Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1999
Commission File Number 0-22982
NAVARRE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MINNESOTA 41-1704319
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
7400 49TH AVENUE NORTH, NEW HOPE, MN 55428
(Address of principal executive offices)
Registrant's telephone number, including area code: (612) 535-8333
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK,
NO PAR VALUE
Indicate by checkmark 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 checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
As of June 21, 1999, the aggregate value of the Company's Common Stock held by
non-affiliates of the Company was $229,461,245 based on the last reported sale
price of $9.81 on the Nasdaq Stock Market on that date.
As of June 21, 1999, the Company had outstanding 23,383,394 shares of Common
Stock, no par value.
DOCUMENTS INCORPORATED BY REFERENCE
The Company's Proxy Statement for its 1999 Annual Meeting of Shareholders, a
copy of which will be filed within 120 days of March 31, 1999, is incorporated
by reference into Part III of this Form 10-K.
PART I
ITEM 1. BUSINESS
GENERAL
Navarre Corporation ("Navarre" or the "Company"), a Minnesota corporation formed
in 1983, is a major distributor of music, software, interactive CD-ROM products
and DVD videos. Navarre sells to major music and software retailers, wholesalers
and rackjobbers. In addition, through its majority-owned subsidiary, NetRadio
Corporation, Navarre owns and operates NetRadio Network, a leading audio content
broadcaster on the Internet.
Navarre's operations are classified into two business segments based upon
products and services provided: home entertainment products and NetRadio. The
home entertainment products segment operates through two principal products, its
computer software products and its music products. The only major distributor to
distribute both music and software, the Company is recognized as an industry
leader in the distribution of consumer software in addition to being recognized
as a leader in the distribution of independent music labels and artists. The
Company's product line contains over 20,000 SKU's of compact discs, cassettes,
personal computer software, interactive CD-ROM software and DVD videos sold to
over 500 customers with over 10,000 locations throughout the United States. The
Company's broad base of customers includes (i) wholesale clubs, (ii) mass
merchandisers, (iii) computer specialty stores, (iv) music specialty stores and
(v) book stores. During fiscal years 1997, 1998 and 1999, computer software
accounted for 75.2%, 69.9% and 71.5% of net sales while sales of music products
accounted for 24.8%, 30.0% and 28.4% of net sales.
NetRadio is a leading broadcaster of originally programmed audio entertainment
over the Internet through its Web site www.netradio.com. NetRadio uses audio
content to generate revenues from sales of audio merchandise through its music
store, CDPoint(TM), and from Internet advertising, including advertisements
placed within NetRadio audio broadcasts. Net revenues from NetRadio have not
been significant.
THE COMPANY'S MARKETS
HOME ENTERTAINMENT PRODUCTS
PRERECORDED MUSIC
The prerecorded music industry is a relatively new industry, which grew largely
during the 1950's and throughout subsequent decades. Prior to the late 1970's,
prerecorded music competed primarily with radio, television and literature for
home entertainment. By the late 1970's and early 1980's, technological advances
brought new forms of home entertainment including video games, video cassettes,
CD's and cable television. According to the Recording Industry Association of
America ("RIAA") at 1998 year-end, manufacturers saw a 12.3% increase in audio
and video product shipped to domestic markets (from $12.2 billion in 1997 to
$13.7 billion units in 1998) at suggested list price.
Beginning in the 1970's, a significant amount of consolidation occurred in both
the production and distribution components of the prerecorded music industry.
Industry sources indicate that approximately seventy-five percent (75%) of the
industry's total revenue is derived from production or distribution by the five
major companies through their record labels and their affiliated distribution
companies. They are (i) Time-Warner and Warner/Elektra/Atlantic Corporation
(WEA); (ii) Sony Corporation and Sony Music Distribution; (iii) Thorn/EMI and
EMI Music Distribution; (iv) Bertelsmann A.G. and BMG Distribution and (v) The
Seagram Company, Ltd./MCA, Inc., Universal Music and Video Distribution, along
with recently acquired PGD Distribution. In addition to these major labels and
their distribution companies, there are a number of independent labels that
produce recordings for artists and a number of independent distribution
companies that enter into exclusive distribution agreements with these labels on
either a regional or national basis. These independent labels and their
distributors currently represent 25% of the industry's total revenue.
1
Distributors perform a number of functions in the music industry. Although the
major labels are generally distributed to the retail channel directly by their
affiliated distribution companies, there are a number of areas where alternative
distribution methods are required. These include (i) the distribution of labels
other than major labels, which cover recordings by national, regional and local
artists, (ii) the distribution of products to retailers that are too small to
buy in quantity from the major label distribution companies, (iii) distribution
channels that the major label distribution companies choose not to sell to (iv)
the distribution of products as secondary suppliers filling in temporary
out-of-stock conditions, (v) the distribution to retailers requiring special
packaging needs, VMI and consolidation of independent labels and (vi)
fulfillment for Internet retailers direct to consumers.
PERSONAL COMPUTER SOFTWARE
The personal computer software distribution channel has traditionally been more
fragmented than the more mature distribution channels for pre-recorded music and
video. In the last twelve months, however, considerable consolidation has
occurred within the personal consumer software distribution channel as Hasbro
Interactive absorbed Microprose, Mattel acquired The Learning Company,
Infogrames Entertainment acquired Accolade and Gremlin, Electronic Arts acquired
Westwood Studios, and Microsoft announced the formation of direct relationships
with a number of key accounts. The consolidation is a migration to
publishing/distribution entities with increased market power and numerous sub or
affiliate labels.
According to P.C. Data, retail software revenues increased 13% in 1998 to $5.2
billion and retail price of software fell 8.9%, the largest year over year
decline on record. The six categories that comprise the 1998 distributor sales
for the software market are business, at 82.9% of units, the largest
contributor, followed by entertainment, finance, personal productivity,
education and reference. In its fiscal year ended March 31, 1999, the Company's
net software sales rose by 9.4% over the previous fiscal year.
During the 1999 fiscal year, the Company dramatically expanded the number of
e-commerce customers for whom it performs fulfillment and distribution services,
and introduced a new business-to-business Web site that integrates on-line
ordering and deployment of text and visual product information. These services
include sales of both prerecorded music and personal computer software.
NETRADIO
NetRadio is a leading broadcaster of originally programmed audio entertainment
over the Internet through its Web site, www.netradio.com. NetRadio organizes its
music and information content into highly targeted audio channels grouped as
communities of similar interest or "COSIs". As of May 1, 1999, NetRadio had over
120 different channels organized in 14 COSIs.
NetRadio uses audio content to generate revenues from sales of audio merchandise
through its music store, CDPoint(TM), and from Internet advertising, including
advertisements placed within NetRadio audio broadcasts. Its interactive display,
NetCompanion encourages impulse purchases by providing information about the
music being played, or the products being advertised, and by linking the
listener either directly to CDPoint(TM) or to NetRadio's advertisers' Web sites.
As noted below, Navarre owns approximately 85% of NetRadio and ValueVision
International, Inc. owns approximately 15%. On March 3, 1999, NetRadio
Corporation filed a registration statement with the Securities and Exchange
Commission for the sale of its common stock to the public.
COMPETITION
The home entertainment products segment comprised of prerecorded music and
personal computer software distribution industry is highly competitive. The
Company's competitors include other national and regional distributors as well
as certain suppliers that sell directly to retailers. Certain of these
competitors have
2
substantially greater financial and other resources than the Company. The
ability of the Company to effectively compete in the future depends upon a
number of factors, including its ability to (i) obtain exclusive national
distribution contracts and licenses with independent labels and manufacturers,
(ii) maintain its margins and volume, (iii) expand its sales through a varied
range of products and personalized services, (iv) anticipate changes in the
marketplace including technological developments, and (v) maintain operating
expenses at an appropriate level.
In the personal computer software industry, the Company faces competition from a
number of distributors including Ingram Micro, Merisel, Inc. and Tech Data
Corporation as well as from manufacturers that sell directly to retailers. In
the pre-recorded music industry, the Company faces competition from the five
major label distribution companies, from regional distributors and from other
entities that sell directly to retailers.
The Company believes that the distribution of both personal computer software
and pre-recorded music will remain highly competitive and the keys to growth and
profitability will be customer service, continued focus on improvements and
operating efficiencies, the ability to develop proprietary products and the
ability to attract higher quality artist and software publishers. The Company
also believes that over the next several years, both the personal computer
software distribution industry and pre-recorded music distribution industry will
continue to further consolidate.
The market for Internet content providers is highly competitive and rapidly
changing. Since the Internet's commercialization in the early 1990's, the number
of Web sites on the Internet competing for consumer's attention and spending has
proliferated. The Company expects that competition between suppliers to Web
retailers will continue to intensify. With respect to recorded music and
interactive CD-ROMs sales, the Company supports numerous Internet retailers,
including traditional music retail chains, record labels and independents with
Web sites on the Internet.
NAVARRE DEPENDS UPON A FEW SIGNIFICANT CUSTOMERS
In each of the past several years, the Company has had one or more customers
that have accounted for 10% or more of the Company's net sales. During the
fiscal year ended March 31, 1999, sales to three customers, CompUSA, Sam's Clubs
and Best Buy, Inc., each represented more than 10% of net sales. The Company
competes with other companies for the business of each of its customers and
there can be no assurance that the Company will continue to recognize a
significant amount of revenue from sales to any specific customers. If the
Company is unable to continue to sell its products to all or any of these three
customers or is unable to continue to maintain its sales to these customers at
their current levels, and is unable to find other customers to replace these
sales, there would be an adverse impact on the Company's revenues and future
profitability.
EMPLOYEES
As of May 1, 1999, the Company had 305 employees, including 100 in finance and
administration, 46 in sales and marketing and 159 in distribution.
BACKLOG
Because the Company's products are shipped in response to orders, the Company
does not maintain any significant backlog.
