Daily Journal Corp: Form 10-Q for the period ended Dec 31, 2022

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., 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 the public, including efiling and a website to pay traffic citations and fees online. These products are licensed in 30 states and internationally.

Impact of the COVID-19 Pandemic

On March 13, 2020, the United States declared the outbreak of COVID-19 to be a national emergency, and several states and municipalities also declared public health emergencies. Unprecedented actions were taken by public health and other governmental authorities to contain and combat the spread of COVID-19, including “stay-at-home” orders and similar mandates that restricted the daily activities of individuals and limited the operation of businesses that were deemed “non-essential”. In addition, most of Journal Technologies’ customers, which are primarily courts and governmental agencies in the United States, Canada and Australia, were either closed or significantly scaled back their activities. Similarly, many law firms and companies from which the Traditional Business derives advertising and subscription revenues also curtailed their in-person operations and spending.

Due to the uncertainties associated with the duration and severity of the COVID-19 pandemic, the efforts to contain it, and the related changes in business operations and personal behaviors, management cannot at this point estimate the magnitude of its impact on the Company’s business operations. In recent years, the newspaper industry, including our Traditional Business, has declined, and we expect this general trend to continue due to the impacts of COVID-19 and its aftermath, including fewer lawyers receiving our newspapers at their offices as they continue to work from home.

For Journal Technologies, there have been several delays or cancellations in government procurement processes. Also, although we have been able to complete some existing projects remotely, we have been delayed in finishing certain implementations and trainings because of our inability to work with clients in-person. Given that we are typically paid for implementation services upon “go-live” of a system, receipt of those revenues has been delayed.

Reportable Segments

The Company’s Traditional Business is one reportable segment and the other is Journal Technologies which includes Journal Technologies, Inc. and Journal Technologies (Canada) Inc. All inter-segment transactions were eliminated. Additional detail about each reportable segment and its income and expenses is set forth below:

Overall Financial Results (000)

For the three months ended December 31, 2022 and 2021

During the three months ended December 31, 2022, the Traditional Business had total operating revenues of $3,787,000 with $2,689,000 recognized after services were provided and $1,098,000 recognized ratably over the publication subscription terms, as compared with total operating revenues of $3,782,000 with $2,672,000 recognized after services were provided and $1,110,000 recognized ratably over the publication subscription terms in the prior fiscal year period. Total operating revenues for the Company’s software business were $8,514,000 with $4,121,000 recognized upon completion of services and $4,393,000 recognized ratably over the subscription periods, as compared with total operating revenues of $7,954,000 with $3,476,000 recognized upon completion of services and $4,478,000 recognized ratably over the subscription periods in the prior fiscal year period.

Approximately 69% of the Company’s revenues during the three-month period ended December 31, 2022 were derived from Journal Technologies, as compared with 68% in the prior year period. In addition, the Company’s revenues have been primarily from the United States with approximately 7% from foreign countries during the three-months ended December 31, 2022. Journal Technologies’ revenues are primarily from governmental agencies.

Comparable three-month periods ended December 31, 2022 and 2021

Consolidated Financial Comparison

Consolidated revenues were $12,301,000 and $11,736,000 for the three months ended December 31, 2022 and 2021, respectively. This increase of $565,000 (5%) was primarily from increases in (i) Journal Technologies’ consulting fees of $561,000 and other public service fees of $84,000 and (ii) the Traditional Business’ advertising service fees and other of $28,000, partially offset by decreases in (i) Journal Technologies’ license and maintenance fees of $85,000 and (ii) the Traditional Business’ advertising revenues of $11,000 and circulation revenues of $12,000.

Consolidated operating expenses increased by $1,337,000 (11%) to $13,017,000 from $11,680,000. Total salaries and employee benefits increased by $1,154,000 (14%) to $9,631,000 from $8,477,000 primarily because of bigger salary adjustments due to recent inflation in the compensation market for talent. Outside services increased by $165,000 (18%) to $1,089,000 from $924,000 mainly because of increased third-party hosting fees which were billed to clients. Newsprint and printing expenses increased by $40,000 (25%) to $199,000 from $159,000 primarily resulting from newsprint price increases and additional purchases of printing supplies. Equipment maintenance and software increased by $63,000 (26%) to $303,000 from $240,000 mainly resulting from increased maintenance costs. Accounting and legal fees decreased by $47,000 (15%) to $273,000 from 320,000 primarily from decreased legal fees. Other general and administrative expenses increased by $356,000 (48%) to $1,095,000 from $739,000 mainly because there were increased miscellaneous office software purchases and business travel expenses as compared to the prior fiscal year period.

