DAILY JOURNAL CORP 10-K

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 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 and fees online. These products are licensed in 42 states and internationally.   Impact of the COVID-19 Pandemic   On March 13, 2020, the United States declared the outbreak of COVID-19 to be a national emergency, and several states and municipalities also declared public health emergencies. Unprecedented actions were taken by public health and governmental authorities to contain and combat the spread of COVID-19, including “stay-at-home” orders and similar mandates that restricted the daily activities of individuals and limited the operation of businesses that were deemed “non-essential”. In addition, most of Journal Technologies’ customers, which are primarily courts and governmental agencies in the United States, Canada and Australia, were either closed or significantly scaled back their activities. Similarly, many law firms and companies from which the Traditional Business derives advertising and subscription revenues also curtailed their in-person operations and spending.   Management believes that the COVID-19 pandemic has had, and, with the Delta and Omicron variant cases, will continue to have, a significant impact on the Company’s business operations. Among other things, dividends from the Company’s securities portfolio have declined and are expected to remain lower than in the past even though some banks have recently started to increase their dividends. It is also possible that governments may again take extreme actions in response to the pandemic and the Delta and Omicron variants, such as the renewed closure, or scaling back of operations, of courts and other governmental agencies that are the customers of the Company. Furthermore, even as courts, governmental agencies and other businesses return to more normal operations, there are likely to be changes in those operations and personal behaviors going forward, including limitations on travel and more working from home, that will adversely affect the Company, its financial results and cash flows.   Due to the uncertainties associated with the duration and severity of the COVID-19 pandemic, the efforts to contain it, and the changes in business operations and personal behaviors that are likely to follow from it, management cannot at this point estimate the magnitude of its impact on the Company’s business operations. In recent years, the newspaper industry, including our Traditional Business, has declined, and we expect this to continue due to the impacts of COVID-19 and its aftermath, as advertising and subscription revenues decrease.   18     For Journal Technologies, there have been several delays or cancellations in government procurement processes. Also, although we have been able to complete some existing projects remotely, we have been unable to finish certain implementations and trainings because of our inability to work with clients in-person. Given that we are typically paid for implementation services upon “go-live” of a system, receipt of those revenues has been delayed. On the other side of the coin, the Company has seen a reduction in operating costs primarily due to lower headcount and reduced business travel.   Reportable Segments   The Company’s Traditional Business is one reportable segment and the other is Journal Technologies. Additional details about each of the reportable segments and its corporate income and expenses is set forth below:   Overall Financial Results (000)   For the twelve months ended September 30                                                                         Reportable Segments                                       Traditional Business     Journal Technologies     Corporate     Total       2021     2020     2021     2020     2021     2020     2021     2020   Revenues                                                                 Advertising   $ 7,635     $ 7,104     $ ---     $ ---     $ ---     $ ---     $ 7,635     $ 7,104   Circulation     4,576       5,090       ---       ---       ---       ---       4,576       5,090   Advertising service fees and other     2,684       2,501       ---       ---       ---       ---       2,684       2,501   Licensing and maintenance fees     ---       ---       21,044       21,647       ---       ---       21,044       21,647   Consulting fees     ---       ---       6,319       7,718       ---       ---       6,319       7,718   Other public service fees     ---       ---       7,131       5,882       ---       ---       7,131       5,882   Total operating revenues     14,895       14,695       34,494       35,247       ---       ---       49,389       49,942   Operating expenses                                                                 Salaries and employee benefits     10,021       10,420       26,044       27,382       ---       ---       36,065       37,802   Others     4,431       4,787       