THE COMPANY'S STRATEGY AND RECENT ACQUISITIONS
The Company's goal is to distribute on an international basis in both music and
interactive CD-ROMs, as well as become a leading content provider to the
Internet. The Company intends to achieve this goal by (i) increasing the number
and quality of exclusive national distribution arrangements with proprietary
prerecorded music artists and labels, (ii) increasing its exclusive personal
computer software and
3
interactive CD-ROM software product lines through distribution agreements, (iii)
continuing to deliver high levels of service to the growth channels of
retailing, including customized services and technological advances such as
electronic commerce ("e-commerce"), (iv) continuing to expand the sale of
prerecorded music and personal computer software products together in the
marketplace, (v) continuing to improve its efficiencies and technologies at its
state of the art distribution center (vi) expanding its business through
strategic acquisitions in areas or in businesses that complement the Company's
existing businesses and (vii) utilizing the Internet to expand the appeal of its
products to a broader customer base internationally.
The Company has also aggressively moved to acquire digital distribution rights
from its independently distributed record labels and software publishers.
NETRADIO
On May 1, 1996 the Company entered into a stock purchase agreement with NetRadio
Corporation, a Nevada corporation ("NetRadio (Nevada)"), which owned and
operated NetRadio Network, an Internet-only radio network under which Navarre
acquired fifty percent of the stock of NetRadio. On March 7, 1997 the Company
entered into an Agreement and Plan of Reorganization with NetRadio (Nevada)
under which it agreed to acquire NetRadio. Under the terms of the transaction,
which closed on March 21, 1997, NetRadio (Nevada) was merged with a wholly owned
subsidiary of the Company ("NetRadio"). Navarre agreed to issue 125,000 shares
of its common stock to the former shareholders of NetRadio (Nevada) and agreed
to issue up to an additional 2,075,000 shares of Common Stock (the "Navarre
Shares"). Of the shares, 20,000 were issued at closing in exchange for certain
guarantees by former shareholders of Net Radio and 105,000 were placed in an
escrow account at closing. The issuance of the remaining shares was subject to
NetRadio achieving specified levels of sales and profits in periods roughly
corresponding to the Company's fiscal year 1998 and fiscal year 1999. No
additional shares were earned. As a result of these two transactions, Navarre
acquired ownership of all the issued and outstanding shares of common stock of
NetRadio.
Concurrent with the Company's acquisition of NetRadio, ValueVision
International, Inc. ("ValueVision") agreed to make a $3,000,000 investment in
NetRadio, consisting of $1,000,000 in cash and an agreement to provide
$2,000,000 worth of television advertising time in exchange for a 15% equity
interest in NetRadio shares. At the time of the ValueVision investment, NetRadio
determined to assign a carrying value of $1,000,000 to the $2,000,000 of
advertising time. ValueVision International is an integrated electronic and
print media direct marketing company that operates a television home shopping
network. Under certain circumstances, ValueVision may acquire an additional
amount of NetRadio securities. ValueVision also has the right to convert its
shares of NetRadio stock into the Company's Common Stock in the future upon the
occurrence of certain events, including insolvency of NetRadio. In the event
that NetRadio has not commenced an initial public offering by March 2002,
ValueVision will have the right to put its investment back to the Company in
exchange for cash or, at the option of the Company, common stock of the Company.
On March 3, 1999, NetRadio Corporation filed a registration statement with the
Securities and Exchange Commission for the initial public offering of shares of
its common stock. In connection with the filing, ValueVision agreed to exercise
its right to purchase additional shares of NetRadio concurrent with the closing
of the NetRadio initial public offering.
VELVEL
On August 28, 1996, the Company entered into a Unit Purchase Agreement and
Operating Agreement (the "Velvel Agreement") with Velvel Musical Industries,
Inc. Under the terms of the Velvel Agreement, Velvel Musical Industries, Inc.
agreed to form Velvel Records LLC, a Delaware limited liability company ("Velvel
Records") and contribute certain of its assets to Velvel Records. The Company
agreed to make a $10.0 million investment in Velvel Records. Of this amount, the
Company made an investment of $5.0 million in Velvel Records on November 15,
1996 and agreed to make an additional investment of $5.0 million in Velvel
Records on or before April 10, 1997. In connection with its investment, the
Company
4
received the right for a period of five years to distribute substantially all of
the Velvel Records products within the United States. In November 1997, Velvel
and the Company agreed to terminate the Company's distribution rights in
exchange for the cancellation of the remaining balance on the Promissory Note
from the Company to Velvel. During May 1999, Navarre's 15% interest in Velvel
was sold to Koch Entertainment LLC for $47,500.
FORWARD LOOKING STATEMENTS
Certain information in this Form 10-K contains forward-looking statements
related to the Company's strategic expectations with respect to future
performance. While Navarre's management is optimistic about the Company's
long-term prospects, the following issues and uncertainties, among others,
should be considered in evaluating its growth outlook.
NAVARRE IS DEPENDENT UPON ITS MANAGEMENT TEAM
Eric H. Paulson, the Company's President and Chief Executive Officer, and
Charles E. Cheney, its Executive Vice President and Chief Financial Officer,
have been with the Company since its inception in 1983 and since 1985,
respectively. Although the Company has invested a substantial amount of time and
effort in developing its total management team, the loss of either Mr. Paulson
or Mr. Cheney could have a materially adverse effect upon the Company. The
Company carries "key person" insurance on the life of Mr. Paulson in the amount
of $1.0 million, one-half of which is pledged to cover any existing indebtedness
to the bank.
NAVARRE'S BUSINESS CAN BE SEASONAL
Much of the Company's business is seasonal in nature with a higher percentage of
sales during the second half of the calendar year. As a distributor of products
ultimately sold at retail, the Company's business is affected by the pattern of
seasonality common to other suppliers of retailers, particularly the holiday
selling season. Historically, more than 70% of the Company's sales and a
substantial portion of the Company's profits have been in the third and fourth
quarters of the calendar year. Due to the lower level of sales during the off
periods, the Company has historically incurred losses during these periods.
Because of this seasonality, if the Company experiences a weak holiday season,
it could significantly affect the Company's profitability for the entire year.
NAVARRE'S INDUSTRY TYPICALLY EXPERIENCES LOW INDUSTRY MARGINS
Competition in the prerecorded music and personal computer software distribution
industries is often based on price, and distributors such as the Company
generally experience low gross and operating margins. Consequently, the
Company's profitability is highly dependent upon achieving expected sales levels
as well as effective cost and management controls. Any erosion in the Company's
gross profit margins could affect the Company's ability to maintain
profitability.
NAVARRE DEPENDS UPON BANK BORROWINGS TO SUPPORT ITS BUSINESS
The Company has relied upon bank borrowings to finance its expansion, primarily
for inventory and accounts receivable financing and currently has a $45.0
million credit facility in place. The Company believes that it may be necessary
for it to acquire additional bank financing in the future depending upon the
growth of its business and the possible financing of acquisitions. If the
Company were unable to obtain additional bank financing, its future growth and
profitability would be adversely affected. Under the terms of the Company's
credit facility, borrowings are dependent upon the eligibility of accounts
receivable and inventory, and certain other covenants in the discretion of the
bank.
5
NAVARRE MAY HAVE ADDITIONAL SIGNIFICANT WORKING CAPITAL NEEDS
As a distributor of prerecorded music and personal computer software products,
the Company purchases products directly from manufacturers for resale to
retailers. As a result, the Company has significant working capital
requirements, the majority of which are to finance inventory and accounts
receivable. These working capital needs will expand as inventory and accounts
receivable increase in response to the Company's growth. Future growth will
likely require additional working capital. Although the Company has obtained
financing sufficient to meet its requirements to date, there can be no assurance
that the Company will be able to obtain additional financing upon favorable
terms when required in the future.
DEPENDENCE UPON SOFTWARE DEVELOPERS AND MANUFACTURERS
The Company distributes interactive CD-ROM software pursuant to distribution
agreements with software developers and manufacturers. The continued growth and
success of the Company depends partly upon its ability to procure and renew
these agreements and sell the underlying software. There can be no assurance
that the Company will sign such developers and manufacturers to distribution
agreements or that it will be able to sell software under existing distribution
agreements. Further, there can be no assurance that any current distribution
agreements will be renewed or those current agreements will not be terminated.
NAVARRE DEPENDS UPON RECORDING ARTISTS
Portions of the sales of the Company's Music Products Division are made pursuant
to exclusive distribution agreements. The continued growth and success of the
Company depends partly upon its ability to procure and renew these agreements
and sell the underlying recordings. In addition, the Company is dependent upon
these artists and labels to generate additional quality recordings. In order to
procure future marketing agreements, the Company regularly reviews artists.
There are no assurances that the Company will sign such artists to distribution
agreements or that it will be able to sell recordings under existing
distribution agreements. Further, there can be no assurance that any current
distribution agreements will be renewed or that current agreements will not be
terminated.
RETURNS AND INVENTORY OBSOLESCENCE POSE RISKS TO NAVARRE
The Company maintains a significant investment in product inventory and, like
other companies in this industry, experiences a relatively high level of product
returns as a percentage of revenues. The Company's agreements with its suppliers
generally permit the Company to return products that are in the suppliers'
current product listing. Adverse financial or other developments with respect to
a particular supplier could cause a significant decline in the value and
marketability of its products, and could make it difficult for the Company to
return products to such a supplier and recover its initial product acquisition
costs. Such an event could have a materially adverse effect upon the Company's
business and financial results. The Company maintains a sales return reserve
based on its trailing twelve months experience of sales returns by product line
and small inventory obsolescence reserve. The Company has historically
experienced an actual return rate range of 15% to 23%, depending upon the
product, which the Company believes is in line with the industry practice.
Although the Company's past experience indicates that these levels are adequate
to cover potential returns in these areas, there can be no assurance that these
reserves are adequate or will be adequate in the future. The Company also takes
a portion of its product offerings on consignment in order to lessen its
exposure to this risk.
