Business Context and Reporting Period
Company: Daily Journal Corp.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 31, 2010
Operations: The Company operates two primary segments: a "Traditional Business" publishing newspapers, magazines (California Lawyer), and providing public notice advertising services; and "Sustain Technologies," a subsidiary supplying case management software to courts and justice agencies. Operations are primarily based in California, Arizona, and Colorado.
Key Financial Metrics
| Metric | Q3 2011 (Ended Dec 31, 2010) | Q3 2010 (Ended Dec 31, 2009) |
|---|---|---|
| Total Revenues | $9,295,000 | $9,858,000 |
| Net Income | $2,184,000 | $2,088,000 |
| Income from Operations | $3,187,000 | $3,157,000 |
| Net Cash from Operating Activities | ($110,000) | $3,127,000 |
| Cash and Cash Equivalents | $3,483,000 | $3,012,000 |
| Working Capital | $61,956,000 | N/A |
| Effective Tax Rate | 35.6% | 38.0% |
| Diluted EPS | $1.58 | $1.51 |
Investment Portfolio: The Company holds significant marketable securities (common stocks and bonds) with a fair value of $60,363,000 and U.S. Treasury Notes/Bills of $13,499,000. Unrealized gains on these investments totaled approximately $39.9 million as of December 31, 2010.
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased by $563,000 (6%) compared to the prior year. This was driven by declines in public notice advertising ($210,000), classified advertising ($40,000), Sustain consulting revenues ($46,000), and circulation revenues ($125,000). Display advertising increased slightly by $29,000.
- Profitability Increase: Despite lower revenues, Net Income increased by $96,000 (4.6%) and Pretax Income increased by $21,000 (1%). This was achieved through a $593,000 (9%) reduction in costs and expenses, primarily due to a $656,000 decrease in personnel costs resulting from departmental reorganizations and reduced incentive plan accruals.
- Segment Performance:
- Traditional Business: Pretax profit increased to $3,676,000 from $3,608,000.
- Sustain: Pretax loss widened to ($287,000) from ($240,000) due to decreased consulting revenues from governmental agencies.
- Cash Flow: Net cash provided by operating activities turned negative at ($110,000), a significant decrease from $3,127,000 in the prior year. This was primarily due to a $4,021,000 increase in accounts receivable and a $440,000 decrease in deferred subscription revenues.
Outlook, Risks, and Management Commentary
- Foreclosure Trend: Management anticipates declining earnings in the traditional business segment for fiscal 2011. Public notice advertising revenues are heavily dependent on foreclosure notices, which decreased by 9% in the quarter. Management does not expect commercial advertising to offset this decline.
- Sustain Risks: Sustain's consulting revenues are subject to uncertainty due to government budget reductions and the timing of project acceptance. Significant internal development costs ($576,000 for the quarter) are expensed until technological feasibility is established; failure of these programs could adversely impact future competitiveness.
- Tax Contingency: The IRS is auditing tax returns for years 2002-2007 and has proposed disallowing approximately $700,000 in research and development credits. The Company is contesting this in Tax Court. A reserve of $700,000 has been established.
- Investment Concentration: The Company's investment portfolio is concentrated in just three companies. A significant decline in the market value of these holdings could materially decrease shareholders' equity.
- Liquidity: The Company maintains strong liquidity with $61.9 million in working capital and expects to fund operations through cash flows and existing capital. Excess cash may be used for stock repurchases or acquisitions.
Investor Verification Checklist
- Foreclosure Volume: Verify the trend in California and Arizona foreclosure notices to assess the sustainability of the Traditional Business revenue stream.
- Sustain Contract Pipeline: Review the status of Sustain's government contracts and the timeline for new software product feasibility to gauge the turnaround potential of the software segment.
- Tax Dispute Resolution: Monitor the status of the IRS audit regarding the $700,000 R&D credit disallowance.
- Investment Valuation: Assess the current market value of the three concentrated equity holdings, as unrealized gains represent a significant portion of the company's equity.
- Accounts Receivable: Analyze the aging of the $11.4 million accounts receivable balance, which increased significantly during the quarter and contributed to negative operating cash flow.