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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the quarterly period ended September 30, 2002
or
[] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
for the transition period from _______________ to _______________
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 (763) 535-8333
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[ ] Yes [X] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, No Par Value - 21,616,187 shares as of November 12, 2002
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NAVARRE CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
Consolidated Balance Sheets -
September 30, 2002 and March 31, 2002
Consolidated Statements of Operations -
Three months and six months ended September 30, 2002 and 2001
Consolidated Statements of Cash Flows - Six months ended
September 30, 2002 and 2001
Notes to Consolidated Financial Statements - September 30, 2002
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
ITEM 4. CONTROLS AND PROCEDURES.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
ITEM 5. OTHER INFORMATION.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
SIGNATURES
CERTIFICATIONS
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NAVARRE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SEPTEMBER 30, 2002 MARCH 31, 2002
------------------ --------------
(UNAUDITED) (NOTE)
ASSETS
Current assets:
Cash $ 9,200 $ 18,966
Accounts receivable, less allowance for doubtful accounts
and sales returns of $5,372 and $2,411 respectively 59,423 42,666
Inventories 32,639 15,316
Prepaid expenses and other current assets 3,410 163
------------------ ------------------
Total current assets 104,672 77,111
Property and equipment, net of accumulated depreciation of
$5,500 and $5,089, respectively 4,046 3,028
Other assets:
Note receivable, related parties 902 289
Other assets 3,115 657
------------------ ------------------
Total assets $ 112,735 $ 81,085
================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Note payable, current portion $ 1,305 --
Accounts payable and other payables 82,363 54,305
Accrued expenses 3,106 2,430
------------------ ------------------
Total current liabilities 86,774 56,735
Note payable, long-term 737 --
------------------ ------------------
Total liabilities 87,511 56,735
Shareholders' equity:
Common stock, no par value:
Authorized shares - 100,000,000,
issued and outstanding shares-21,616,187 and
21,616,187, respectively 91,404 91,404
Retained deficit (66,180) (67,054)
------------------ ------------------
Total shareholders' equity 25,224 24,350
------------------ ------------------
Total liabilities and shareholders' equity $ 112,735 $ 81,085
================== ==================
Note: The balance sheet at March 31, 2002 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
3
NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net sales $ 88,864 $ 67,676 $158,838 $122,161
Cost of sales 77,432 60,728 139,358 108,829
-------- -------- -------- --------
Gross profit 11,432 6,948 19,480 13,332
Operating expenses:
Selling and promotion 3,801 1,734 5,931 3,584
Distribution and warehousing 1,282 1,169 2,430 2,414
General and administration 5,327 3,982 9,730 8,143
Depreciation and amortization 385 361 675 703
-------- -------- -------- --------
10,795 7,246 18,766 14,844
-------- -------- -------- --------
Income (loss) from operations 637 (298) 714 (1,512)
Other expense:
Interest expense (63) (3) (95) (27)
Other income and expense 102 333 255 633
-------- -------- -------- --------
Net income (loss) $ 676 $ 32 $ 874 $ (906)
======== ======== ======== ========
Income (loss) per common share:
Basic $ 0.03 $ (0.00) $ 0.04 $ (0.04)
======== ======== ======== ========
Diluted $ 0.03 $ (0.00) $ 0.04 $ (0.04)
======== ======== ======== ========
Weighted average common and
common equivalent shares outstanding
Basic 21,616 23,201 21,616 23,450
======== ======== ======== ========
Diluted 21,692 23,203 21,736 23,450
======== ======== ======== ========
4
NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED SEPTEMBER 30,
------------------------------
2002 2001
---------------- -------------
OPERATING ACTIVITIES
Net income (loss) $ 874 $ (906)
Adjustments to reconcile net income (loss) to net cash
Used in operating activities:
Depreciation and amortization 675 703
Write off of notes receivable 129 56
Changes in operating assets and liabilities:
net of amounts acquired
Accounts receivable (12,783) (1,861)