TECHNOLOGY DEVELOPMENTS MAY ADVERSELY AFFECT DISTRIBUTION
Prerecorded music and personal computer software have traditionally been
marketed and delivered on a physical delivery basis. Traditionally all the
Company's revenues have been generated from sales to retail and wholesale
channels. If in the future these products are increasingly marketed and
delivered through technology transfers, such as "electronic downloading" to a
retail store or consumer's home, through the Internet or another delivery
mechanism, then retail and distribution could be revolutionized. As physical
6
and electronic distribution grows exponentially through Internet resellers,
competition between suppliers to such resellers will intensify. Navarre has
developed a significant number of supplier relationships with major electronic
retailers resulting in significant growth in fulfil1ment of software, music and
video products. The company anticipates that this will represent a rapidly
increasing share of overall sales. The Company is also developing relationships
to facilitate electronic distribution of software and music content as industry
standards become established.
WHOLESALERS AND RETAILERS MAY CHANGE THEIR METHODS OF DISTRIBUTION
The success of the Company's current sales strategy depends upon its wholesale
and retail customers' continued purchasing of products through the Company
rather than directly from manufacturers, through other distributors or through
other means of distribution. These customers and retailers are constantly
searching for ways to lower costs in an attempt to maintain competitive prices
and meet the pricing demands of consumers. The Company's business could be
adversely affected if its customers decide to purchase directly from
manufacturers, other distributors or other distribution channels rather than
from the Company.
NAVARRE'S MAJORITY-OWNED SUBSIDIARY NETRADIO
In March 1997, the Company, which had an equity interest in NetRadio, completed
an acquisition of all of the outstanding stock of NetRadio in an effort to
increase its presence in the marketplace as a content provider on the Internet,
and to become a publisher and distributor on an international basis in both
music and interactive CD-ROM. Navarre currently owns eighty-five percent (85%)
of the outstanding shares of NetRadio Corporation. NetRadio owns and operates
the NetRadio Network, an Internet-only radio network. NetRadio has operated at a
loss since the Company acquired it, and Navarre has continued to supply
NetRadio's working capital needs. Although NetRadio has filed a registration
statement with the Securities and Exchange Commission for an initial public
offering there can no assurance that it will successfully complete the offering.
If NetRadio is unable to successfully complete its initial public offering and
is unable to obtain financing from third parties, Navarre may be required to
continue to fund NetRadio working capital needs. In addition, there can be no
assurance that NetRadio will ever achieved future printability and there can be
no assurance that Navarre will be able to recoup its investment in NetRadio.
POSSIBLE VOLATILITY OF STOCK PRICE
The stock markets have experienced price and volume fluctuations, resulting in
changes in the market prices of the stock of many companies, which may not have
been directly related to the operating performance of those companies. In
addition, the market price of the Company's common stock has fluctuated
significantly since April 1996. The Company believes that factors such as
indications of the market's acceptance of the Company's products and failure to
meet market expectations, as well as general volatility in the securities
markets, could cause the market price of Navarre's common stock to fluctuate
substantially.
ITEM 2. PROPERTIES
On March 12, 1998, the Company entered into a new operating lease agreement for
its principal facilities in suburban Minneapolis. The prior operating lease was
with a partnership whose two partners are major shareholders and officers of the
Company. Under the new lease, the Company leases approximately 86,500 square
feet of office and warehouse space. The lease expires in 2013 and provides for
monthly payments of $38,750 over the lease term, with a 2.5% increase every 30
months. In addition, the Company is responsible for taxes and all operating
costs associated with building.
7
On May 1, 1999, the Company entered into an operating lease agreement for a
second facility in suburban Minneapolis. The Company leases approximately 74,000
square feet of office and warehouse space. The lease expires in the year 2002
and provides for a monthly rental of $32,640 over the lease term. In addition,
the Company is responsible for taxes and all operating costs associated with the
building.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of its business, the Company is involved in a number of
routine litigation matters that are incidental to the operation of its business.
These matters include collection matters with regard to products distributed by
the Company and accounts receivable owed to the Company. The Company currently
believes that the resolution of any pending matters will not have a material
adverse effect on its financial position or results of operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
three-month period ended March 31, 1999.
8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
The Company's Common Stock is traded on the Nasdaq Stock Market under the symbol
NAVR. The following table below presents the range of high and low trading sale
prices for the Company's stock for each period indicated as reported by Nasdaq.
Quarter High Low
Fiscal 1999
First $ 12.75 $ 2.38
Second 11.13 2.82
Third 27.00 2.19
Fourth 21.94 10.00
Fiscal 1998
First $ 3.38 $ 2.25
Second 4.13 2.00
Third 5.25 2.00
Fourth 3.13 2.00
At June 9, 1999, the Company had approximately 23,400 shareholders of record.
The Company has not paid any dividends on its common stock and does not intend
to pay any dividends on its common stock in the foreseeable future.
RECENT SALE OF UNREGISTERED SECURITIES
On May 1, 1998, the Company issued 1,523,810 shares of Class A Convertible
Preferred Stock in a private placement to a group of investors for aggregate
consideration of $20.0 million. The Class A Convertible Preferred Stock was
issued at a price of $13.125 per share and was convertible into five shares of
Navarre common stock any time after June 30, 1998. In addition, for each share
of Class A Convertible Preferred Stock acquired, each investor received a
five-year warrant to purchase five shares of Navarre common stock at $3.50 per
share. The Class A Convertible Preferred Stock had a cumulative annual dividend
of 10% per annum payable quarterly, beginning on June 30, 1998. In connection
with the private placement, the Company also granted a four year warrant to
purchase 380,953 shares of common stock at a price of $2.625 per share to Delphi
Financial Corporation, the Company's agent in the private placement, and paid
Delphi selling commissions of five percent of the gross proceeds from the sale
of the Class A Convertible Preferred Stock.
During the period from July 1, 1998 through March 31, 1999, holders of all
1,523,810 shares of the Company's Class A Convertible Preferred Stock converted
their Preferred Stock into 7,619,050 shares of common stock and holders of
warrants issued May 1998 exercised their warrants for an aggregate of 7,913,815
shares and paid the Company gross proceeds of $27,348,500. The Company believes
that the transactions were exempt pursuant to Section 4(2) of the Securities Act
of 1933 and Rule 506 under Regulation D.
9
ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per share data)
YEARS ENDED MARCH 31,
1999 1998 1997 1996 1995
-----------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Net sales $ 210,386 $ 196,648 $ 200,697 $ 158,354 $ 119,498
Gross profit 8,762 24,993 23,282 19,851 15,452
Income (loss) from operations (25,572) 1,458 (3,703) 3,889 3,461
Interest expense (2,543) (3,108) (2,110) (1,521) (753)
Income taxes (benefit) -- (470) (527) 917 1,061
Equity earnings (loss) in NetRadio
Corporation -- -- (719) -- --
Net income (loss) $ (27,670) $ (974) $ (6,189) $ 1,319 $ 1,607
Earnings (loss) per basic and diluted
share(1) $ (4.41) $ (.14) $ (.92) $ .20 $ .26
Diluted weighted average common
shares outstanding(2) 14,179 6,921 6,692 6,458 6,283
BALANCE SHEET DATA:
Total assets $ 79,480 $ 83,689 $ 78,397 $ 60,108 $ 45,705
Short-term borrowings 422 32,607 25,892 21,115 9,639
Long-term debt 114 181 315 -- 445
Shareholders' equity 25,164 4,328 5,099 9,648 8,215
(1) See Note 1 of Notes to Financial Statements for the computation of basic
and diluted (loss) per share.
(2) Adjusted to reflect a two-for-one stock split in the form of a 100% stock
dividend distributed June 21, 1996.
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of net
sales represented by certain items included in the Company's "Consolidated
Statements of Operations."
1999 1998 1997
-----------------------------------
Net sales:
Computer software 71.5% 69.9% 75.2%
Music 28.4 30.0 24.8
-----------------------------------
Home entertainment products 99.9 99.9 100.0
NetRadio .1 .1 --
-----------------------------------
Total net sales 100.0 100.0 100.0
Cost of sales 95.8 87.3 88.4
-----------------------------------
Gross profit 4.2 12.7 11.6
Selling and marketing 4.1 2.9 2.8
Distribution and warehousing 2.2 1.5 1.3
General and administration 9.0 6.3 6.4
Depreciation and amortization 0.9 1.2 2.9
-----------------------------------
Income (loss) from operations (12.0) 0.7 (1.8)
Interest expense 1.2 1.6 1.1
-----------------------------------
Net (loss) (13.2) (0.5) (3.1)
===================================
Certain information in this section contains forward-looking statements. The
Company's actual results could differ materially from the statements contained
in the forward-looking statements as a result of a number of factors, including
risks and uncertainties inherent in the Company's business, the consumer market
for music products and computer software products, retail customer buying
patterns, new or different competition in the Company's traditional and new
markets and the rate of new product development and commercialization. See
"Business - Forward Looking Statements" in Item 1 of the Form 10-K.
FISCAL 1999 COMPARED TO FISCAL 1998
Net sales of home entertainment products increased 6.9% from $196.4 million in
fiscal 1998 to $210.0 million in fiscal 1999. Computer software sales increased
as a percent of total Company sales from 69.9% of net sales in fiscal 1998 to
71.5% of net sales in fiscal 1999. Music sales, which yield higher margins,
decreased as a percent of total Company sales from 30.0% of net sales for fiscal
1998 to 28.4% of net sales in fiscal 1999. Computer software sales increased by
9.4% from $137.5 million in fiscal 1998 to $150.4 million in fiscal 1999. The
increase was primarily due to a higher level of sales to both existing customers
as well as to new customers. Music sales increased 1.2% from $58.9 million in
fiscal 1998 to $59.6 million in fiscal 1999. The increase was primarily due to
the addition of several higher quality labels. Price increases did not
materially contribute to the increase in net sales.
