DAILY JOURNAL CORP - Quarter Report: 2003 December (Form 10-Q)

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 2003

OR

For the transition period from                      to                     

Commission File Number 0-14665

DAILY JOURNAL CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (213) 229-5300

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: x No: ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.) Yes: ¨ No: x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

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DAILY JOURNAL CORPORATION

INDEX

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PART I

Item 1. FINANCIAL STATEMENTS

DAILY JOURNAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying notes to consolidated financial statements.

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DAILY JOURNAL CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

See accompanying notes to consolidated financial statements.

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DAILY JOURNAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to consolidated financial statements.

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DAILY JOURNAL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - The Corporation and Operations

The Daily Journal Corporation (the “Company”) publishes newspapers and web sites covering California, Arizona and Nevada, as well as the California Lawyer magazine, and produces several specialized information services. SUSTAIN Technologies, Inc. (“Sustain”), now a 93% owned subsidiary as of December 31, 2003, has been consolidated since it was acquired in January 1999. (See Note 2.) Sustain supplies case management software systems and related products to courts and other justice agencies, including district attorney offices and administrative law organizations. These courts and agencies use the Sustain family of products to help manage cases and information electronically and to interface with other critical justice partners. Sustain’s products are designed to help users manage electronic case files from inception to disposition, including all aspects of calendaring and accounting, report and notice generation, the implementation of standards and business rules and other corollary functions. Essentially all of the Company’s operations are based in California, Arizona, Colorado and Nevada.

Note 2 - Basis of Presentation

In the opinion of the Company, the accompanying interim unaudited consolidated financial statements contain all adjustments necessary for a fair statement of its financial position as of December 31, 2003, the results of operations for the three-month periods ended December 31, 2003 and 2002 and its cash flows for the three months ended December 31, 2003 and 2002. The results of operations for the three-months ended December 31, 2003 and 2002 are not necessarily indicative of the results to be expected for the full year.

The consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003.

Certain reclassifications of previously reported amounts have been made to conform to the current year’s presentation.

Note 3 - Basic and Diluted Income Per Share

The Company does not have any common stock equivalents, and therefore the basic and diluted income per share are the same.

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Note 4 - Operating Segments

Summarized financial information concerning the Company’s reportable segments is shown in the following table:

Note 5 - Capitalized Software, net

The Company’s expenditures in support of the Sustain software are highly significant. The capitalized Sustain software costs consist of purchased software upon the acquisition of Sustain of $3,023,000, less accumulated amortization of $3,016,000 and $2,995,000 as of December 31, 2003 and September 30, 2003, respectively. The remaining capitalized software, net, represents software costs accounted for pursuant to Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. This software is being amortized over five years. The amortization expense for capitalized software was $21,000 and $151,000 for the comparative periods ended December 31, 2003 and 2002, respectively. Costs related to the research and development of new Sustain software products are expensed as incurred until technological feasibility of the product has been established, at which time such costs are capitalized, subject to expected recoverability.

The Company is continuing its internal Sustain software development efforts and has teamed with other service providers to seek new business opportunities. If these development and marketing efforts are not successful, there will be a significant and adverse impact on 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. These Sustain software development costs ($326,000 and $293,000 for the three months ended December 31, 2003 and 2002, respectively), which are primarily incremental costs, are being expensed as incurred and accordingly will materially impact earnings at least through fiscal 2004, and very likely much longer.

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Note 6 - Income Tax Accounting (See Note 5)

At December 31, 2003, the Company has a deferred tax asset of $3,003,000 primarily related to fiscal 2001’s net operating loss and research and development credit carry-forwards which expire in years 2015 through 2021. Due to the uncertainty surrounding the timing of realizing the benefits of its tax attributes in future tax returns, the Company has provided a valuation allowance against the asset of $1,915,000, resulting in a net deferred tax asset of $1,088,000. The reduction in the valuation allowance for the quarter ended December 31, 2003 was $749,000 primarily due to utilization of net operating loss carry-forwards. In the future, the Company may utilize the remaining tax benefits from the valuation allowance of $724,000, for financial statement purposes, from past Sustain-segment losses.

Note 7 - Debt and Other Commitments

The Company owns its facilities in Los Angeles and leases space for its other offices under operating leases which expire at various dates through 2009. The Company is responsible for a portion of maintenance, insurance and property tax expenses relating to certain leased property. Rental expenses for comparable periods ended December 31, 2003 and 2002 were $221,000 and $240,000, respectively.

As of December 31, 2003, the Company has a real estate loan of $1,778,000, which bears interest at approximately 6.84% and is repayable in equal monthly installments of about $18,000 through 2016. The real estate loan is secured by some of the Company’s facilities in Los Angeles.

In conjunction with the acquisition of Sustain in January 1999, Sustain entered into five-year employment agreements with each of the three Sustain principals. Sustain paid an aggregate of $65,000 per month pursuant to the three employment agreements, each of which expired in January 2004. Sustain did not extend or renew these employment agreements.