6,741       8,636       ---       ---       11,172       13,423   Total operating expenses     14,452       15,207       32,785       36,018       ---       ---       47,237       51,225   Income (loss) from operations     443       (512 )     1,709       (771 )     ---       ---       2,152       (1,283 )                                                                   Dividends and interest income     ---       ---       ---       ---       2,908       4,965       2,908       4,965   Other income     ---       ---       ---       ---       69       3       69       3   Interest expenses on note payable collateralized by real estate and other     ---       ---       ---       ---       (94 )     (119 )     (94 )     (119 ) Interest expense on margin loans     ---       ---       ---       ---       (233 )     (434 )     (233 )     (434 ) Gains on sales of marketable securities, net     ---       ---       ---       ---       41,749       4,193       41,749       4,193   Net unrealized gains (losses) on marketable securities     ---       ---       ---       ---       106,499       (3,099 )     106,499       (3,099 ) Pretax income (loss)     443       (512 )     1,709       (771 )     150,898       5,509       153,050       4,226   Income tax (expense) benefit     (115 )     100       (425 )     100       (39,610 )     (385 )     (40,150 )     (185 ) Net income (loss)   $ 328     $ (412 )   $ 1,284     $ (671 )   $ 111,288     $ 5,124     $ 112,900     $ 4,041   Total assets   $ 22,412     $ 35,896     $ 20,480     $ 22,277     $ 347,685     $ 180,402     $ 390,577     $ 238,575   Capital expenditures   $ 22     $ 121     $ 7     $ 63       ---       ---     $ 29     $ 184     During fiscal 2021 and 2020, the Traditional Business had total operating revenues of $14,895,000 and $14,695,000 of which $10,319,000 and $9,605,000, respectively, were recognized after services were provided while $4,576,000 and $5,090,000, respectively, were recognized ratably over the subscription terms. Total operating revenues for the Company’s software business were $34,494,000 and $35,247,000, of which $14,787,000 and $14,025,000, respectively, were recognized upon completion of services while $19,707,000 and $21,222,000, respectively, were recognized ratably over the subscription periods.   19     Fiscal 2021 compared with fiscal 2020   Consolidated Financial Comparison   Consolidated revenues were $49,389,000 and $49,942,000 for fiscal 2021 and 2020, respectively. This decrease of $553,000 (1%) was primarily from decreases in (i) Journal Technologies’ license and maintenance fees of $603,000 and consulting fees of $1,399,000, and (ii) the Traditional Business’ trustee sale notice advertising net revenues of $264,000, display advertising net revenues of $92,000 and circulation revenues of $514,000, partially offset by increases in (i) Journal Technologies’ public service fees of $1,249,000 and (ii) the Traditional Business’ classified advertising net revenues of $13,000, legal notice advertising net revenues of $663,000 and government notice advertising net revenues of $158,000.   Approximately 70% of the Company’s revenues during fiscal 2021 were derived from Journal Technologies, as compared with 71% in the prior fiscal year. In addition, the Company’s revenues have been primarily from the United States, with approximately 4% from foreign countries. Almost all of Journal Technologies’ revenues are from governmental agencies.   Consolidated operating expenses decreased by $3,988,000 (8%) to $47,237,000 from $51,225,000. Total salaries and employee benefits decreased by $1,737,000 (5%) to $36,065,000 from $37,802,000 primarily resulting from lower headcount. Outside services decreased by $344,000 (10%) to $3,084,000 from $3,428,000 mainly because of decreased independent contractor costs for Journal Technologies. Postage and delivery expenses decreased by $58,000 (8%), and newsprint and printing expenses also decreased by $74,000 (11%) to $625,000 from $699,000 primarily resulting from reduced subscribers. Depreciation and amortization costs decreased by $44,000 (8%) to $480,000 from $524,000 because of more fully-depreciated assets. Rent expenses decreased by $326,000 (53%) to $286,000 from $612,000 because of the closures of the Colorado office in August 2020 and the Corona, California office in March 2021. Equipment maintenance and software decreased by $229,000 (18%) to $1,039,000 from $1,268,000 primarily resulted from reduced maintenance and software costs due to the above-mentioned office closures. Other general and administrative expenses decreased by $1,612,000 (42%) to $2,236,000 from $3,848,000 mainly resulting from reduced business travel expenses due to the pandemic.   The Company’s non-operating income, net of expenses, increased by $145,389,000 to a gain of $150,898,000 from $5,509,000 in the prior fiscal year primarily because of the realized gains on sales of marketable securities of $41,749,000 and the recording of net unrealized gains on marketable securities of $106,499,000 during fiscal 2021, as compared with realized gains of $4,193,000 and unrealized losses of $3,099,000 during the prior fiscal year.   