The Company’s non-operating income, net of expenses, increased by $13,261,000 (117%) to $24,643,000 from $11,382,000 in the prior fiscal year period primarily because of (i) the recording of net unrealized gains on marketable securities of $24,025,000 during the three months ended December 31, 2022 as compared with net unrealized losses of $36,088,000 in the prior fiscal year period, and (ii) increases in dividends and interest income of $194,000 (22%) to $1,069,000 from $875,000. These increases were partially offset by (i) the recording of realized net gains on sales of marketable securities of $422,000 during the three months ended December 31, 2022 as compared with $46,694,000 in the prior fiscal year period and (ii) increases in interest expenses of $774,000 (782%) to $873,000 from $99,000, primarily due to the federal rate increases.

During the three months ended December 31, 2022, the Company’s consolidated pretax income was $23,927,000, as compared to $11,438,000 in the prior fiscal year period. There was consolidated net income of $17,827,000 ($12.95 per share) for the three months ended December 31, 2022, as compared with $6,878,000 ($4.98 per share) in the prior fiscal year period.

At December 31, 2022, the aggregate fair market value of the Company’s marketable securities was $307,151,000. These securities had approximately $144,717,000 of net unrealized gains before taxes of $38,290,000. They generated approximately $1,069,000 in dividends income during the three months ended December 31, 2022, as compared with $875,000 in the prior fiscal year period. Most of the unrealized gains were in the common stocks of three U.S. financial institutions and one foreign manufacturer.

Taxes

For the three months ended December 31, 2022, the Company recorded an income tax provision of $6,100,000 on the pretax income of $23,927,000. The income tax provision consisted of a tax provision of $110,000 on the realized gains on marketable securities and $6,360,000 on the unrealized gains on marketable securities, partially offset by a tax benefit of $140,000 on loss from operations, $80,000 for the dividends received deduction and other permanent book and tax differences, and $150,000 for the effect of a change in state apportionment on the beginning of the year’s deferred tax liability. Consequently, the overall effective tax rate for the three months ended December 31, 2022 was 25.49%, after including the taxes on the realized and unrealized gains on marketable securities.

For the three months ended December 31, 2021, the Company recorded a provision for income taxes of $4,560,000 on pretax income of $11,438,000. The income tax provision consisted of a tax provision of $230,000 on income from operations, a tax provision of $12,612,000 on the realized gains on marketable securities and a tax provision of $1,556,000 for the effect of a change in state apportionment on the beginning of the year’s deferred tax liability, partially offset by a tax benefit of $9,747,000 on the unrealized losses on marketable securities, and a tax benefit of $91,000 for the dividends received deduction and other permanent book and tax differences. Consequently, the overall effective tax rate for the three months ended December 31, 2021 was 39.87%, after including the taxes on the realized gains and unrealized losses on marketable securities.

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 2019 with regard to federal income taxes and fiscal 2018 for state income taxes.

The Traditional Business

The Traditional Business’ pretax income increased by $429,000 (85%) to $935,000 from $506,000 in the prior fiscal year period, primarily resulting from a decrease to the long-term supplemental compensation accrual of $410,000 (456%) to $500,000 from $90,000 in the prior fiscal year period.

During the three months ended December 31, 2022, the Traditional Business had total operating revenues of $3,787,000, as compared with $3,782,000 in the prior fiscal year period. Advertising revenues decreased by $11,000 (1%) to $1,990,000 from $2,001,000, primarily resulting from decreased commercial advertising revenues of $47,000, legal notice advertising revenues of $7,000 and government notice advertising revenues of $12,000, partially offset by increased trustee sale notice advertising revenues of $55,000 mainly because of the lifting of Covid-related foreclosure moratoriums on lenders.

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 increased by 44% during the three months ended December 31, 2022 as compared to the prior fiscal year period. The Company’s smaller newspapers, those other than the Los Angeles and San Francisco Daily Journals (“The Daily Journals”), accounted for about 88% of the total public notice advertising revenues during the three months ended December 31, 2022. Public notice advertising revenues and related advertising and other service fees, including trustee sales legal advertising revenues, constituted about 22% of the Company's total operating revenues for the three months ended December 31, 2022 and 23% in the prior fiscal year period.