Note 8 - Contingencies

Management has received information furnished by legal counsel on the current stage of all outstanding legal proceedings and the development of these matters to date. There continue to be outstanding issues, including the amounts due to each of them from the other, between Sustain and the terminated outside service provider whose software development work was terminated by Sustain in April 2001 as a result of serious flaws and long delays. The terminated outside service provider filed for bankruptcy in December 2001 and stated in its filings with the U.S. Bankruptcy Court that it was considering bringing a collection action against Sustain. If it does, Sustain will assert counter-claims that completely offset the terminated outside provider’s claims. Sustain will vigorously defend any litigation or action brought by the terminated outside service provider, although no assurances can be made as to the ultimate outcome of the dispute. It is the opinion of management that adequate provision has been made for any amounts that may become due as a result of the dispute.

In addition, Sustain received a letter in April 2003 from counsel to the Ontario, Canada Ministry of the Solicitor General, Ministry of Public Safety and Security and Ministry of the Attorney General (collectively, the “Ministries”). The Ministries had entered into a contract with Sustain, dated as of April 22, 1999 (the “Contract”), pursuant to which the Ministries sought to license the software product that was to be developed by the outside service provider referred to above. The Contract was formally terminated in June 2002. The letter from counsel purported to invoke the dispute resolution process set forth in the Contract and claimed damages in the amount of $20 million. Counsel for Sustain and

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counsel for the Ministries engaged in preliminary discussions with respect to this matter, and the parties so far have not utilized the dispute resolution process set forth in the Contract. Counsel for Sustain last communicated with counsel for the Ministries by a letter sent in April 2003. At this point, management is unable to determine whether this matter will have a material adverse effect on Sustain and the Company.

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Results of Operations

Revenues were $8,645,000 and $8,489,000 for the three months ended December 31, 2003 and 2002, respectively. Consulting and other fees of Sustain increased by $326,000, while advertising and subscription revenues declined by $118,000.

Display advertising revenues increased by $125,000, while classified advertising revenues decreased by $11,000. Public notice advertising revenues decreased by $129,000 primarily resulting from a slowdown in government advertising because of the sharp cuts in government funding throughout California and the decline in trustee foreclosure sales because of the strong housing market with low interest rates. The Company’s smaller newspapers, those other than the Los Angeles and San Francisco Daily Journals (“The Daily Journals”), accounted for about 91% of the total public notice advertising revenues. Public notice advertising revenues and related advertising and other service fees constituted about 25% of the Company’s total revenues. Circulation revenues decreased an aggregate of $103,000 primarily because the court rule revenues declined as more courts are now providing their rules online. The Daily Journals accounted for about 72% of the Company’s total circulation revenues, and their circulation levels decreased slightly. The court rule and judicial profile services generated about 17% of the total circulation revenues, with the other newspapers and services accounting for the balance. Information system and service revenues increased by $326,000 primarily because of increased consulting revenues for the installation of Sustain software in several California counties. The Company’s revenues derived from Sustain’s operations constituted about 15% and 12% of the Company’s total revenues for the three months ended December 31, 2003 and 2002, respectively.

Costs and expenses decreased by $331,000 (4%) to $7,598,000 from $7,929,000. Total personnel costs were $4,197,000, representing an increase of $14,000. Commissions and other outside services declined by $70,000 (5%) primarily because of reduced consulting expenses for Sustain. Postage and delivery expenses decreased by $31,000 (6%) mainly resulting from the reduction in postage expenses as we continue to expand hand delivery services. Depreciation and amortization expenses decreased by $275,000 (50%) primarily due to more fully depreciated assets. Other general and administrative expenses increased by $35,000 (4%) mainly because of more legal fees.

The Company’s expenditures for the development of Sustain software products are highly significant and will materially impact overall results at least through fiscal 2004, and very likely much longer. These Sustain internal software development costs, primarily incremental costs, aggregated $326,000 and $293,000 for the three months ended December 31, 2003 and 2002, respectively. If these 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.

The Company’s traditional business segment pretax profit increased by $48,000 (5%) to $1,096,000 from $1,048,000 primarily resulting from reduced depreciation and amortization expenses, partially offset by the declines in advertising and subscription revenues. Sustain’s business segment pretax loss decreased by $425,000 (86%) to $69,000 from $494,000, primarily due to increased consulting revenues. The consolidated net income was $977,000 and $554,000 for the three months ended December 31, 2003 and 2002, respectively. No tax provisions were recorded for the three months ended December 31, 2002 and $50,000 were recorded for the three months ended December 31, 2003, because the Company was

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able to utilize some net operating loss carry-forwards attributable to the Sustain-segment losses in prior years to offset taxes which otherwise would have been payable. In the future, the Company may utilize the remaining tax benefits from the valuation allowance of $724,000, for financial statement purposes, from past Sustain-segment losses. Net income per share increased to $.67 from $.37.

