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DJCO > SEC Filings for DJCO > Form 10-K on 12-Dec-2011All Recent SEC Filings

Show all filings for DAILY JOURNAL CORP

Form 10-K for DAILY JOURNAL CORP


12-Dec-2011

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

Results of Operations

The Company continues to operate as two different businesses: (1) The "traditional business", being the business of newspaper and magazine publishing and related services that the Company had before 1999 when it purchased Sustain, and (2) the Sustain software business, which supplies case management software systems and related products to courts and other justice agencies, including administrative law organizations.

During fiscal 2011, consolidated pretax income decreased by $272,000 (2%) to $12,000,000 from $12,272,000 in the prior year. Consolidated revenues declined by $3,067,000, and costs and expenses decreased by $2,428,000. Dividends and interest income increased by $366,000. The Company's traditional business segment pretax profit increased by $418,000 (3%) to $13,622,000 from $13,204,000 primarily because of a reduction in personnel costs related to the Company's Management Incentive Plan ("Incentive Plan"). Sustain's business segment had a pretax loss of $1,622,000 compared to $932,000 in the prior year primarily due to a decrease in consulting and support revenues from governmental agencies in part because of continuing governmental budget constraints.

                                          Reportable Segments
                                     Traditional
                                       business         Sustain           Total

      Fiscal 2011
      Revenues                       $ 31,532,000     $  2,981,000     $ 34,513,000
      Pretax income (loss)             13,622,000       (1,622,000 )     12,000,000
      Income tax benefit (expense)     (4,735,000 )        575,000       (4,160,000 )
      Net income (loss)                 8,887,000       (1,047,000 )      7,840,000

      Fiscal 2010
      Revenues                       $ 34,243,000     $  3,337,000     $ 37,580,000
      Pretax income (loss)             13,204,000         (932,000 )     12,272,000
      Income tax benefit (expense)     (4,950,000 )        350,000       (4,600,000 )
      Net income (loss)                 8,254,000         (582,000 )      7,672,000

Consolidated revenues were $34,513,000 and $37,580,000 for fiscal 2011 and 2010, respectively. This decrease of $3,067,000 (8%) was primarily from decreases of $2,135,000 (14%) in trustee sale notice and related service fee revenues, $196,000 (11%) in classified advertising revenues, $172,000 (20%) in Sustain consulting revenues and $304,000 (4%) in circulation revenues, partially offset by an increase of $47,000 (2%) in display advertising revenues. Although public notice advertising revenues were down compared to the prior year, the Company still continued to benefit from the large number of foreclosures in California and Arizona for which public notice advertising is required by law. Sustain's information systems and services revenues decreased by $356,000 (11%) primarily because of the decrease in consulting and support revenues. The Company's revenues derived from Sustain's operations constituted about 9% of the Company's total revenues for both fiscal 2011 and 2010.


Costs and expenses decreased by $2,428,000 (9%) to $23,711,000 from $26,139,000. Total personnel costs decreased by $2,530,000 (16%) to $13,473,000 primarily due to savings from departmental reorganizations and a $1,810,000 reduction in expenses related to the Incentive Plan, partially offset by annual salary adjustments. The reduction in Incentive Plan expenses consisted of a decrease of $500,000 in the Incentive Plan accrual during fiscal 2011 due to reduced consolidated pretax profits before this accrual versus an increase of $1,310,000 in the prior year. Newsprint and printing expenses decreased by $97,000 (7%) primarily resulting from fewer subscribers, partially offset by an increase in the price of paper.

The traditional business segment revenues are very much dependant on the number of California and Arizona foreclosure notices. The number of foreclosure notices published by the Company decreased by 17% during fiscal 2011 as compared to the prior year. Because this slowing is expected to continue, we anticipate there will be fewer foreclosure notice advertisements and declining revenues in fiscal 2012. We do not expect to experience an offsetting increase in commercial advertising as a result of this trend because of the continuing challenges in the commercial advertising business. The Company's smaller newspapers, those other than the Los Angeles and San Francisco Daily Journals ("The Daily Journals"), accounted for about 96% of the total public notice advertising revenues. Public notice advertising revenues and related advertising and other service fees constituted about 58% of the Company's total revenues. 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 Daily Journals accounted for about 83% of the Company's total circulation revenues. The court rule and judicial profile services generated about 14% of the total circulation revenues, with the other newspapers and services accounting for the balance.

Sustain's consulting revenues, which are subject to uncertainty because they depend on (i) the timing of the acceptance of the completed consulting tasks,
(ii) the unpredictable needs of Sustain's existing customers, and (iii) Sustain's ability to secure new customers, continued to decline in fiscal 2011 in part because many governments have reduced their budgets for services like those provided by Sustain. Revenues from Sustain's new installation projects will only be recognized, if at all, upon completion and acceptance of Sustain's services by the various customers. The Company's expenditures for the development of new Sustain software products are significant and will materially impact overall results at least through fiscal 2012. These costs are expensed as incurred until technological feasibility of the product has been established, at which time such costs are capitalized, subject to expected recovery. Sustain expensed personnel costs of $2,864,000 and $2,316,000 for the development and implementation of its Web-based case management system during fiscal 2011 and 2010, respectively. If Sustain's internal development programs are not successful, they will significantly and adversely impact the Company's ability to maximize its existing investment in the Sustain software, to service its existing customers and to compete for new opportunities in the case management software business. However, Sustain has installed its new Web-based case management system in several courts and government agencies, and additional installations are in progress.