During fiscal 2021, consolidated pretax income was $153,050,000, as compared to $4,226,000 in the prior fiscal year. There was consolidated net income of $112,900,000 ($81.77 per share) for fiscal 2021, as compared with $4,041,000 ($2.93 per share) in the prior fiscal year.   During fiscal 2021, the Company’s cash and cash equivalents and restricted cash decreased by $14,324,000 to $14,639,000 from $28,963,000, primarily because of the purchase of additional marketable securities. At September 30, 2021, the aggregate fair market value of the Company’s marketable securities was $347,573,000. These securities had approximately $244,093,000 of net unrealized gains before taxes of $64,115,000. They generated approximately $2,908,000 in dividends income during fiscal 2021, as compared with $4,965,000 in the prior fiscal year. Most of the unrealized gains were in the common stocks of three U.S. financial institutions and one foreign manufacturer.   20     Taxes   For fiscal 2021, the Company recorded a provision for income taxes of $40,150,000 on pretax income of $153,050,000.   The effective rate of 26% was higher than the statutory rate of 21% primarily due to the recording of (i) state taxes, which were offset by the dividends received deduction (“DRD”), resulting in a tax provision of $1,260,000 on pretax income before the unrealized and realized gains on marketable securities, (ii) a tax provision of $27,938,000 on the unrealized gains on marketable securities and (iii) a tax provision of $10,952,000 on the realized gains on marketable securities.  The Company was able to utilize all of its federal and certain state net operating losses (“NOLs”) carryforward in fiscal 2021.   For fiscal 2020, the Company recorded an income tax provision of $185,000 on pretax income of $4,226,000.  The effective tax rate was less than the statutory rate primarily due to the DRD, a benefit resulting from the Coronavirus Aid, Relief and Economic Security (“CARES”) Act and net state tax benefits.   The effective tax rate for fiscal 2020 was 4.4%, after including the DRD, the tax benefits from the CARES Act and state taxes.   The CARES Act, which was signed into law on March 27, 2020, contained two federal tax provisions beneficial to the Company: (i) net operating losses arising in tax years beginning in 2018, that were previously only available to be carried forward, were allowed to be carried back to the five previous years, and (ii) any alternative minimum tax credits carried forward from prior years could be claimed as a refund in years beginning in 2018. Consequently, the Company recorded a tax benefit, in fiscal 2020, resulting from carrying back a portion of the net operating loss generated in fiscal 2019 to fiscal 2014.  The Company received refunds for all taxes and alternative minimum taxes paid in fiscal 2014.  The tax benefit of $187,000 resulting from carrying back the net operating loss was primarily attributable to the difference in the federal tax rates of 34% in fiscal 2014 and 21% in fiscal 2019.   During fiscal 2020, the Company recorded net unrealized losses on marketable securities of $3,099,000. An income tax benefit of $1,371,000 resulting from these losses was recorded as a temporary difference in deferred income taxes. The Company also recorded a net gain of $4,193,000 on the sales of marketable securities.   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 2018 with regard to federal income taxes and fiscal 2017 for state income taxes.    The Traditional Business   The Traditional Business’ pretax income increased by $955,000 (187%) to $443,000 from a pretax loss of $512,000 in the prior fiscal year.   Advertising revenues increased by $531,000 (7%) to $7,635,000 from $7,104,000, primarily because of increased legal notice advertising net revenues of $663,000 mainly from fictitious business name publishing (as counties have tried to catch up with their backlogs), government notice advertising net revenues of $158,000 and classified advertising net revenues of $13,000. These increases were partially offset by decreased display advertising net revenues of $92,000 and trustee sale notice advertising net revenues of $264,000 primarily because of limited foreclosures due to the temporary halt or suspension of mortgage foreclosures in accordance with the federal COVID-19 related “Eviction and Foreclosure Orders” which started in February 2020 and expired in July 2021 with the eviction portion extended through the end of September 2021. In addition, although the national eviction ban has lapsed, many states or cities continue to have their own moratoriums. For example, Los Angeles County’s “COVID-19 Tenant Protection” essentially prevents evictions for residential and commercial tenants through January 31, 2022.   