Item 2. MANAGEMENT
’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of Op
erations
The
Company continues to operate as two different businesses: (1) The Traditional Business, being the business of newspaper publishing and related services that the Company had before 1999 when it purchased a software development company, and (2) Journal Technologies, Inc. (“Journal Technologies”), a wholly-owned subsidiary which supplies case management software systems and related products to courts, prosecutor and public defender offices, probation departments and other justice agencies, including administrative law organizations, city and county governments and bar associations. These organizations use the Journal Technologies family of products to help manage cases and information electronically, to interface with other critical justice partners and to extend electronic services to the public, including efiling and a website to pay traffic citations online, and bar members. These products are licensed to more than 500 organizations in 42 states and internationally.
Comprehensive Income
Com
prehensive income includes net income (loss) and unrealized net gains on investments, net of taxes, as summarized below:
|
Comprehensive Income
|
|
|
|
|
Three
months ended December 31
|
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
14,739,000
|
|
|
$
|
(1,471,000
|
)
|
|
Net
increase in unrealized appreciation of
marketable securities (net of taxes)
|
|
|
12,118,000
|
|
|
|
15,019,000
|
|
|
|
|
$
|
26,857,000
|
|
|
$
|
13,548,000
|
|
Comparable
three
-month periods ended
December 31
, 2017 and 2016
Consolidated revenues were $
10,252,000 and $9,990,000 for the three months ended December 31, 2017 and 2016, respectively. This increase of $262,000 was primarily from increased Journal Technologies’ license and maintenance fees of $384,000, consulting fees of $147,000 and public service fees of $47,000, partially offset by the reduction in The Traditional Business’s trustee sale notice and its related service fee revenues of $57,000, commercial advertising revenues of $64,000, and circulation revenues of $86,000. The Company’s revenues derived from Journal Technologies’ operations constituted about 60% and 56% of the Company’s total revenues for the three months ended December 31, 2017 and 2016, respectively.
Consolidated operating expenses increased by $854,000 (7%) to $13,697,000 from $12,843,000, primarily resulting from additional personnel costs and services for Journal Technologies. Total personnel costs increased by $556,000 (7%) to $8,197,000 from $7,641,000. Outside services increased by $59,000 (6%) to $1,039,000 from $980,000 mainly because of increased contractor’s costs for Journal Technologies. Depreciation and amortization costs, which included primarily the amortization of Journal Technologies’ intangible assets, decreased by $174,000 to $1,218,000 from $1,392,000. Other general and administrative expenses increased by $471,000 (20%) to $2,814,000 from $2,343,000 mainly because of increased accounting and legal fees and office equipment and software maintenance fees for Journal Technologies.
The Company’s non-operating income, net of expenses, increased by $262,000 (24%) to $1,334,000 from $1,072,000 primarily because of more dividend income, partially offset by increases in the interest rate on the two acquisition margin loans.
During
the three months ended December 31, 2017, consolidated pretax loss was $2,111,000, as compared with $1,781,000 in the prior year period. There was a consolidated net income of $14,739,000 ($10.67 per share) after tax benefits, primarily due to tax cuts, for the three months ended December 31, 2017, as compared with net loss of $1,471,000 (-$1.07 per share) in the prior year period. (See
Taxes
.)
At
December 31, 2017, the aggregate fair market value of the Company’s marketable securities was $244,934,000. These securities had approximately $181,540,000 of unrealized gains before taxes of $48,140,000 and generated approximately $1,483,000 in dividends and interest income during the three months ended December 31, 2017, which lowers the Company’s effective income tax rate because of the dividends received deduction. Most of the unrealized gains were in the common stocks of three U.S. financial institutions and one foreign manufacturer.