On a pretax profit of $12,000,000 and $12,272,000 for fiscal 2011 and 2010, the Company recorded a tax provision of $4,160,000 and $4,600,000, respectively, which was lower in each case than the amount computed using the statutory rate because of the available dividends received deduction and the domestic production activity deduction (which increased in fiscal 2011). Consequently, the Company's effective tax rate was 34.7% and 37.5% for fiscal 2011 and 2010, respectively. The Company files federal income tax returns in the United States and with various state jurisdictions and is no longer subject to examinations for years before 2002 as well as for years 2008 and 2009 with regard to federal income taxes. The Internal Revenue Service has been examining the tax returns for years 2002 to 2007 and has proposed an assessment that, if upheld, would result in disallowance of about $700,000 of previously claimed research and development credits. As of September 30, 2011, the Company had approximately $700,000 of unrecognized tax benefits all of which would have an effective rate impact if recognized. The Company is continuing to contest the issue in the United States Tax Court, and the ultimate resolution of this dispute cannot be ascertained at this time. Net income per share increased to $5.68 from $5.56.


Liquidity and Capital Resources

During fiscal 2011, the Company's cash and cash equivalents, U.S. Treasury and marketable security positions increased by $5,078,000. Cash and cash equivalents and U.S. Treasury Bills were used primarily for the purchase of marketable securities of $11,154,000 and capital assets of $129,000 (mostly computer software and office equipment). In February 2009, the Company purchased shares of common stock of two Fortune 200 companies and certain bonds of a third. During the second and the third quarters of fiscal 2011, the Company bought shares of common stock of two foreign manufacturing companies. The investments in marketable securities, which cost approximately $31,584,000 and had a market value of about $56,116,000 at September 30 2011, generated about $1,233,000 in dividends and interest income which lowers the effective income tax rate because of the dividends received deduction. As of September 30, 2011, there were unrealized pretax gains of $24,532,000 as compared to $29,655,000 at September 30, 2010. Most of the unrealized gains were in the common stocks.

The cash provided by operating activities of $10,317,000 included a net increase in deferred subscription and other revenues of $401,000. Proceeds from the sale of subscriptions from newspapers, court rule books and other publications and for software licenses and maintenance and other services are recorded as deferred revenue and are included in earned revenue only when the services are rendered. Cash flows from operating activities increased by $993,000 during fiscal 2011 as compared to the prior year primarily resulting from a decrease in accounts receivable of $2,614,000, partially offset by a decrease in accounts payable and accrued liabilities of $1,136,000.

As of September 30, 2011, the Company had working capital of $58,378,000, including the liability for deferred subscription and other revenues of $5,405,000 which are scheduled to be earned within one year and the deferred tax liability of $9,772,000 for the unrealized gains described above.

The Company believes that it will be able to fund its operations for the foreseeable future through its cash flows from operating activities and its current working capital and expects that any such cash flows will be invested in its two businesses. The Company also may entertain business acquisition opportunities. Any excess cash flows will be invested as management and the Board of Directors deem appropriate at the time.

Such investments may include additional securities of the companies in which the Company has already invested, securities of other companies, government securities (including U.S. Treasury Notes and Bills) or other instruments. The decision as to particular investments will be driven by the Company's belief about the risk/reward profile of the various investment choices at the time, and it may utilize government securities as a default if attractive opportunities for a better return are not available. The Company's Chairman of the Board, Charles Munger, is also the vice chairman of Berkshire Hathaway Inc., which maintains a substantial investment portfolio. The Company's Board of Directors has utilized his judgment and suggestions, as well as those of J.P. Guerin, the Company's vice chairman, when selecting investments, and both of them will continue to play an important role in monitoring existing investments and selecting any future investments.


As noted above, however, the investments are concentrated in just five companies. Accordingly, a significant decline in the market value of one or more of the Company's investments may not be offset by the hypothetically better performance of other investments, and that could result in a large decrease in the Company's stockholders' equity and, under certain circumstances, in the recognition of impairment losses in the Company's income statement.

Critical Accounting Policies

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 capitalized software costs and income taxes are critical accounting policies.

The Company recognizes revenues from both the lease and sale of software products. Revenues from leases of software products are recognized over the life of the lease while revenues from software product sales are recognized normally upon delivery, installation or acceptance pursuant to a signed agreement. Revenues from annual maintenance contracts generally call for the Company to provide software updates and upgrades to customers and are recognized ratably over the maintenance period. Consulting and other services are recognized as performed or upon acceptance by the customers. Proceeds from the sale of subscriptions for newspapers, court rule books and other publications and other services are recorded as deferred revenue and are included in earned revenue only when the services are provided, generally over the subscription or lease term. Advertising revenues are recognized when advertisements are published and are net of commissions.

Accounting Standards Codification ("ASC") 985-20, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, provides that costs related to the research and development of a new software product are to be expensed as incurred until the technological feasibility of the product is established. Accordingly, costs related to the development of new Sustain software products are expensed as incurred until technological feasibility has been established, at which time such costs are capitalized, subject to expected recoverability. In general, "technological feasibility" is achieved when the developer has established the necessary skills, hardware and technology to produce a product and a detailed program design has been (i) completed, (ii) traced to the product specifications and (iii) reviewed for high-risk development issues.

ASC 740, Income Taxes, establishes financial accounting and reporting standards for the effect of income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and the deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns. This accounting guidance also prescribes recognition thresholds and measurement attributes for the financial statements recognition and measurement of a tax position taken or expected to be taken in a tax return. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could materially impact the Company's financial position or its results of operations. See Note 3 of Notes to Consolidated Financial Statements for further discussion.

The above discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included in this report.


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