Daily Journal Corporation — Q2 FY2019 Form 10-Q
Reporting period: Quarter and six months ended March 31, 2019; fiscal year ends September 30. The company operates a Traditional newspaper and public-notice business and Journal Technologies, which supplies case-management software and related services, primarily to government justice agencies.
Financial performance
| Metric | Three months ended March 31, 2019 | Six months ended March 31, 2019 |
|---|---|---|
| Revenue | $10.712 million, up 15% year over year | $21.140 million, up 8% |
| Operating loss | $2.671 million, versus $4.373 million | $5.192 million, versus $7.818 million |
| Net income (loss) | $5.018 million ($3.63 per share), versus a $0.232 million loss | $(16.515) million ($(11.96) per share), versus $14.507 million income |
| Operating cash flow | Not separately reported for the quarter | $(3.375) million, versus $(4.153) million |
- Six-month revenue growth came chiefly from Journal Technologies: revenue increased 15% to $12.936 million, led by licensing/maintenance fees and public-service fees. Traditional Business revenue was $8.204 million, slightly below the prior year.
- Six-month operating expenses fell 4% to $26.332 million, mainly because Journal Technologies’ intangible assets were fully amortized by the prior fiscal year-end. Salary and benefit expense increased 4% to $17.446 million.
- Journal Technologies remained loss-making at the operating level: its six-month operating loss was $5.048 million, compared with $7.616 million. Traditional Business had a $0.144 million operating loss, versus $0.202 million.
- The six-month net loss was heavily affected by $20.143 million in unrealized investment losses. Excluding that noncash item, reported operating losses remained; the filing does not present an adjusted earnings measure. In Q2, $8.497 million of unrealized investment gains contributed to quarterly net income.
Liquidity, investments and debt
- At March 31, cash and cash equivalents were $5.782 million and marketable securities were $192.153 million, versus $9.301 million and $212.296 million, respectively, at September 30, 2018. The combined decrease was $23.662 million, including the investment valuation decline.
- Working capital was $177.009 million, including $19.941 million of deferred subscriptions, installation contracts, maintenance agreements and other deferred obligations. Operating cash use was $3.375 million; capital expenditures were $0.084 million.
- Marketable securities had an adjusted cost basis of $53.889 million and fair value of $192.153 million, with $138.264 million of pretax unrealized gains remaining. The portfolio was concentrated in six companies; most unrealized gains were in three U.S. financial institutions and one foreign manufacturer.
- Debt included $29.493 million of investment margin borrowings, collateralized by marketable securities, and approximately $1.896 million of real-estate debt. The margin borrowing rate was 3% at March 31, 2019, is variable, and has no stated maturity. Six-month interest expense on margin loans was $0.425 million.
Changes, outlook and risks
- Effective October 1, 2018, the company adopted ASU 2016-01. Unrealized changes in equity-security values are now recognized in net income rather than other comprehensive income; prior periods were not restated. The $115.786 million opening accumulated other comprehensive income balance was reclassified to retained earnings.
- The prior-year six-month net income included a substantial tax benefit related primarily to the Tax Cuts and Jobs Act; the 2019 six-month tax benefit was $6.600 million, compared with $16.950 million a year earlier. This makes the year-over-year net-income comparison especially sensitive to investment marks and tax accounting.
- Management expects fewer foreclosure notices and declining public-notice advertising revenue for the remainder of fiscal 2019, and says print-based earnings may decline because expense reductions may not offset lost revenue. Changes to legal publication requirements or loss of a newspaper’s adjudicated status could materially affect this business.
- Management stated it expects to fund operations for the foreseeable future from operating cash flows and working capital. No quantified earnings or revenue guidance was provided. The company may pursue acquisitions, repay debt, or invest excess cash.
- Other disclosed risks include concentrated investment holdings and market-price declines; software development, implementation and cybersecurity risks; dependence on government-agency engagements; and the CEO’s reduced work schedule due to a health issue. Management said there were no material changes in market-risk exposures since September 30, 2018.
- Management concluded disclosure controls and procedures were not effective as of March 31, 2019, in light of material weaknesses previously reported. No material changes in internal control over financial reporting were reported during the quarter.
- Management said ordinary-course contingencies, including litigation, were not expected to materially affect financial position, results or cash flows. No subsequent events requiring recognition or disclosure were identified.
Key facts for investors to verify
- Whether Journal Technologies’ revenue growth and project go-lives can improve its operating performance, and whether implementation delays or costs persist.
- How public-notice advertising, foreclosure volumes and circulation develop against management’s stated expectation of further declines.
- The size, composition and valuation sensitivity of the concentrated securities portfolio, including the impact of future unrealized gains or losses on reported earnings and equity.
- The terms, collateral coverage and ongoing cost of margin borrowings, particularly if marketable-security values fall.
- Progress in remediating the previously disclosed material weaknesses and improving disclosure controls.
- The effects of tax benefits and accounting changes when comparing reported net income across periods.