Additional detail about each of the Company
’s reportable segments, and its corporate income and expenses, is set forth below:
|
Overal
l Financial Results (000)
|
|
For the
three months ended December 31
|
|
|
|
Reportable Segments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Traditional
Business
|
|
|
Journal
Technologies
|
|
|
Corporate
income and expenses
|
|
|
Total
|
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Advertising
|
|
$
|
2,116
|
|
|
$
|
2,310
|
|
|
$
|
---
|
|
|
$
|
---
|
|
|
$
|
---
|
|
|
$
|
---
|
|
|
$
|
2,116
|
|
|
$
|
2,310
|
|
|
Circulation
|
|
|
1,363
|
|
|
|
1,449
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
1,363
|
|
|
|
1,449
|
|
|
Advertising service fees and other
|
|
|
602
|
|
|
|
638
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
602
|
|
|
|
638
|
|
|
Licensing and maintenance fees
|
|
|
---
|
|
|
|
---
|
|
|
|
4,350
|
|
|
|
3,966
|
|
|
|
---
|
|
|
|
---
|
|
|
|
4,350
|
|
|
|
3,966
|
|
|
Consulting fees
|
|
|
---
|
|
|
|
---
|
|
|
|
995
|
|
|
|
848
|
|
|
|
---
|
|
|
|
---
|
|
|
|
995
|
|
|
|
848
|
|
|
Other public service fees
|
|
|
---
|
|
|
|
---
|
|
|
|
826
|
|
|
|
779
|
|
|
|
---
|
|
|
|
---
|
|
|
|
826
|
|
|
|
779
|
|
|
Total revenues
|
|
|
4,081
|
|
|
|
4,397
|
|
|
|
6,171
|
|
|
|
5,593
|
|
|
|
---
|
|
|
|
---
|
|
|
|
10,252
|
|
|
|
9,990
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and employee benefits
|
|
|
2,568
|
|
|
|
2,565
|
|
|
|
5,629
|
|
|
|
5,076
|
|
|
|
---
|
|
|
|
---
|
|
|
|
8,197
|
|
|
|
7,641
|
|
|
Amortization of intangible assets
|
|
|
---
|
|
|
|
---
|
|
|
|
1,062
|
|
|
|
1,224
|
|
|
|
---
|
|
|
|
---
|
|
|
|
1,062
|
|
|
|
1,224
|
|
|
Others
|
|
|
1,746
|
|
|
|
1,835
|
|
|
|
2,692
|
|
|
|
2,143
|
|
|
|
---
|
|
|
|
---
|
|
|
|
4,438
|
|
|
|
3,978
|
|
|
Total operating expenses
|
|
|
4,314
|
|
|
|
4,400
|
|
|
|
9,383
|
|
|
|
8,443
|
|
|
|
---
|
|
|
|
---
|
|
|
|
13,697
|
|
|
|
12,843
|
|
|
Loss
from operations
|
|
|
(233
|
)
|
|
|
(3
|
)
|
|
|
(3,212
|
)
|
|
|
(2,850
|
)
|
|
|
---
|
|
|
|
---
|
|
|
|
(3,445
|
)
|
|
|
(2,853
|
)
|
|
Dividends and interest income
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
1,483
|
|
|
|
1,171
|
|
|
|
1,483
|
|
|
|
1,171
|
|
|
Gain on sale of capital asset
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
2
|
|
|
|
---
|
|
|
|
2
|
|
|
|
---
|
|
|
Other income (net)
|
|
|
---
|
|
|
|
15
|
|
|
|
---
|
|
|
|
---
|
|
|
|
9
|
|
|
|
---
|
|
|
|
9
|
|
|
|
15
|
|
|
Interest expenses on note payable collateralized by real estate
|
|
|
(24
|
)
|
|
|
(26
|
)
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
(24
|
)
|
|
|
(26
|
)
|
|
Interest expenses on margin loans
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
(136
|
)
|
|
|
(79
|
)
|
|
|
(136
|
)
|
|
|
(79
|
)
|
|
Interest expenses
accrual for
uncertain and unrecognized
tax benefits
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
(9
|
)
|
|
|
---
|
|
|
|
---
|
|
|
|
---
|
|
|
|
(9
|
)
|
|
Pretax (loss) income
|
|
$
|
(257
|
)
|
|
$
|
(14
|
)
|
|
$
|
(3,212
|
)
|
|
$
|
(2,859
|
)
|
|
$
|
1,358
|
|
|
$
|
1,092
|
|
|
$
|
(2,111
|
)
|
|
$
|
(1,781
|
)
|
The Traditional Business segment
’s pretax loss increased by $243,000 to $257,000 from $14,000.
Advertising revenues decreased by $
194,000 to $2,116,000 from $2,310,000, primarily resulting from the declines in trustee sale notice advertising and its related service fee revenues of $57,000 and commercial advertising revenues of $64,000.
