Business Context and Reporting Period
Daily Journal Corporation (Daily Journal) is a publisher of newspapers and websites covering California, Arizona, and Nevada, including the Daily Journal and California Lawyer. The company also operates Sustain Technologies, Inc., a 93% owned subsidiary providing case management software to courts and justice agencies. This Form 10-Q covers the quarterly period ended June 30, 2006, and the nine-month period ended June 30, 2006.
Key Financial Metrics
Revenue (Nine Months Ended June 30, 2006): $25,079,000
- Advertising: $13,569,000
- Circulation: $6,938,000
- Information Systems and Services (Sustain): $2,380,000
Profitability:
- Net Income: $1,647,000 (vs. $3,409,000 in prior year)
- Income from Operations: $2,739,000
- Net Income Per Share (Basic & Diluted): $1.13
Cash Flow and Liquidity:
- Cash and Cash Equivalents (June 30, 2006): $829,000
- U.S. Treasury Notes and Bills: $15,517,000 (Current: $9,058,000; Long-term: $6,459,000)
- Cash Provided by Operating Activities: $2,290,000
- Working Capital (excluding deferred revenue): $8,621,000
Debt:
- Total Notes Payable: $4,254,000 ($192,000 current; $4,062,000 long-term)
- Interest Rate: Fixed at 6.84% on two real estate loans secured by Los Angeles buildings.
Material Changes vs. Prior Period
Revenue Decline: Total revenue decreased by $824,000 (3%) compared to the nine months ended June 30, 2005. This was primarily driven by a $1,010,000 drop in Information Systems and Services revenue due to lower consulting revenues from Sustain and a $274,000 decline in circulation revenues. These decreases were partially offset by growth in advertising revenue.
Profitability Drop: Net income fell significantly to $1,647,000 from $3,409,000 in the prior year. While the traditional publishing segment increased its pretax profit by $545,000 to $4,088,000, the Sustain segment swung from a $41,000 profit to a $1,176,000 loss.
Tax Provision: The effective tax rate increased materially. The tax provision was $1,265,000 on $2,912,000 of pretax income, compared to only $175,000 on $3,584,000 of pretax income in the prior year. The prior year benefited from state tax carry-forwards and federal R&D credits not available in the current period.
Guidance, Outlook, and Risks
Outlook: Management expects Sustain's consulting revenues for fiscal 2006 to be approximately 50% lower than fiscal 2005. This is due to the deferral of about $1.5 million in contracted projects into fiscal 2007. Future consulting revenues remain uncertain, dependent on project acceptance timing and customer needs.
Development Costs: Sustain incurred $1,159,000 in internal software development costs for the nine-month period. Management notes that if these development programs are not successful, they will significantly and adversely impact the company's ability to compete and service customers.
Contingencies:
- Ontario, Canada Dispute: The Ontario Ministries claimed $20 million in damages regarding a terminated contract. Management is unable to determine if this will have a material adverse effect, though Sustain intends to vigorously defend against any action.
- Bankruptcy Dispute: A terminated outside service provider filed for bankruptcy in 2001 and may bring a collection action. Sustain plans to assert counter-claims to offset any such claims.
Investor Verification Checklist
- Verify the sustainability of the 50% projected decline in Sustain consulting revenues and the timing of deferred project revenue recognition.
- Assess the impact of the loss of federal R&D tax credits and state loss carry-forwards on future effective tax rates.
- Monitor the status of the $20 million potential claim from the Ontario, Canada Ministries and the outcome of the dispute with the bankrupt service provider.
- Review the success of Sustain's internal software development programs, given the high expensed costs ($1.159M) and the risk to future competitiveness.
- Confirm the stability of the traditional publishing segment's advertising revenue growth, which is currently offsetting declines in other areas.