Liquidity and Capital Resources

During the three months ended December 31, 2003, the Company’s cash and cash equivalents and U.S. Treasury Bill positions increased by $381,000. Cash and cash equivalents were used for the net purchase of capital assets of $1,414,000 primarily for additional facilities in Los Angeles. The cash provided by operating activities of $1,881,000 included a net increase in prepayments for subscriptions and others of $184,000, primarily related to a prepayment for Sustain licenses. Proceeds from the sale of subscriptions from newspapers, court rule books and other publications and for software 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 $934,000 for the three months ended December 31, 2003 as compared to the prior comparable period primarily due to increased net income and less accounts receivable. As of December 31, 2003 the Company had working capital of $4,680,000 before deducting the liability for deferred subscription revenues and other revenues of $7,093,000 which will be earned within one year.

During fiscal 2004, and very likely much longer, the Company expects its total expenditures in support of the development of the Sustain software to continue to be very significant. In addition, there has never been a resolution of the issues between Sustain and the outside software development service provider which was terminated in April 2001. The terminated outside service provider filed for bankruptcy in December 2001 and stated in its filings with the U.S. Bankruptcy Court that it was considering bringing a collection action against Sustain. If it ever does, Sustain will assert counter-claims that completely offset the terminated outside provider’s claims. Sustain will vigorously defend any litigation or action brought by the terminated outside service provider, although no assurances can be made as to the ultimate outcome of the dispute. It is the opinion of management that adequate provision has been made for any amounts that may become due as a result of the dispute. In a related matter, counsel for the Ontario, Canada Ministry of the Solicitor General, Ministry of Public Safety and Security and Ministry of the Attorney General sent a letter to Sustain claiming damages of $20 million as a result of Sustain’s inability to deliver a functional software system due to the flawed work of the outside service provider. In addition to the legal risks associated with these matters, the pendency of these issues could have an impact on Sustain’s ability to attract new customers or work with its existing customers.

The Company has a real estate loan of $1,778,000 secured by some of its Los Angeles facilities. In addition, a bank has expressed interest in lending the Company up to an additional $3.4 million to be secured by the new building and parking facilities, and the Company is in the process of pursuing this opportunity.

If the Company requires additional funds, it may, among other things, change Sustain’s development strategy or attempt to secure additional financing, which may or may not be available to the Company on acceptable terms.

Critical Accounting Policies

The Company’s financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles. Preparing financial statements requires management to make

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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 both accounting for capitalized software costs and income tax accounting are critical accounting policies.

Pursuant to Statement of Financial Accounting Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, 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 (a) completed, (b) traced to the product specifications and (c) reviewed for high-risk development issues. For a period of time prior to the second quarter of fiscal 2001, the Company believed that technological feasibility had been established for Sustain software being developed by the outside service provider referred to above. Upon determining that a significant development issue had arisen, the entire amount of the previously capitalized costs associated with the software project were written off and expensed. Those events had no effect on the financial information presented in this quarterly report.

Statement of Financial Accounting Standards No. 109, Accounting for 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. 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. In the future, there may be tax benefits, for financial statement purposes, from past Sustain-segment losses.

The above discussion and analysis for the three months ended December 31, 2003 and 2002 should be read in conjunction with the unaudited consolidated financial statements and the notes thereto included in this report. (See Notes 7 and 8 for debt and other commitments and contingencies.)

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 Items 1 and 2, 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 the functionality and resources required for new and existing case management software projects; the success or failure of Sustain’s internal software development efforts; the ultimate resolution, if any, of the disputes with the Ontario, Canada Ministries and Sustain’s

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terminated outside service provider; material changes in the costs of materials; a potential decline in subscriber revenue; an inability to continue borrowing on current terms; possible changes in tax laws; collectibility of accounts receivable; potential increases in employee and consultant costs; attraction, training and retention of employees; changes in accounting guidance; and competitive factors in both the case management software business and the publishing business. In addition, such statements could be affected by general industry and market conditions and growth rates, 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 disclosed in this Form 10-Q, including without limitation 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.

The Company does not use derivative financial instruments. The Company does maintain a portfolio of cash equivalents maturing in three months or less as of the date of purchase and of U.S. Treasury Bills maturing within one year. Given the short-term nature of the investments and borrowings, and the fact that the Company had no outstanding borrowing except for the real estate loan which bears a fixed interest rate, the Company was not subject to significant interest rate risk. The real estate loan of $1,778,000 bears interest at approximately 6.84% and is repayable in equal monthly installments of about $18,000 through 2016. The real estate loan is secured by some of the Company’s facilities in Los Angeles.

An evaluation was performed under the supervision and with the participation of the Company’s management, including Gerald L. Salzman, its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2003. Based on that evaluation, Mr. Salzman concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported as specified in the rules and forms of the Securities Exchange Commission. There have been no material changes in the Company’s internal controls over financial reporting or in other factors reasonably likely to affect the internal controls over financial reporting during the quarter ended December 31, 2003.

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PART II

None.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

DATE: February 13, 2004

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