Trustee sale notices are very much dependent on the number of California and Arizona foreclosures for which public notice advertising is required by law. The number of foreclosure notices published by the Company decreased by 15% during the three months ended December 31, 2017 as compared to the prior year period. Because this slowing is expected to continue, the Company expects there will be fewer foreclosure notice and other public notice advertisements and declining revenues in fiscal 2018, and the Company’s print-based earnings will also likely decline significantly because it will be impractical for the Company to offset all revenue losses by expense reduction. The Company’s smaller newspapers, those other than the Los Angeles and San Francisco Daily Journals (“The Daily Journals”), accounted for about 88% of the total public notice advertising revenues in the three months ended December 31, 2017. Public notice advertising revenues and related advertising and other service fees constituted about 20% and 22% of the Company’s total revenues for the three months ended December 31 2017 and 2016, respectively. Because of this concentration, the Company’s revenues would be significantly adversely affected if California and Arizona eliminated the legal requirement to publish public notices in adjudicated newspapers of general circulation, as had been recently implemented in Arizona for one notice type. Also, if the adjudication of one or more of the Company’s newspapers was challenged and revoked, those newspapers would no longer be eligible to publish public notice advertising, and it could have a material adverse effect on the Company’s revenues.
The Daily Journals accounted for about 89% of The Traditional Business’ total circulation revenues, which declined by $86,000 to $1,363,000 from $1,449,000. The court rule and judicial profile services generated about 8% of the total circulation revenues, with the other newspapers and services accounting for the balance. 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 Traditional Business segment operating expenses decreased by $86,000 (2%) to $4,314,000 from $4,400,000, primarily due to decreased delivery service costs.
Journal Technologies
Journal Technologies’ business segment pretax loss increased by $353,000 (12%) to $3,212,000 from $2,859,000, after the amortization costs of intangible assets of $1,062,000 and $1,224,000 for the three months ended December 31, 2017 and 2016, respectively.
Revenues increased by $578,000 (10%) to $6,171,000 from $5,593,000 in the prior year period. Licensing and maintenance fees increased by $384,000 (10%) to $4,350,000 from $3,966,000. Consulting fees also increased by $147,000 (17%) to $995,000 from $848,000. Other public service fees increased by $47,000 (6%) to $826,000 from $779,000 primarily due to an increase in the number of traffic tickets processed online for the public to pay traffic citations.
Operating expenses increased by $940,000 (11%) to $9,383,000 from $8,443,000, primarily due to increased personnel costs and computer services for Journal Technologies.
Intangible assets, including customer relationships and developed technology, are being amortized on a straight-line basis over five years for financial statement purposes, due to the short l
ife cycle of technology on which customer relationships depend and over 15 years for tax purposes. Goodwill, which is not amortized for financial statement purposes, is amortized over 15 years for tax purposes. Goodwill represents the expected synergies in expanding the Company’s software business. Goodwill is evaluated for impairment annually, or whenever events or changes in circumstances indicate that the value may not be recoverable. Considered factors for potential goodwill impairment evaluation include the current year’s operating financial results before intangible amortization, fluctuations of revenues, changes in the market place, the status of installation contracts and new business, among other things. There was no indicator of impairment during the three-month periods ended December 31, 2017 and 2016. Journal Technologies is continuing to update and upgrade its software products. These costs are expensed as incurred and will impact earnings at least through the foreseeable future.
Taxes
The December 2017 Tax Cuts and Jobs Act (“Tax Act”) reduced the maximum corporate tax rate from 35% to 21% effective January 1, 2018. The Company has completed its review of the Tax Act. The impact to its financial statements is as follows: (i) current income tax expense or benefit is calculated on a blended rate of 24.28% pursuant to IRC Section 15, (ii) deferred tax expense includes a discrete net tax benefit of approximately $16 million resulting from a revaluation of deferred tax assets and liabilities to the expected tax rate that will be applied when temporary differences are expected to reverse, (iii) items that are expected to reverse during fiscal 2018 are valued at the blended rate of 24.28% while temporary differences that will reverse after fiscal 2018 are valued at 21%, and (iv) approximately $20 million of the revaluation of deferred taxes relates to items that were initially recorded as accumulated other comprehensive income (“AOCI”). This revaluation is recorded as a component of income tax expense or benefit in continuing operations.
