DAILY JOURNAL CORP quarterly report, Q1 FY2019

Business context and reporting period

Daily Journal Corporation’s Form 10-Q covers the three months ended December 31, 2018, its fiscal 2019 first quarter, compared with the three months ended December 31, 2017. The company operates a Traditional Business publishing newspapers and related services, and Journal Technologies, which provides case-management software and related services primarily to justice agencies. Journal Technologies generated about 60% of consolidated revenue in both periods.

Financial performance and liquidity

Revenue increased 1.7%. Operating expenses fell 5% to $12.949 million, chiefly because Journal Technologies’ acquired intangible assets were fully amortized by the end of the prior fiscal year; personnel costs rose 6% to $8.655 million. The resulting operating loss narrowed. The operating loss does not include the substantial investment mark-to-market loss described below.

Journal Technologies revenue was $6.229 million, up from $6.171 million, and its operating loss was $2.512 million versus $3.212 million. Licensing and maintenance revenue increased 10% to $4.790 million; consulting revenue fell 46% to $0.541 million because of fewer customer go-lives. Traditional Business revenue was $4.199 million versus $4.081 million, with an operating loss of $9,000 compared with $233,000.

The company adopted ASU 2016-01 on October 1, 2018. It now records unrealized equity-security gains and losses in net income; the quarter included a $28.640 million noncash net unrealized investment loss. The prior-year comparison instead recorded investment appreciation in other comprehensive income. The company reported $129.767 million of net unrealized gains in its portfolio at December 31, 2018, before tax, and concluded that an unrealized loss on one security was temporary.

Cash and cash equivalents were $6.691 million at December 31, 2018. Marketable securities were $183.656 million, bringing cash and securities to $190.347 million, down $31.250 million from September 30, 2018. The portfolio’s adjusted cost basis was $53.889 million. Working capital was $170.008 million, including $20.013 million of deferred subscription, installation, maintenance and other obligations. Total debt was approximately $31.420 million: $29.493 million of investment-margin borrowings and $1.927 million on the real-estate loan. The margin borrowings are secured by marketable securities, bear a floating rate (3% at quarter-end), and have no maturity; the real-estate loan bears a fixed 4.66% rate and is repayable through 2030.

Material changes, outlook and risks

• The net loss compares with prior-year net income, but the periods are affected by different investment accounting and an unusually large prior-year tax benefit associated primarily with the 2017 Tax Cuts and Jobs Act. The effective tax rate was 28% this quarter versus 798% in the prior-year quarter, as reported by the company.
• Management expects fewer foreclosure notices to continue and anticipates declining public-notice advertising revenue and print-based earnings in fiscal 2019; it says expense reductions may not fully offset revenue losses. Foreclosure notices published fell 14% year over year.
• Management believes available working capital and operating cash flows can fund operations for the foreseeable future. It provided no quantified revenue or earnings guidance. It may pursue acquisitions, repay borrowings or make additional investments.
• Marketable securities were concentrated in six companies, with most unrealized gains in three U.S. financial institutions and one foreign manufacturer. Management warns that declines in one or more holdings could materially reduce earnings and shareholders’ equity.
• Other stated risks include changes to laws requiring public notices, loss of a newspaper’s adjudicated status, continued declines in print advertising or circulation, software development and implementation challenges, cybersecurity incidents, and reliance on the CEO, whose work schedule had recently been reduced for a health issue.
• Management said disclosure controls and procedures were not effective as of December 31, 2018, in light of previously reported material weaknesses in internal control over financial reporting. It reported no material changes in internal control during the quarter.
• Management said ordinary-course contingencies, including litigation, were not expected to have a material effect. No subsequent events requiring recognition or disclosure were identified through issuance.

Important facts for investors to verify

1. Portfolio composition, concentration, valuation changes and the impact of further market declines on earnings, equity and borrowing capacity.
2. Progress addressing the reported internal-control material weaknesses and any effect on reporting reliability.
3. Trends in foreclosure notices, public-notice rules and advertising, including potential effects on newspaper eligibility and revenue.
4. Journal Technologies’ go-live pipeline, consulting revenue, deferred contract balances and ability to convert implementations into recurring licensing and maintenance revenue.
5. Operating cash generation, margin-account terms and collateral requirements, and the company’s plans for cash, debt repayment, investments or acquisitions.