Gross profit of home entertainment products decreased $16.3 million or 65.7%
from $24.8 million in fiscal 1998 to $8.5 million in fiscal 1999. As a
percentage of net sales, gross profit decreased from 12.6% in fiscal 1998 to
4.1% in fiscal 1999. The gross profit from computer software sales was $10.0
million or 6.6% of computer software net sales in fiscal 1999 compared with
$16.4 million or 11.9% of computer software net sales in fiscal 1998. The
decrease in gross margin in computer sales was primarily due to a one-time,
non-cash adjustment to inventory and the write-off of accounts payable debit
balances of several financially distressed vendors. The gross margin from music
sales was $(1.5) million or (2.5%) of music net sales in fiscal 1999 compared
with $8.4 million or 14.3% of music net sales in fiscal 1998. The
11
decrease in gross margin in music sales was primarily due to the write-off of
accounts payable debit balances of several financially distressed vendors.
Selling and marketing expenses of home entertainment products increased from
$5.5 million in fiscal 1998 to $7.6 in fiscal 1999 and increased as a percentage
of sales from 2.8% in fiscal 1998 to 3.6% in fiscal 1999. The increase resulted
primarily from higher freight costs. NetRadio's selling and marketing increased
from $221,000 in fiscal 1998 to $1.1 million in fiscal 1999. The increase in
sales and marketing expenses was primarily due to the growth in NetRadio's sales
force and marketing staff and the usage of $150,000 in advertising contributed
by ValueVision.
Distribution and warehousing expenses increased from $2.9 million in 1998 to
$4.7 million in 1999 and increased as a percentage of sales from 1.5% in 1998 to
2.2% in 1999. This increase was primarily due to the expenses associated with
the improved returns processing system.
General and administrative expenses of home entertainment products increased
from $10.7 million in fiscal 1998 to $14.7 million in fiscal 1999. As a
percentage of sales, they increased from 5.5% in fiscal 1998 to 7.0% in fiscal
1999. The higher expenses were primarily due to the growth of the Company and
legal expenses associated with the financially distressed vendors. NetRadio's
general and administrative expenses increased from $1.7 million in fiscal 1998
to $4.3 million in fiscal 1999. The increase in general and administrative
expense reflects the costs associated with adding key personnel and building
infrastructure for NetRadio and $880,000 in compensation expense as a result of
the issuance of stock options to employees and directors with exercise prices
below the estimated fair market value of their common stock on the date of
grant.
Depreciation and amortization decreased from $2.4 million in fiscal 1998 to $2.0
million in fiscal 1999. In November 1997, the Company terminated its
distribution agreement with Velvel and wrote off its remaining investment.
The net operating loss for the home entertainment products was $20.1 million for
fiscal 1999 compared to a profit of $3.6 million for fiscal 1998. The net
operating loss for NetRadio was $5.5 million for fiscal 1999 compared to $2.1
million for fiscal 1998.
Interest expense decreased from $3.1 million for fiscal 1998 to $2.5 million for
fiscal 1999. This decrease resulted from substantially lower borrowings due to
the Company's issuance of its Class A Convertible Preferred Stock in a private
placement and those purchasers exercising the five-year warrants attached to
those shares.
The consolidated net loss for the Company was $27.7 million for fiscal 1999
compared to a loss of $974,000 for fiscal 1998.
The Company's effective tax rate decreased to zero for fiscal 1999 as a result
of the operating loss.
The Company's basic and diluted loss per share for the twelve months ended March
31, 1999 included a $34,229,000 charge associated with the non-detachable
conversion feature included in the preferred stock and the accompanying warrants
issued May 1, 1998.
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales of home entertainment products decreased 2.0% from $200.7 million in
fiscal 1997 to $196.4 million in fiscal 1998. Computer software sales decreased
as a percent of total Company sales from 75.2% of net sales in fiscal 1997 to
69.9% of net sales in fiscal 1998. Music sales, which yield higher margins,
increased as a percent of total Company sales from 24.8% of net sales for fiscal
1997 to 30.0% of net sales in fiscal 1998. Computer software sales decreased by
8.8% from $150.9 million in fiscal 1997 to $137.5 million in fiscal 1998. The
decrease was primarily a result of several major publishers shifting to direct
12
shipments to retailers and the limitations of the Company's working capital
caused by the difficulties of certain retailers. Music sales increased 18.3%
from $49.8 million in fiscal 1997 to $58.9 million in fiscal 1998. Music sales
increased primarily due to the restructuring of the music label base with the
addition of several higher quality labels. Price increases did not materially
contribute to the increase in music net sales.
Gross profit of home entertainment products increased $1.5 million or 6.4% from
$23.3 million in fiscal 1997 to $24.8 million in fiscal 1998. As a percentage of
net sales, gross profit increased from 11.6% in fiscal 1997 to 12.6% in fiscal
1998. Overall gross margins increased due to the increase in the computer
software gross profit and the increase in music sales which produce higher
margins than software sales. The gross profit from computer software sales was
$16.4 million or 11.9% of computer software net sales in fiscal 1998 compared
with $13.6 million or 9.0% of computer software net sales in fiscal 1997. This
increase in the gross margin percent of computer software sales was primarily
due to strategic decisions with regard to our computer software suppliers. The
gross margin from music sales was $8.4 million or 14.3% of music net sales in
fiscal 1998 compared with $9.7 million or 19.5% of music net sales in fiscal
1997.
Selling and marketing expenses of home entertainment products decreased from
$5.7 million in fiscal 1997 to $5.5 million in fiscal 1998 and as a percentage
of sales remained the same at 2.8% for both fiscal 1997 and fiscal 1998.
NetRadio's selling and marketing expenses increased to $221,000 in fiscal 1998.
Distribution and warehousing expenses of home entertainment products increased
from $2.7 million in 1997 to $2.9 million in 1998 and also increased as a
percentage of sales from 1.3% in 1997 to 1.5% in 1998. This increase was
primarily due to the value-added services provided to customers, which allowed
the Company to increase margins.
General and administrative expenses of home entertainment products decreased
from $12.7 million in fiscal 1997 to $10.7 million in fiscal 1998. As a
percentage of sales they decreased slightly from 6.3% in fiscal 1997 to 5.5% in
fiscal 1998 reflecting the lower net sales. NetRadio's general and
administrative expenses rose from $96,000 in fiscal 1997 to $1.7 million in
fiscal 1998 due to the growth of their company.
Amortization and writedown of intangible assets decreased from $5.8 million in
fiscal 1997 to $2.4 million in fiscal 1998. In fiscal 1997, the Company wrote
down the value of its interest in Velvel by $3.8 million. In November 1997, the
Company terminated its distribution agreement with Velvel and wrote off its
remaining investment. Both writedowns were attributed in part to the Company's
former relationship with Velvel Records.
Interest expense increased from $2.1 million for fiscal 1997 to $3.1 million for
fiscal 1998. This increase resulted from higher borrowings to support the
Company's accounts receivable and inventory levels.
The consolidated net loss was $974,000 for fiscal 1998 compared to a loss of
$6.2 million for fiscal 1997. The net loss for fiscal 1998 was primarily due to
the Company's $1.6 million loss in Net Radio.
The Company's effective tax rate increased from 8.8% in fiscal 1997 to 28.0 %
for fiscal 1998 as a result of the $1.8 million valuation allowance against
deferred tax assets related to the write down and amortization of Velvel's
distribution rights.
YEAR 2000
The Company has been evaluating the potential impact of what is commonly
referred to as the Year 2000 issue, concerning the inability of certain
information systems to properly recognize and process dates containing the year
2000 and beyond. The Company established a Year 2000 team working with every
operational area throughout the Company, and this team worked with management to
commence the following steps: (i) implementing a Year 2000 Assessment and
Testing Plan for all internal information
13
systems and other systems that contain micro-controllers that may be affected by
the Year 2000 date change; (ii) implementing a Year 2000 Assessment and Testing
Plan for all Company products, (iii) communicating with third parties that
supply product to the Company to ensure they are addressing the Year 2000 issue;
and (iv) contingency and disaster recovery planning to ensure Year 2000 problem
resolution.
The Company has identified and tested the systems it believes are critical and
the test results indicate that these systems are Year 2000 compliant. The
Company engaged in an ongoing process to test, reprogram, update or replace all
computer system non-compliant hardware and software and non-computer system
related non-compliant office and warehouse systems and equipment. The Company
has completed testing of mission critical systems and expects to complete
testing of non-mission critical systems by June 30, 1999. Implementation of
software upgrades and replacement of non-compliant hardware is substantially
completed. The Company also completed the upgrade of the warehouse systems and
Electronic Data Interchange (EDI) systems and is listed as being compliant by
the National Retail Federation. Regardless of the Year 2000 compliance of the
Company's systems and products, there can be no assurance that the Company will
not be adversely affected by the failure of others to become Year 2000
compliant.
To date, the Company has incurred expenditures totaling $216,000 in connection
with the Company's effort to become Year 2000 compliant. At this time, the
Company estimates that its additional costs for Year 2000 compliance will
consist of costs related to Year 2000 compliance and expenditures for software
in the approximate amount of $350,000.
While the Company cannot at this time state with certainty that the Year 2000
issues will not have a material adverse impact on its financial condition,
results of operations and liquidity, the Company considers it unlikely. The
Company believes that the following situations make up the Company's "most
reasonably likely worst case Year 2000 scenarios": (i) disruption of a
significant customer's ability to accept products or pay invoices, (ii)
disruption of suppliers, (iii) disruption of the Company's internal management
information systems, and (iv) disruption of the Company's external management
information systems.
While the Company recognized the need for contingency planning, it has not yet
developed any specific contingency plans for potential Year 2000 disruptions.
The Company does anticipate developing contingency plans for its most critical
areas, but details of such plans will depend on the Company's final assessment
of the problems of customers and suppliers as well as the evaluation and success
of its remediation efforts.
MARKET RISK
The Company is subject to interest rate risk. A 10% increase or reduction in
interest rates would not have a material effect on future earnings, fair values
or cash flows.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically financed its working capital needs through bank
borrowings. The level of borrowings has historically fluctuated significantly
during the year. At March 31, 1999, the Company had net accounts receivable of
$43.5 million and inventory of $29.2 million and had accounts payable of $51.8
million and bank borrowings of $329,000 to finance these assets.