For the three months ended December 31, 2017, the Company recorded an income tax benefit of $16,850,000 on pretax loss of $2,111,000. The income tax benefit was the result of applying the effective tax rate anticipated for fiscal 2018 to pretax loss for the three-month period ended December 31, 2017. The effective tax rate (before the discrete item discussed above) was greater than the statutory rate primarily due to the dividends received deduction which increases the loss for tax purposes. On pretax loss of $1,781,000 for the three months ended December 31, 2016, the Company recorded an income tax benefit of $310,000 which was the net result of applying the effective tax rate anticipated for fiscal 2017 to pretax loss for the three months ended December 31, 2016. The effective tax rate was greater than the statutory rate mainly resulting from the dividends received deduction. The Company’s effective tax rate was 798% and 17% for the three months ended December 31, 2017 and 2016, respectively.
The Company files consolidated federal income tax returns in the United States and with various state jurisdictions and is no longer subject to examinations for fiscal years before fiscal 2015
with regard to federal income taxes and fiscal 2013
for state income taxes
.
Liquidity and Capital Resources
During
the three months ended December 31, 2017, the Company’s cash and cash equivalents and marketable security positions increased by $14,793,000 to $247,442,000. Cash and cash equivalents were used for the purchase of capital assets of $34,000 and operating activities of $814,000 which included net decreases of $797,000 in deferred subscriptions, deferred installation contracts and deferred maintenance agreements and others.
The investments in marketable securities, which had an adjusted cost basis of approximately $63,39
4,000 and a market value of about $244,934,000 at December 31, 2017, generated approximately $1,483,000 in dividends and interest income.
Cash flows from operating activities
increased by $497,000 during the three months ended December 31, 2017 as compared to the prior year period, primarily resulting from increases in net income of $16,210,000, partially offset by increases in deferred income taxes of $15,861,000, mainly because of the discrete tax items mentioned above.
As of
December 31, 2017, the Company had working capital of $230,284,000, including the liabilities for deferred subscriptions, deferred installation and maintenance agreements and others of $17,539,000.
The Company believes that it will be able to fund its operations for the foreseeable future through its cash flows from operations and its current working capital and expects that any such cash flows will
be invested in its businesses. The Company may or may not have the ability to borrow against its marketable securities. The Company also may entertain additional business acquisition opportunities. Any excess cash flows could be used to reduce the investment margin account liability or note payable collateralized by real estate or 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 alr
eady 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 of
December 31, 2017, the investments were concentrated in just seven 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 shareholders’ equity and, under certain circumstances, in the recognition of impairment losses in the Company’s income statement.
Critical Accounting Policies and Estimates
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 software costs, fair value measurement and disclosures (including for the long-term Incentive Plan liabilities), accounting for business combinations, testing for goodwill impairment and income taxes are critical accounting policies and estimates.
The Company
’s critical accounting policies are detailed in its Annual Report on Form 10-K for the year ended September 30, 2017. The above discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in this report.
Disclosure Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q includes “
forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Certain statements contained in this document, including but not limited to those in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking” statements that involve risks and uncertainties that may cause actual future events or results to differ materially from those described in the forward-looking statements. Words such as “expects,” “intends,” “anticipates,” “should,” “believes,” “will,” “plans,” “estimates,” “may,” variations of such words and similar expressions are intended to identify such forward-looking statements. We disclaim any intention or obligation to revise any forward-looking statements whether as a result of new information, future developments, or otherwise. There are many factors that could cause actual results to differ materially from those contained in the forward-looking statements. These factors include, among others: risks associated with software development and implementation efforts; Journal Technologies’ reliance on professional services engagements with justice agencies, including California courts, for a substantial portion of its revenues; material changes in the costs of postage and paper; possible changes in the law, particularly changes limiting or eliminating the requirements for public notice advertising; possible loss of the adjudicated status of the Company’s newspapers and their legal authority to publish public notice advertising; a further decline in public notice advertising revenues because of fewer foreclosures; a further decline in subscriber and commercial advertising revenues; possible security breaches of the Company’s software or websites; the Company’s reliance on its president and chief executive officer; changes in accounting guidance; material weaknesses in the Company’s internal control over financial reporting; and declines in the market prices of the securities owned by the Company. In addition, such statements could be affected by general industry and market conditions, general economic conditions (particularly in California) and other factors. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in this Form 10-Q, including in conjunction with the forward-looking statements themselves. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time to time in documents filed by the Company with the Securities and Exchange Commission, including in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2017.