21     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 43% during the twelve months ended September 30, 2021 as compared to the prior fiscal year, primarily because of limited foreclosures, as discussed above. The Company’s smaller newspapers, those other than the Los Angeles and San Francisco Daily Journals (“The Daily Journals”), accounted for about 87% of the total public notice advertising revenues in fiscal 2021. Public notice advertising revenues and related advertising and other service fees, including trustee sales legal advertising revenues, constituted about 17% of the Company's total operating revenues in fiscal 2021 and 15% in 2020.   The Daily Journals accounted for about 91% of the Traditional Business’ total circulation revenues, which declined by $514,000 (10%) to $4,576,000 from $5,090,000. The court rule and judicial profile services generated about 6% 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 $755,000 (5%) to $14,452,000 from $15,207,000, primarily resulting from reduced outside services.   Journal Technologies   During fiscal 2021, Journal Technologies’ business segment pretax income increased by $2,480,000 (322%) to $1,709,000 from a pretax loss of $771,000 in the prior fiscal year.   Revenues decreased by $753,000 (2%) to $34,494,000 from $35,247,000 in the prior fiscal year. Licensing and maintenance fees decreased by $603,000 (3%) to $21,044,000 from $21,647,000 primarily resulting from the reduction in legacy software products’ maintenance and support revenues as the Company ended effective July 1, 2021 the maintenance of these legacy software products, so as to focus on supporting the Company’s main eSeries products. Consulting fees decreased by $1,399,000 (18%) to $6,319,000 from $7,718,000 due to fewer go-lives. Other public service fees increased by $1,249,000 (21%) to $7,131,000 from $5,882,000 primarily due to increased traffic citation fee revenues and efiling fee revenues.   Deferred consulting fees primarily represent advances from customers of Journal Technologies for installation services and are recognized upon final project go-lives. Deferred revenues on license and maintenance contracts represent prepayments of annual license and maintenance fees and are recognized ratably over the maintenance period.   Operating expenses decreased by $3,233,000 (9%) to $32,785,000 from $36,018,000 primarily because of decreased personnel costs primarily due to lower headcount and reduced business travel expenses.   Journal Technologies continues to update and upgrade its software products. These costs are expensed as incurred and will impact earnings at least through the foreseeable future.   22     Liquidity and Capital Resources   During fiscal 2021, the Company’s cash and cash equivalents, restricted cash, and marketable security positions increased by $153,881,000, after additional net borrowing of $2,507,000 and net pretax unrealized gains on marketable securities of $106,499,000. Cash, cash equivalents and the proceeds from the sales of marketable securities were primarily used to purchase additional marketable securities of $64,990,000 and pay down the real estate loan principal of $131,000.   The investments in marketable securities, which had an adjusted cost basis of approximately $103,480,000 and a market value of about $347,573,000 at September 30, 2021, generated approximately $2,908,000 in dividends income during fiscal 2021. These securities had approximately 244,093,000 of net unrealized gains before estimated taxes of $64,115,000 which will become due only when we sell securities in which there is unrealized appreciation.   Cash flows from operating activities increased by $950,000 during fiscal 2021 as compared to the prior fiscal year, primarily due to (i) decreases in the Company’s income tax receivable of $1,049,000 and deferred tax assets of $31,305,000, (ii) increases in the Company’s income tax payable of $6,244,000; accounts payable and accrued liabilities of $1,055,000 (because of the timing difference in remitting efiling fees to the courts) and the additional accrual to the long-term supplemental compensation accrual of $1,835,000 and (iii) a net increase in deferred revenues of $757,000. This was partially offset by (i) a decrease in net income of $38,295,000, excluding the additional realized gains on sales of marketable securities of $37,556,000 and increases in unrealized gains on marketable securities of $109,598,000 and (ii) an increase in accounts receivable of $3,106,000 primarily resulting from more billings. Cash provided from operating activities of $3,286,000 included net decreases of $1,051,000 in total current and long-term deferred revenues of $18,325,000.   As of September 30, 2021, the Company had working capital of $338,324,000, including the liabilities for deferred subscriptions, deferred consulting fees and deferred maintenance agreements and others of $17,330,000.   