For the fiscal year ended March 31, 1999, net sales were $210.4 million, an
increase of $13.7 million over 1998 fiscal year net sales of $196.7 million. The
Company had a net loss of $27.7 million during this period. The Company used
cash of $13.4 million in operating activities. During the period, accounts
receivable decreased by $8.9 million. This change was offset by an increase in
inventories of $6.0 million. Accounts payable increased by $7.2 million.
Investing activities used $1.9 million of cash, including $2.0 million for the
purchase of furniture, equipment and leasehold improvements. The Company
generated net cash of $15.3 million in financing activities during the period
primarily through proceeds from a private
14
placement and exercise of options and warrants for the aggregate net
consideration of $46.9 million and made bank payments of $32.1 million.
The Company has a revolving line of credit with Congress Financial Corporation.
The credit facility has a maximum borrowing limit of $45 million and is secured
by substantially all the Company's assets. The available amount fluctuates based
on an asset-borrowing base.
On May 1, 1998, the Company issued 1,523,810 shares of Class A Convertible
Preferred Stock in a private placement to a group of investors for aggregate
consideration of $19.0 million, net of expenses. Each share of Class A
Convertible Preferred Stock was issued at a price of $13.125 per share and was
convertible into five shares of Navarre common stock. For each share of Class A
Convertible Preferred Stock, each purchaser received a warrant to purchase five
shares of Navarre common stock at $3.50 per share. Under the terms of the Class
A Convertible Preferred Stock, the Company was required to pay cumulative
dividends of 10% per annum payable quarterly, beginning on June 30, 1998. During
the year ended March 31, 1999, the Company paid cash and stock dividends of
$594,000 and $68,000, respectively.
During the year ended March 31, 1999, holders of all 1,523,810 shares of the
Company's Class A Convertible Preferred Stock converted their Preferred Stock
into 7,619,050 shares of common stock and holders of warrants issued May 1998
exercised their warrants for an aggregate of 7,913,815 shares and paid the
Company gross proceeds of $27,348,500. The Company used the proceeds of the
offering for working capital purposes, including payment of amounts due under
its credit facility.
The Company anticipates it will utilize its credit facility during the next
twelve months to meet seasonal working capital needs. The Company believes that
the funds available under its current credit facility together with cash flow
from operations will be adequate to fund its anticipated working capital
requirements over the next twelve months.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information with respect to disclosures about market risk is contained in the
section entitled "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Market Risk" in Item 7 of this Form 10-K.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements are included in Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
15
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required under this item with respect to directors is contained in
the section "Election of Directors" in the Company's Proxy Statement for the
Annual Meeting of Shareholders to be held on September 9, 1999 (the "1999 Proxy
Statement"), a definitive copy of which will be filed with the Commission within
120 days of the close of the past fiscal year, and is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
Information required under this item is contained in the sections entitled
"Executive Compensation," "Employment Agreements" and "Stock Option Plan" in the
Company's 1999 Proxy Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required under this item is contained in the section entitled
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's 1999 Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information required under this item is contained in the section entitled
"Certain Transactions" in the Company's 1999 Proxy Statement and is incorporated
herein by reference.
16
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report
(1) Financial Statements. The following financial statements of the
Company are set forth at the end of this document.
Report of Independent Auditors
Consolidated Balance Sheets as of March 31, 1999 and 1998
Consolidated Statements of Operations for each of the three
years in the period ended March 31, 1999
Consolidated Statement of Shareholders' Equity as of March 31,
1999
Consolidated Statements of Cash Flows for each of the three
years in the period ended March 31, 1999
Notes to Consolidated Financial Statements
(2) Financial Statement Schedule for each of the three years in the
period ended March 31, 1999
Schedule II - Valuation and Qualifying Accounts and Reserves
Schedules other than those listed above have been omitted
because they are inapplicable or the required
information is either immaterial or shown in the
Financial Statements or the notes thereto.
(3) Exhibits
* Indicates compensatory agreement.
3.1 Articles of Incorporation.
3.2 Bylaws, incorporated herein by reference from Exhibit
3.2 to Form S-1, Registration Number 33-68392.
10.1 *Employment Agreement, dated October 1, 1996, between
the Company and Eric H. Paulson, incorporated
herein by reference from Exhibit 10.1 to Form
10-K for year ended March 31, 1997.
10.2 *Employment Agreement, dated October 1, 1996, between
the Company and Charles E. Cheney, incorporated
herein by reference from Exhibit 10.2 to Form
10-K for year ended March 31, 1997.
10.3 1992 Stock Option Plan, amended and restated,
incorporated herein by reference from Exhibit
10.3 to the Company's Form 10-Q for the quarter
ended December 31, 1996.
10.4 Form of Individual Stock Option Agreement under 1992
Stock Option Plan, from Exhibit 10.4 to Form
S-1.
10.5 Form of Termination Agreement for Executives of the
Company, incorporated herein by reference from
Exhibit 10.6 to Form 10-K for year ended March
31, 1996.
10.6 Lease dated March 12, 1998 between Navarre Corporation
and Cambridge Apartments, Inc. with respect to
the corporate headquarters in New Hope, MN.
10.7 Lease dated May 1, 1999 between Navarre Corporation and
Sunlite III, LLP with respect to a second
facility in Brooklyn Park, MN
10.8 Loan and Security Agreement between Congress Financial
Corporation and Navarre Corporation, dated June
12, 1997, incorporated herein by reference from
Exhibit 10.13 to Form 10-K for year ended March
31, 1997.
17
10.8.1 Amendment No.1 to Loan Documents, dated September 19,
1997, incorporated herein by reference from
Exhibit 10.11.1 to Form 10-K for year ended
March 31, 1998.
10.8.2 Amendment No.2 to Loan Documents, dated October 29,
1997, incorporated herein by reference from
Exhibit 10.11.2 to Form 10-K for year ended
March 31, 1998.
10.8.3 Amendment No.3 to Loan Documents, dated May 1, 1998,
incorporated herein by reference from Exhibit
10.11.3 to Form 10-K for year ended March 31,
1998.
10.9 Agreement and Plan of Reorganization dated March 7, 1997
by and among NetRadio Corporation, a Nevada
corporation, Navarre Corporation and NetRadio
Corporation, a Minnesota Corporation,
incorporated herein by reference from Exhibit
10.14 to Form 10-K for year ended March 31,
1997.
10.10 Stock Purchase Agreement dated as of March 7, 1997, by
and among ValueVision International, Inc.
NetRadio Corporation (Minnesota), Navarre
Corporation, and NetRadio Corporation
(Delaware), incorporated herein by reference
from Exhibit 10.18 to Form 10-K for year ended
March 31, 1997.
10.11 Conversion Agreement dated March 20, 1997 by and between
ValueVision International, Inc. and Navarre
Corporation), incorporated herein by reference
from Exhibit 10.18 to Form 10-K for year ended
March 31, 1997.
10.12 Form of Warrant dated May 1, 1998 issued to Delphi
Financial Corporation.
10.13 Form of Warrant dated May 1, 1998 issued to investors in
connection with the Company's May 1, 1998
private placement of Class A Convertible
Preferred Stock, incorporated by reference to
Exhibit 4 to Form 8-K dated May 1, 1998.
21 List of Subsidiaries.
23.1 Consent of Ernst & Young LLP.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
March 31, 1999
18
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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.
NAVARRE CORPORATION
(Registrant)
June 29, 1999 By /s/ Eric H. Paulson
-------------------------------------
Eric H. Paulson
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
(Power of Attorney)
Each person whose signature appears below constitutes and appoints Eric H.
Paulson and Charles E. Cheney as his true and lawful attorneys-in-fact and
agents, each acting alone, with full power of substitution and resubstitution,
for him and in his name, place and stead, in any and all capacities, to sign any
of all amendments to this Annual Report on Form 10-K and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, each acting alone, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all said attorneys-in-fact and agents,
each acting alone, or his substitute or substitutes, may lawfully do or cause to
be done by virtue thereof.
Signature Title Date
- --------- ----- ----
/s/ Eric H. Paulson Chairman of the Board, President June 29, 1999
- ---------------------------- and Chief Executive Officer
Eric H. Paulson
/s/ Charles E. Cheney Director, Treasurer and Secretary, June 29, 1999
- ---------------------------- Executive Vice President and
Charles E. Cheney Chief Financial Officer
/s/ Dickinson G. Wiltz Director June 29, 1999
- ----------------------------
Dickinson G. Wiltz
/s/ James G. Sippl Director June 29, 1999
- ----------------------------
James G. Sippl
/s/ Michael L. Snow Director June 29, 1999
- ----------------------------
Michael L. Snow
/s/ Alfred Teo Director June 29, 1999
- ----------------------------
Alfred Teo
19
Report of Independent Auditors
The Board of Directors and Shareholders
Navarre Corporation
We have audited the accompanying consolidated balance sheets of Navarre
Corporation as of March 31, 1999 and 1998, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended March 31, 1999. Our audit also included the
financial statement schedule for the year ended March 31, 1999 listed in the
Index at Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Navarre
Corporation at March 31, 1999 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
March 31, 1999, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
Minneapolis, Minnesota
April 30, 1999
20
Navarre Corporation
Consolidated Balance Sheets
(in thousands, except share amounts)
MARCH 31
1999 1998
---------------------------
ASSETS
Current assets:
Cash $ 92 $ 23
Accounts receivable, less allowance for doubtful accounts
and sales returns of $3,810 in 1999 and $2,412 in 1998 43,465 52,383
Inventories 29,223 23,188
Notes receivable, related parties 221 406
Refundable income taxes 613 2,265
Prepaid expenses and other current assets 908 962
---------------------------
Total current assets 74,522 79,227
Property and equipment, net of accumulated depreciation of $5,251 and
$3,647, respectively 3,361 2,957
Other assets:
Goodwill 853 1,174
Other assets 744 331
---------------------------
Total assets $ 79,480 $ 83,689
===========================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable to bank $ 329 $ 32,445
Current portion of long-term debt 93 162
Accounts payable 51,831 45,554
Accrued expenses 1,949 1,019
---------------------------
Total current liabilities 54,202 79,180
Long-term debt, less current maturities 114 181
Shareholders' equity:
Preferred stock, no par value:
Authorized shares - 10,000,000
Issued and outstanding shares - None -- --
Common stock, no par value:
Authorized shares - 50,000,000
Issued and outstanding shares - 23,344,046 and 7,009,170, respectively 91,415 8,113
Retained deficit (66,119) (3,558)
Unearned compensation (132) (227)
---------------------------
Total shareholders' equity 25,164 4,328
---------------------------
Total liabilities and shareholders' equity $ 79,480 $ 83,689
===========================
SEE ACCOMPANYING NOTES.