The Daily Journals accounted for about 92% of the Traditional Business’ total circulation revenues, which declined by $12,000 (1%) to $1,098,000 from $1,110,000. The court rule and judicial profile services generated about 5% 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, excluding the adjustments to the long-term supplemental compensation accrual, decreased by $14,000 to $3,352,000 from $3,366,000, primarily resulting from reduced legal fees.

Journal Technologies

During the three months ended December 31, 2022, Journal Technologies’ business segment pretax loss increased by $1,201,000 (267%) to $1,651,000 from $450,000 in the prior fiscal year period.

Revenues increased by $560,000 (7%) to $8,514,000 from $7,954,000 in the prior fiscal year period. Licensing and maintenance fees decreased by $85,000 (2%) to $4,395,000 from $4,480,000 primarily resulting from the reduction in legacy software products’ maintenance and support revenues. Consulting fees increased by $561,000 (32%) to $2,322,000 from $1,761,000 mainly resulting from more project go-lives. Other public service fees increased by $84,000 (5%) to $1,797,000 from $1,713,000 primarily because of increased efiling fee revenues.

Deferred consulting fees primarily represent advances from customers of Journal Technologies for installation services and are recognized upon final project go-lives. Deferred revenues on license and maintenance contracts represent prepayments of annual license and maintenance fees and are recognized ratably over the maintenance period.

Operating expenses increased by $1,761,000 (21%) to $10,165,000 from $8,404,000 primarily because of (i) increased personnel costs because of bigger salary adjustments due to recent inflation in the compensation market for talent, (ii) increased third-party hosting fees which were billed to clients and (iii) additional miscellaneous office software license purchases and increased business travel expenses.

Journal Technologies continues to update and upgrade its software products. These costs are expensed as incurred and will impact earnings at least through the foreseeable future.

Liquidity and Capital Resources

For the three-months ended December 31, 2022, the Company’s cash and cash equivalents, restricted cash, and marketable security positions increased by $32,797,000, after the sales of marketable securities of approximately $2,826,000 and additional borrowing of $6,011,000 from the margin loan account, partially offset by the recording of net pretax unrealized gains on marketable securities of $24,025,000. Cash, cash equivalents, the proceeds from the sales of marketable securities and additional borrowing were primarily used to purchase additional marketable securities of $10,001,000.

The investments in marketable securities, which had an adjusted cost basis of approximately $162,434,000 and a market value of about $307,151,000 at December 31, 2022, generated approximately $1,069,000 in dividends income during the three months ended December 31, 2022. These securities had approximately $144,717,000 of net unrealized gains before estimated taxes of $38,290,000 which will become due only when we sell securities in which there is unrealized appreciation.

Cash flows from operating activities increased by $2,073,000 during the three months ended December 31, 2022, as compared to the prior fiscal year period, primarily due to (i) decreases in the Company’s deferred tax benefit of $14,064,000 and its accounts receivable of $3,204,000 mainly resulting from more collections and (ii) increases in deferred revenues of $448,000. This was partially offset by (i) decreases in net income of $2,892,000, excluding the increases in unrealized gains on marketable securities of $60,113,000 and decreases in realized net gains on sales of marketable securities of $46,272,000 and (ii) decreases in the Company’s income tax payable of $12,527,000 and (iii) decreases in net accounts payable and accrued liabilities of $249,000 (because of the timing difference in remitting efiling fees to the courts)

As of December 31, 2022, the Company had working capital of $305,380,000, including the liabilities for deferred subscriptions, deferred consulting fees and deferred maintenance agreements and others of $21,677,000.

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. The Company may or may not have the ability to borrow additional amounts against its marketable securities and, among other possibilities, it may be required to consider selling some of those securities to generate cash if needed to fund ongoing operations. The amount available for borrowing is based on the market value of the Company’s investment portfolio and fluctuates depending on the value of the underlying securities. In addition, the Company could be subject to margin calls should the balance of the investment decrease significantly.

The Company is not a smaller version of Berkshire Hathaway Inc. Instead, it hopes to be a significant software company while it also operates its Traditional Business.

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 the long-term Incentive Plan liabilities) 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, 2022. 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; 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; the impacts of COVID-19 and the efforts to contain it on the Company’s customers, advertisers and subscribers, particularly the closure or scaling back of operations of courts, justice agencies and other businesses; a further decline in subscriber revenues; possible security breaches of the Company’s software or websites; 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, 2022.

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, 2022, management concluded that the Company’s disclosure controls and procedures were not effective as of December 31, 2022. 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 quarter ended December 31, 2022.