tax benefits relating to an acquisition in fiscal 2013. During the second quarter of fiscal 2017, the Internal Revenue Service concluded its examination of the Company’s fiscal 2014 income tax return and proposed no changes to the tax position that gave rise to this liability. Consequently, this liability was reversed in March 2017 along with the related accrued interest and penalty expenses of $743,000. In addition, a deferred tax liability, in the amount of $352,000, relating to temporary differences that would only exist if the uncertain tax position was never recognized, was reversed.

The income tax benefit was also the result of applying the effective tax rate anticipated for fiscal 2017 to pretax loss for the nine-month period ended June 30, 2017. The effective tax rate (before the discrete item discussed above) was greater than the statutory rate primarily due to the dividends received deduction which increases the loss for tax purposes.  On pretax loss of $606,000 for the nine months ended June 30, 2016, the Company recorded an income tax benefit of $525,000 which was the net result of applying the effective tax rate anticipated for fiscal 2016 to pretax loss for the nine months ended June 30, 2016. The Company’s effective tax rate was 103% and 87% for the nine months ended June 30, 2017 and 2016, respectively.

The Company files consolidated 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 2015 with regard to federal income taxes and fiscal 2013 for state income taxes.

Comparable three-month periods ended June 30 , 2017 and 2016

Consolidated revenues were $10,201,000 and $10,338,000 for the three months ended June 30, 2017 and 2016, respectively. This decrease of $137,000 (1%) was primarily from the reduction in (i) The Traditional Business’s trustee sale notice and related service fee revenues of $218,000 and (ii) Journal Technologies’ public service fees of $156,000 primarily due to a reduction in the number of traffic tickets processed online for the public to pay traffic citations. These decreases were partially offset by increases in Journal Technologies’ license and maintenance fees of $237,000 and consulting fees of $121,000. The Company’s revenues derived from Journal Technologies’ operations constituted about 55% and 53% of the Company’s total revenues for the three months ended June 30, 2017 and 2016, respectively.

Consolidated operating expenses increased by $1,714,000 (14%) to $13,834,000 from $12,120,000 primarily due to increased personnel costs and services for Journal Technologies. Total personnel costs increased by $1,266,000 (18%) to $8,126,000 from $6,860,000. Outside services increased by $203,000 (22%) to $1,116,000 from $913,000. Depreciation and amortization costs, which included primarily the amortization of Journal Technologies’ intangible assets of $1,224,000 for both fiscal periods, decreased by $22,000 to $1,423,000 from $1,445,000.

The Company’s non-operating income, net of expenses, decreased by $342,000 to $817,000 from $1,159,000 primarily because of the timing difference of one invested company’s dividend declaration dates which occurred during the second quarter of this fiscal year as compared to the third quarter of the prior fiscal year. There were also increases in the interest rate on the two acquisition margin loans.

During the three months ended June 30, 2017, consolidated pretax loss was $2,816,000, as compared with $623,000 in the prior year period. There was a net loss of $1,351,000 (-$0.98 per share) for the three months ended June 30, 2017, as compared with a net loss of $338,000 (-$0.25 per share) in the prior year period.

Liquidity and Capital Resources

During the nine months ended June 30, 2017, the Company’s cash and cash equivalents and marketable security positions increased by $35,143,000 to $213,188,000. Cash and cash equivalents were used primarily for the purchase of marketable securities of $5,013,000 and capital assets of $251,000. The investments in marketable securities, which had an adjusted cost basis of approximately $63,392,000 and a market value of about $210,553,000 at June 30, 2017, generated approximately $3,491,000 in dividends and interest income.

Cash flows from operating activities decreased by $3,475,000 during the nine months ended June 30, 2017 as compared to the prior year period primarily resulting from increases in deferred taxes of $2,835,000 and decreases in net income tax payable of $2,374,000 because of the reversal of the liability for uncertain and unrecognized tax benefits mentioned above, partially offset by increases in net income of $238,000 and net increases in accounts payable and accrued liabilities of $1,373,000. The net cash used in operating activities of $3,430,000 included net decreases of $527,000 in deferred subscriptions, deferred installation contracts and deferred maintenance agreements and others.

As of June 30, 2017, the Company had working capital of $140,890,000, including the liabilities for deferred subscriptions and deferred installation contracts and deferred maintenance agreements and others of $17,101,000, which are scheduled to be earned within one year, and the deferred tax liability of $57,240,000 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 operations 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. 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, 2017, 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, 2016. 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, 2016.

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, 2016. There have been no material changes to the Company’s market risk exposures since September 30, 2016.

An evaluation was performed under the supervision and with the participation of the Company’s management, including Gerald L. Salzman, its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2017. Based on that evaluation, Mr. Salzman concluded that the Company’s disclosure controls and procedures were effective. 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-month period ended June 30, 2017.

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.

DATE: August 8, 2017

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