21
Navarre Corporation
Consolidated Statements of Operations
(in thousands, except share amounts)
YEAR ENDED MARCH 31
1999 1998 1997
--------------------------------------------
Net sales: $ 210,386 $ 196,648 $ 200,697
Cost of sales 201,624 171,655 177,415
--------------------------------------------
Gross profit 8,762 24,993 23,282
Operating expenses:
Selling and marketing 8,675 5,716 5,669
Distribution and warehousing 4,712 2,936 2,697
General and administrative 18,994 12,445 12,793
Depreciation and amortization 1,953 2,438 5,826
--------------------------------------------
34,334 23,535 26,985
--------------------------------------------
(Loss) income from operations (25,572) 1,458 (3,703)
Other expense:
Interest expense (2,543) (3,108) (2,110)
Other income (expense) 445 (10) (184)
--------------------------------------------
Loss before income taxes and equity
in loss of NetRadio Corporation (27,670) (1,660) (5,997)
Income tax benefit -- (470) (527)
Minority interest in subsidiary -- (216) --
Equity in loss of NetRadio Corporation -- -- (719)
--------------------------------------------
Net loss $ (27,670) $ (974) $ (6,189)
============================================
Net loss available to common shareholders $ (62,561) $ (974) $ (6,189)
============================================
Basic and diluted loss per share $ (4.41) $ (.14) $ (.92)
Basic and diluted weighted average common shares
outstanding 14,179 6,921 6,692
SEE ACCOMPANYING NOTES.
22
Navarre Corporation
Consolidated Statements of Shareholders' Equity
(in thousands, except share amounts)
PREFERRED COMMON RETAINED
SHARES PREFERRED SHARES COMMON EARNINGS UNEARNED
ISSUED STOCK ISSUED STOCK (DEFICIT) COMPENSATION
----------------------------------------------------------------------------------
Balance at March 31, 1996 -- $ -- 6,328,946 $ 6,460 $ 3,605 $ (417)
Shares issued in acquisitions -- -- 475,000 1,359 -- --
Shares issued upon exercise of stock options -- -- 98,302 186 -- --
Net loss -- -- -- -- (6,189) --
Amortization of unearned compensation -- -- -- -- -- 95
----------------------------------------------------------------------------------
Balance at March 31, 1997 -- $ -- 6,902,248 $ 8,005 $ (2,584) $ (322)
Shares issued upon exercise of stock options -- -- 106,922 108 -- --
Net loss -- -- -- -- (974) --
Amortization of unearned compensation -- -- -- -- -- 95
----------------------------------------------------------------------------------
Balance at March 31, 1998 -- $ -- 7,009,170 $ 8,113 $ (3,558) $ (227)
Preferred shares issued in private placement 1,523,810 18,821 -- -- -- --
Preferred share conversions, net of fees (1,523,810) (18,821) 7,619,050 18,821 -- --
Value of preferred stock conversion feature -- -- -- 34,229 (34,229) --
Shares issued upon exercise of stock warrants -- -- 8,093,815 28,050 -- --
Shares issued upon exercise of stock options -- -- 611,568 1,216 -- --
Dividends paid -- -- -- -- (594) --
Dividends issued in the form of shares -- -- 10,443 40 (68) --
NetRadio stock option valuation adjustment -- -- -- 880 -- --
NetRadio shares issued -- -- -- 66 -- --
Net loss -- -- -- -- (27,670) --
Amortization of unearned compensation -- -- -- -- -- 95
----------------------------------------------------------------------------------
Balance at March 31, 1999 -- $ -- 23,344,046 $ 91,415 $ (66,119) $ (132)
==================================================================================
SEE ACCOMPANYING NOTES.
23
Navarre Corporation
Consolidated Statements of Cash Flows
(in thousands)
YEARS ENDED MARCH 31
1999 1998 1997
--------------------------------------------
OPERATING ACTIVITIES
Net loss $ (27,670) $ (974) $ (6,189)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation 1,635 1,090 871
Amortization and writedown of intangible assets 321 1,348 4,955
Amortization of unearned compensation 95 95 95
Equity in loss of NetRadio Corporation -- -- 719
Minority interest in subsidiary -- (216) --
NetRadio stock valuation adjustment 880 -- --
Changes in operating assets and liabilities:
Accounts receivable 8,918 (5,220) (6,114)
Inventories (6,035) (6,379) (2,038)
Prepaid expenses and other assets (359) 1,942 (737)
Refundable income taxes 1,652 (2,265) --
Accounts payable and accrued expenses 7,178 (166) 16,589
Income taxes payable -- (135) (174)
--------------------------------------------
Net cash (used in) provided by operating activities (13,385) (10,880) 7,977
INVESTING ACTIVITIES
Notes receivable, related parties 185 (192) (214)
Acquisition of businesses, net of cash received -- -- (552)
Payment for Velvel distribution rights -- -- (5,000)
Purchases of equipment and leasehold improvements (2,039) (748) (870)
--------------------------------------------
Net cash used in investing activities (1,854) (940) (6,636)
FINANCING ACTIVITIES
Payments on long-term debt (135) (614) (511)
Proceeds from note payable, bank 197,230 176,925 170,717
Payments on note payable, bank (229,346) (165,231) (171,082)
Proceeds from sale of common stock -- -- 186
Proceeds from sale of subsidiary stock 66 -- --
Proceeds from sale of preferred stock and warrants 18,821 -- --
Proceeds from exercise of common stock warrants 28,050 -- --
Payment of dividends on Class A stock (594) -- --
Proceeds from exercise of common stock options 1,216 108 --
--------------------------------------------
Net cash provided by (used in) financing activities 15,308 11,188 (690)
--------------------------------------------
Net increase/(decrease) in cash 69 (632) 651
Cash at beginning of year 23 655 4
--------------------------------------------
Cash at end of year $ 92 $ 23 $ 655
============================================
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
Velvel distribution rights partially financed by note payable $ -- $ -- $ 5,000
Note payable and common stock issued for acquired businesses $ -- $ -- $ 1,859
Cancellation of Velvel distribution agreement $ -- $ 4,500 $ --
SEE ACCOMPANYING NOTES.
24
1. ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
The Company distributes home entertainment products including prerecorded tapes,
compact discs, digital versatile disks (DVD's), personal computer software and
interactive CD-ROM computer software primarily to retailers and wholesalers in
the United States. In addition, through its majority-owned subsidiary, NetRadio
Corporation, Navarre owns and operates NetRadio Network, a leading audio content
broadcaster on the Internet.
CONSOLIDATION
The financial statements include the accounts of the Company and its wholly
owned subsidiary, Digital Entertainment, Inc. and its majority-owned subsidiary,
NetRadio Corporation (collectively, the Company). NetRadio has been consolidated
since the Company purchased controlling interest in the operation. All
intercompany accounts and transactions have been eliminated.
REVENUE RECOGNITION
Revenues from sales of product are recorded upon shipment. Allowances are
provided for estimated sales returns at the time the sale is recorded based on
the Company's trailing twelve months' experience by product line.
The Company performs periodic credit evaluations of its customers' financial
condition and generally does not require collateral. Receivables generally are
due within sixty days. Credit losses relating to customers consistently have
been within management's expectations.
INVENTORIES
Inventories are stated at the lower of cost or market with cost determined on
the first-in, first-out (FIFO) method.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed using the
straight-line method for leasehold improvements and accelerated methods for
equipment over estimated useful lives of 3 to 10 years.
INTERNAL-USE SOFTWARE
The Company follows the Accounting Standards Executive Committee of the AICPA
Statement of Position (SOP) 98-1, Accounting for Costs of Computer Software
Developed or Obtained for Internal Use. The SOP requires the capitalization of
certain costs incurred to develop or obtain internal-use software.
Software is being depreciated over a three-year life.
25
1. ACCOUNTING POLICIES (CONTINUED)
ACCOUNTING FOR LONG LIVED ASSETS
The Company records losses on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in accounting
for its stock options. Under APB 25, when the exercise price of stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
GOODWILL
Goodwill represents the excess of the purchase price over the fair value of the
net tangible assets of acquired businesses and is amortized on a straight line
basis over 5 to 15 years. Accumulated amortization at March 31, 1999 and 1998
was $1,005,000 and $684,000, respectively.
INCOME TAXES
Income taxes are recorded under the liability method. Deferred income taxes are
provided for temporary differences between the financial reporting and tax bases
of assets and liabilities.
26
1. ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER COMMON SHARE
The basic earnings per share is computed by dividing the net loss by the
weighted average number of common shares outstanding.
Preferred stock, preferred stock warrants and employee stock options are not
included in the period ending March 31, 1999 calculation because they are
anti-dilutive.