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 additional amounts against its marketable securities and, among other possibilities, it may be required to consider selling some of those securities to generate cash if needed to fund ongoing operations. The amount available for borrowing is based on the market value of the Company’s investment portfolio and fluctuates depending on the value of the underlying securities.  In addition, the Company could be subject to margin calls should the balance of the investment decrease significantly.  (Also see “Risks Associated with Our Holdings of Marketable Securities” mentioned above.)   The Company is not a smaller version of Berkshire Hathaway Inc.  Instead, it hopes to be a significant software company while it also operates its Traditional Business.   23     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, income taxes and segment reporting are critical accounting policies and estimates.   The Company recognizes revenues in accordance with the provisions of ASU No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606) . For the Traditional Business, 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 term. Advertising revenues are recognized when advertisements are published and are net of agency commissions.   Journal Technologies contracts may include several products and services, which are generally distinct and include separate transaction pricing and performance obligations. Most are one-transaction contracts. These current subscription-type contract revenues include (i) implementation consulting fees to configure the system to go-live, (ii) subscription software license, maintenance (including updates and upgrades) and support fees, and (iii) third-party hosting fees when used. Revenues for consulting are recognized at point of delivery (go-live) upon completion of services. These contracts include assurance warranty provisions for limited periods and do not include financing terms. For some contracts, the Company acts as a principal with respect to certain services, such as data conversion, interfaces and hosting that are provided by third-parties, and recognizes such revenues on a gross basis. For legacy contracts with perpetual license arrangements, licenses and consulting services are recognized at point of delivery (go-live), and maintenance revenues are recognized ratably after the go-live. Other public service fees are earned and recognized as revenues when the Company processes credit card payments on behalf of the courts via its websites through which the public can efile cases and pay traffic citations and other fees.   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 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. The Company believes its process for developing software is essentially completed concurrent with the establishment of technological feasibility, and accordingly, no software development costs have been capitalized to date.   ASC 820, Fair Value Measurement and Disclosures , requires the Company to (i) disclose the amounts of transfers in and out of Level 1 and Level 2 fair value measurements and the reasons for the transfers and (ii) present separately information about purchases, sales, issuances and settlements in the reconciliation of Level 3 measurements. This guidance also provides clarification of existing disclosures requiring the Company to determine each class of its investments based on risk and to disclose the valuation techniques and inputs used to measure fair value for both Level 2 and Level 3 measurements. The Company made no transfers in and out of Level 1 and Level 2 measurements in fiscal years 2021 and 2020. During that time all of the Company’s investments have been quoted on public markets and, therefore, all fair value calculations have been based on Level 1 measurements. The estimated Incentive Plan’s future commitment is calculated using Level 3 inputs, based on an average of the prior fiscal year (fiscal 2020) and the current year’s pretax earnings before certain items, discounted to the present value at 6% since each granted Incentive Plan Unit will expire over its remaining life term of up to 10 years.   24     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 and its deferred tax liabilities related to the unrealized net gains on investments. See Note 3 of Notes to Consolidated Financial Statements for further discussion.   ASC 280-10, Segment Reporting , defines an operating segment as a component of a public entity that has discrete financial information that is evaluated regularly by the Company’s Chief Executive Officer to decide how to allocate resources and to assess performance. In accordance with ASC 280-10, the Company has two reportable business segments which are: (i) the Traditional Business and (ii) Journal Technologies.   The above discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included in this report.   25