The following table sets forth the computation of basic and diluted earnings per
share:
(In thousands, except for per share data) YEAR ENDED MARCH 31
1999 1998 1997
-----------------------------------------
Numerator:
Net loss $ (27,670) $ (974) $ (6,189)
Less preferred non-detachable conversion
feature and warrant valuation (34,229) -- --
Less preferred dividend requirements (662) -- --
-----------------------------------------
Adjusted net loss applicable to common stock $ (62,561) $ (974) $ (6,189)
=========================================
Denominator for basic and diluted earnings per share -
weighted average shares 14,179 6,921 6,692
=========================================
Basic and diluted earnings per share $ (4.41) $ (.14) $ (.92)
=========================================
RECLASSIFICATION
Certain balances have been reclassified to conform to the March 31, 1999,
presentation.
27
2. ACQUISITIONS
During May 1996, the Company acquired a 50% interest in NetRadio Corporation, an
Internet radio network. The Company accounted for its investment in NetRadio
Corporation under the equity method. In March 1997, the Company acquired the
remaining 50% of NetRadio Corporation. In total, the Company paid $1,000,000 in
cash, issued a $500,000 note payable and issued 295,000 shares of the Company's
common stock valued at $954,000.
The purchase price of the remaining 50% interest may be adjusted if NetRadio
Corporation attains certain revenue and income results. The excess of purchase
price over fair value of the assets acquired in March 1997 resulted in goodwill
of approximately $1,263,000 which is being amortized on a straight-line basis
over a 5-yesr period.
Concurrent with the closing of the second investment in NetRadio Corporation,
the Company sold 15% of the common stock of NetRadio Corporation to ValueVision
International, Inc., (ValueVision) for $1,000,000 in the form of cash and
$2,000,000 in future advertising on the ValueVision network valued by the
Company at $1,000,000. ValueVision International is an integrated electronic and
print media direct marketing company, that operates a television home shopping
network. Under certain circumstances, ValueVision may acquire an additional
amount of NetRadio securities. ValueVision also has the right to convert its
shares of NetRadio stock into the Company common stock upon the occurrence of
certain events, including the insolvency of NetRadio. In the event that NetRadio
Corporation has not commenced an initial public offering by March 2002,
ValueVision will have the right to put its investment back to the Company
payable to ValueVision in cash or common stock at the option of the Company.
In May 1996, the Company purchased Record Service, Inc., with its wholly owned
subsidiary, Surfside Distributors, Inc., a Hawaii based music distributor for
$250,000 in cash and 180,000 shares of the Company's common stock valued at
$405,000. The excess of purchase price over fair value of the assets acquired
resulted in goodwill of approximately $479,000, which is being amortized on a
straight-line basis over a 15-year period.
Both acquisitions have been accounted for as purchases and, accordingly, their
net assets and operating results are included in the Company's financial
statements from the respective dates of acquisition. The pro forma impact of the
acquisitions on the Company's results of operations for all years presented was
not material.
28
3. VELVEL DISTRIBUTION RIGHTS
In August 1996, the Company entered into a unit purchase agreement with Velvel
Records LLC (Velvel) to acquire the exclusive distribution rights of Velvel's
wholly owned labels for a period of five years. The Company invested $10 million
in Velvel of which $5 million was paid upon entering the agreement and the
remaining $5 million in the form of a demand promissory note. Upon payment of
the first installment, the Company received a capital interest in Velvel of
14.2%. The Company paid $500,000 of the demand promissory note in May 1997.
Under the agreement, owners of capital interest do not participate in earnings
or losses of Velvel.
Amortization of the distribution rights was $834,000 for the year ended March
31, 1997. In March 1997, the Company recorded a write-down of $3,820,000 in the
Velvel distribution agreement where the expected future cash flows (undiscounted
and without interest) is less than the carrying amount of the distribution
agreement. Under SFAS 121, the amount of the impairment loss is the excess
carrying amount of the impaired asset over the fair value of the asset
discounted at a rate commensurate with the risks involved. The remaining
carrying value of the distribution rights as of March 31, 1997 was $5,346,000.
As of November 4, 1997, Velvel and the Company agreed to terminate the Company's
distribution rights in exchange for the cancellation of the $4.5 million Demand
Promissory Note from the Company to Velvel. The net effect to amortization
expense from the cancellation of the Velvel agreement was $167,000. Total
amortization recorded for the year ended March 31, 1998 was $846,000. During May
1999, Navarre's 15% interest in Velvel was sold to Koch Entertainment LLC for
$47,500.
4. NOTES RECEIVABLE, RELATED PARTIES
The related party notes receivable are due on demand and bear interest at rates
between 7.75% and 8.75% per year and are unsecured.
29
5. BANK FINANCING AND DEBT
On June 12, 1997, the Company entered into a revolving line of credit with
Congress Financial Corporation. The credit facility has a maximum borrowing
limit of $45 million, fluctuates based on an asset-borrowing base, and is
secured by substantially all the Company's assets. The agreement requires the
Company to deliver various reports to Congress Financial as well as maintain
accurate inventory and fixed asset records. The covenant also gives Congress
access to the Company's books and records for auditing the collateral. The
revolving line of credit with Congress Financial Corporation expires June 12,
2000.
Interest is at prime plus 1% (8.75% at March 31, 1999) and LIBOR rate plus 2.75%
(7.687% at March 31, 1999) and is payable monthly. The weighted average interest
rate was 9.5% for the years ended March 31, 1999 and 1998.
Long-term debt consists of the following (in thousands):
MARCH 31
1999 1998
------------------
Capital equipment leases with monthly payments of $1 to $6,
secured by equipment $ 207 $ 288
Notes payable in monthly installments of $5 through September
1998, interest at 10%, unsecured -- 55
------------------
207 343
Less current portion 93 162
------------------
Long-term debt $ 114 $ 181
==================
Interest paid was $2,543,000, $3,238,000 and $2,112,000 for the years ended
March 31, 1999, 1998 and 1997, respectively.
Maturities of long-term debt are as follows: 2000- $93,000; 2001- $78,000; 2002-
$36,000; and $0 thereafter.
30
6. SHAREHOLDERS' EQUITY
The Company had issued warrants to the lead underwriter, of the December 16,
1993 public offering, to purchase 180,000 common shares, exercisable for five
years from the date of the public offering at $3.90 per share. All warrants were
exercised for $702,000 in the current year.
On May 21, 1996, the Board of Directors declared a two-for-one stock split in
the form of a fifty-percent stock dividend distributed on June 21, 1996, to
shareholders of record on June 5, 1996. All earnings (loss) per share and per
share data have been adjusted to reflect the two-for-one stock split.
The Board of Directors resolved to amend the Company's articles of incorporation
to increase the authorization of a class of preferred stock from 5,000,000 to
10,000,000 shares. The amendment was approved by the Company's shareholders on
June 19, 1998.
On May 1, 1998, the Company issued 1,523,810 shares of Class A Convertible
Preferred Stock in a private placement to a group of investors for aggregate
consideration of $20 million. The Class A Convertible Preferred Stock was issued
at a price of $13.125 per share and was convertible into five shares of Navarre
common stock at any time after June 30, 1998. All of the Class A Convertible
Preferred Stock was converted into common stock in the current year. In
addition, for each share of Class A Convertible Preferred Stock acquired, each
investor received a five-year warrant to purchase five shares of Navarre common
stock at a price $3.50 per share. The Company also issued warrants to the
underwriters to purchase 380,953 common shares at $2.625 per share. During the
current year 7,913,815 common stock warrants were exercised for $27,348,500.
There were 75,908 warrants outstanding at March 31, 1999. The Class A
Convertible Preferred Stock paid cumulative quarterly dividends of ten percent
(10%) payable beginning June 30, 1998. Total cash and stock dividends paid for
the year were $594,000 and 68,000, respectively.
The Class A Convertible Preferred Stock securities were deemed to have contained
beneficial conversion features that were recognized as a dividend paid to
preferred stockholders. Allocation of proceeds to the beneficial conversion
feature and warrants are analogous to a dividend, and were recognized as a
return to the preferred stockholders over the minimum conversion period (from
date securities were issued to date they were first convertible). The Company
valued the Nondetachable Conversion Feature and accompanying warrants at
$34,229,000.
31
7. STOCK OPTIONS AND GRANTS
The Company has an incentive stock option plan for officers, key employees and
directors. The options are granted at fair market value and expire between five
and eight years after the grant date. Option activity is summarized as follows:
PLAN OPTIONS WEIGHTED AVERAGE
AVAILABLE FOR PLAN OPTIONS EXERCISE PRICE PER
GRANT OUTSTANDING SHARE
----------------------------------------------------
Balance on March 31, 1996 853,600 1,187,224 $ 2.43
Granted (141,000) 141,000 5.37
Canceled 99,356 (99,356) 2.29
Exercised -- (98,302) 1.89
----------------------------------------------------
Balance on March 31, 1997 811,956 1,130,566 $ 2.85
Granted (357,350) 357,350 2.88
Canceled 91,820 (91,820) 5.05
Exercised -- (106,922) 1.01
----------------------------------------------------
Balance on March 31, 1998 546,426 1,289,174 $ 2.92
Granted (532,000) 532,000 3.07
Canceled 100,772 (100,772) 3.57
Exercised -- (644,806) 1.89
----------------------------------------------------
Balance on March 31, 1999 115,198 1,075,596 $ 2.92
====================================================
In October 1997, the Company's Board of Directors repriced options covering
51,850 shares, representing all of the qualified outstanding options with
exercise prices ranging from $5.12 to $11.38, to an exercise price of $4.38 per
share. The vesting terms of these options remain unchanged.
The weighted average fair value of options granted in 1999, 1998 and 1997 was
$2.18, $1.69 and $2.45 per share, respectively.
32
7. STOCK OPTIONS AND GRANTS (CONTINUED)
The exercise price of options outstanding at March 31, 1999 ranged from $1.9375
to $13.625 per share, as summarized in the following table:
SHARES
OUTSTANDING WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE
RANGE OF AT MARCH 31, REMAINING SHARES EXERCISE
EXERCISE PRICE 1999 CONTRACTUAL LIFE EXERCISABLE PRICE PER SHARE
- ---------------------------------------------------------------------------------------------
$ 1.94 - $2.63 440,966 3.9 years 182,284 $ 2.36
$ 2.64 - 2.94 421,600 4.9 years 20,800 $ 2.87
$ 2.95 - 4.38 207,030 3.9 years 41,874 $ 3.99
$ 4.39 - 13.63 6,000 4.7 years 1,200 $11.06
-------------- -------------
Total 1,075,596 4.3 years 246,158 $ 2.92
============== =============
The number of options exercisable at March 31, 1999, 1998 and 1997 was 246,158,
648,548 and 425,334, respectively, at a weighted average exercise price of
$2.92, $2.84 and $2.07 per share, respectively.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 1999, 1998 and 1997, respectively; risk-free interest rate of
5.2%, 4.9% and 6.7%, volatility factor of the expected market price of the
Company's common stock of 82%, 82%, and 57% and a weighted-average expected life
of the option of five years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value statement, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
33
7. STOCK OPTIONS AND GRANTS (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
MARCH 31
1999 1998 1997
--------------------------------------
Pro forma net loss $(62,736) $(1,187) $(6,352)
Pro forma basic and diluted loss per share $(4.42) $(.17) $(.94)
These pro forma amounts may not be indicative of future years' amounts since the
Statement provides for a phase-in of option values beginning with those granted
in fiscal 1996.
The Company has granted restricted common shares to key employees, which are
recorded at the market value on the date of the grant. A total of 150,000 common
shares were issued under restricted stock grants for the year ended March 31,
1996. The total market value on the date of grant of common shares is treated as
unearned compensation charged to expense over the vesting period of five years.
Compensation charged to expense was $95,000 for the years ended March 31, 1999,
1998 and 1997. The remaining unamortized unearned compensation is expected to be
charged to operations over the five-year vesting period.
In March 1999 the Company recognized $880,000 in compensation expense associated
with the issuance of incentive stock options of its subsidiary NetRadio to
employees with stock prices below the estimated fair market value of the
Company's common stock on the date of grant.
8. INCOME TAXES
The components of income tax benefit are as follows (in thousands):
YEAR ENDED MARCH 31
1999 1998 1997
------------------------------------
Current:
Federal $ 0 $(2,256) $ 560
State 0 (166) 120
------------------------------------
0 (2,422) 680
Deferred 0 1,952 (1,207)
------------------------------------
Income tax expense (benefit) $ 0 $ (470) $ (527)
====================================
34
8. INCOME TAXES (CONTINUED)
Deferred income taxes reflect the available tax carryforwards and the net tax
effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's deferred tax assets as of
March 31, 1999 and 1998 included in prepaid expenses and other assets are as
follows (in thousands):
MARCH 31
1999 1998
-------------------------
Debit balance $ 1,867 $ --
Net operating loss carryforward 7,913 117
Allowance for uncollectible accounts 836 443
Allowance for sales returns 686 520
Book/tax depreciation 44 58
Reserve for sales discounts 176 142
Accrued vacations 79 85
Inventory - uniform capitalization 150 118
Inventory - obsolescence 257 --
Price protection reserve 159 120
-------------------------
12,167 1,603
Valuation allowance (12,167) (1,603)
-------------------------
Total deferred tax assets $ -- $ --
=========================
The net operating loss carryforward of $222,000 created as a result of the
change in the Company's year-end in 1994 is limited to a utilization limit of
$111,000 per year through the year 2000. The remaining net operating loss of
$19,672,000 expires in the year 2019.
35
8. INCOME TAXES (CONTINUED)
A reconciliation of income tax benefit to the statutory federal rate is as
follows (in thousands):
YEAR ENDED MARCH 31
1999 1998 1997
-----------------------------------------
Tax expense (benefit) at statutory rate $ (9,408) $ (564) $ (2,039)
State income taxes (benefit), net of
federal benefit (1,220) (94) (365)
Valuation allowance 10,564 (147) 1,750
Goodwill amortization 28 43 92
Other 36 292 35
-----------------------------------------
$ 0 $ (470) $ (527)
=========================================
Effective tax rate 0% (28)% (8.8)%
=========================================
Cash paid (received) for income taxes was $(1,623,000), $0 and $855,000 for the
years ended March 31, 1999, 1998 and 1997, respectively.
9. COMMITMENTS
LEASES
On March 12, 1998, the Company entered into an operating lease agreement for
office and warehouse space. The lease expires in 2013 and provides for monthly
payments of $38,750 over the lease term, with a 2.5% increase every 30 months.
In addition, the Company is responsible for all operating costs associated with
the building. The prior operating lease was with a partnership whose two
partners are major shareholders and officers of the Company. The Company also
leases additional facilities and office equipment. The partners sold the
building in 1999 to an unrelated party.
Total rent expense was $1,368,000, $1,069,000 and $804,000 for the years ended
March 31, 1999, 1998 and 1997, respectively.
36
9. COMMITMENTS (CONTINUED)
The following is a schedule of future minimum rental payments required under
noncancelable operating leases as of March 31, 1999 (in thousands):
2000 $ 820
2001 622
2002 521
2003 523
2004 527
Thereafter 4,788
--------------
$ 7,801
==============
10. MAJOR CUSTOMERS
The Company has three major customers who accounted for 59%, 44% and 47% of
sales in fiscal 1999, 1998 and 1997, respectively.
11. BUSINESS SEGMENTS
The Company adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE
AND RELATED INFORMATION, during the quarter ended March 31, 1999. SFAS 131
establishes standards for reporting information about operating segments in
annual financial statements of public companies and requires selected
information about operating segments to be reported in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about products and services and geographic areas. The Company has defined its
operating segments based upon the financial information available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.
Navarre's operations are classified into two business segments based upon
products and services provided: home entertainment products and NetRadio. The
Company distributes home entertainment products including prerecorded tapes,
compact discs, interactive CD-ROM computer software, DVD products and personal
computer software primarily to retailers and wholesalers in the United States
and Canada. NetRadio is an internet-only radio network.
37
Financial Information by reportable business segment is included in the
following summary:
YEARS ENDED
- ------------------------------------------------------------------------------------------------------------------
In thousands MARCH 31, 1999 MARCH 31, 1998 MARCH 31, 1997
- ------------------------------------------------------------------------------------------------------------------
NET SALES FROM EXTERNAL CUSTOMERS
Home Entertainment Products $ 210,000 $ 196,444 $ 200,697
NetRadio 386 204 --
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 210,386 $ 196,648 $ 200,697
==================================================================================================================
OPERATING INCOME (LOSS)
Home Entertainment Products $ (20,082) $ 3,607 $ (3,602)
NetRadio (5,490) (2,149) (101)
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ (25,572) $ 1,458 $ (3,703)
- ------------------------------------------------------------------------------------------------------------------
Net Interest Expense (2,543) (3,108) (2,110)
Other Income (Expense) 445 (10) (184)
- ------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES $ (27,670) $ (1,660) $ (5,997)
==================================================================================================================
IDENTIFIABLE ASSETS
Home Entertainment Products $ 76,363 $ 82,287 $ 76,005
NetRadio 3,117 1,402 2,392
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 79,480 $ 83,689 $ 78,397
==================================================================================================================
DEPRECIATION AND AMORTIZATION
Home Entertainment Products $ 1,572 $ 2,023 $ 5,826
NetRadio 381 415 0
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 1,953 $ 2,438 $ 5,826
==================================================================================================================
CAPITAL EXPENDITURES
Home Entertainment Products $ 1,020 $ 732 $ 870
NetRadio 1,019 16 --
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 2,039 $ 748 $ 870
==================================================================================================================
YEARS ENDED
- ------------------------------------------------------------------------------------------------------------------
In thousands MARCH 31, 1999 MARCH 31, 1998 MARCH 31, 1997
- ------------------------------------------------------------------------------------------------------------------
SALES BY CLASSES OF SIMILAR PRODUCTS OR SERVICES
Computer Software $ 150,350 $ 137,479 $ 150,859
Music 59,650 58,965 49,838
NetRadio 386 204 --
- ------------------------------------------------------------------------------------------------------------------
CONSOLIDATED $ 210,386 $ 196,648 $ 200,697
==================================================================================================================
38
NAVARRE CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
- -----------------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- -----------------------------------------------------------------------------------------------------------------------------------
Additions
--------------------------------
Balance at Charged to Charged to Balance at
Beginning Costs and Other Accounts -- Deductions -- End of
Description Of Period Expenses Describe Describe Period
- -----------------------------------------------------------------------------------------------------------------------------------
Year ended March 31, 1999:
Deducted from asset accounts:
Inventory obsolescence reserve $ 0 $ 658,000 $ 0 $ 658,000
Allowance for doubtful accounts 1,112,000 960,000 (23,000)(1) 2,095,000
Allowance for sales returns 1,300,000 415,000 1,715,000
------------------------------ ------------------------------------
Totals $ 2,412,000 $ 2,033,000 $ (23,000)(1) $ 4,468,000
============================== ====================================
Year ended March 31, 1998:
Deducted from asset accounts:
Inventory obsolescence reserve $ 0 $ 0 $ 0 $ 0
Allowance for doubtful accounts 2,388,000 (22,000) 1,254,000(1) 1,112,000
Allowance for sales returns 1,197,000 103,000 1,300,000
------------------------------ ------------------------------------
Totals $ 3,585,000 $ 81,000 $ 1,254,000(1) $ 2,412,000
================================ ====================================
Year ended March 31, 1997:
Deducted from asset accounts:
Inventory obsolescence reserve $ 0 $ 0 $ 0 $ 0
Allowance for doubtful accounts 196,000 2,439,000 $ 508,000(2) 755,000(1) 2,388,000
Allowance for sales returns 747,000 450,000 1,197,000
-----------------------------------------------------------------------------------------------
Totals $ 943,000 $ 2,889,000 $ 508,000 $ 755,000 $ 3,585,000
===============================================================================================
(1) Uncollectible accounts written off, net of recoveries.
(2) Increase in allowance transferred from acquisition of Record
Service, Inc. and NetRadio, Inc.
39