Inventories (16,006) (3,780)
Prepaid expenses and assets (1,870) (268)
Accounts payable and accrued expenses 27,629 (1,087)
--------- ---------
Net cash used in operating activities (1,352) (7,143)
INVESTING ACTIVITIES
Acquisition of Encore, net of cash (7,046) --
Note receivable, related parties (742) --
Purchase of equipment and leasehold improvements (559) (588)
--------- ---------
Net cash used in investing activities (8,347) (588)
FINANCING ACTIVITIES
Repayment of note (67) --
Repurchase of Navarre common stock -- (1,651)
--------- ---------
Net cash used in financing activities (67) (1,651)
Net decrease in cash (9,766) (9,382)
Cash at beginning of period 18,966 19,118
--------- ---------
Cash at end of period $ 9,200 $ 9,736
5
NAVARRE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2002
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited financial statements of Navarre Corporation have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
All intercompany accounts and transactions have been eliminated. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Because of the
seasonal nature of our business, the operating results for the six month period
ended September 30, 2002 are not necessarily indicative of the results that may
be expected for the year ending March 31, 2003. For further information, refer
to the financial statements and footnotes thereto included in Navarre
Corporation's Annual Report on Form 10-K for the year ended March 31, 2002.
NOTE B - ACQUISITIONS
We acquired the primary assets of Encore Software, Inc. ("Encore") from the
United States Bankruptcy Court for the Central District of California pursuant
to an Amended and Restated Asset Purchase Agreement between the Company and
Encore effective as of July 10, 2002, as amended by amendment No. 1 to the
Agreement effective as of July 31, 2002 (collectively, the "Purchase
Agreement"). The transaction closed on August 2, 2002. We paid approximately
$7.4 million in cash and $2.1 million in debt. The assets purchased by the
Company included certain fixed assets, intellectual property, inventory,
receivables, and contract rights related to Encore's business. We acquired
Encore, an interactive publisher in the video game and PC CD-ROM markets, to
enable us to more actively participate in the high-growth video game industry
and enable us to further extend our direct distribution relationships with large
retailers generating solid sell-through of Encore titles. The acquisition was
accounted for using the purchase method in accordance with SFAS No. 141.
Accordingly, the net assets were recorded at their estimated fair values and
operating results were included in our financial statements from the date of
acquisition. The purchase price was allocated on a preliminary basis using
information currently available. The allocation of the purchase price to the
assets acquired will be finalized in fiscal 2004. We will adjust the allocation
of the purchase price after obtaining more information regarding asset
valuations. The preliminary allocations resulted in goodwill of $2.3 million.
Under SFAS No.142, goodwill is not amortized.
The preliminary purchase price allocation was as follows:
(in thousands)
Cash $ 354
Accounts receivable, net of allowances 3,974
Inventories 1,317
Prepaid expenses and other current assets 1,513
Property and equipment 1,134
Goodwill 2,322
Current liabilities (1,105)
-------
$ 9,509
=======
Subsequent to our acquisition of the assets of Encore Software, Inc. on August
24, 2002, we entered into a five-year agreement with Michael Bell, to serve as
Chief Executive Officer of Encore Software, Inc. On the same date, we also
entered into a stock purchase agreement with Mr. Bell under which he acquired
20,000 of the 100,000 outstanding shares of Encore. In connection with the
stock purchase, a stock buy and sell agreement was entered into between Mr.
Bell and Encore.
6
NOTE C - BUSINESS SEGMENTS
Financial information by reportable business segment is included in the
following summary:
THREE MONTHS ENDED SIX MONTHS ENDED
(In thousands) SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
NET SALES
Home Entertainment Products $ 87,506 $ 67,676 $ 157,480 $ 122,161
Encore 3,757 -- 3,757 --
Intercompany Elimination (2,399) -- (2,399) --
--------- --------- --------- ---------
Consolidated 88,864 $ 67,676 $ 158,838 $ 122,161
========= ========= ========= =========
OPERATING INCOME (LOSS)
Home Entertainment Products 826 (298) 903 (1,512)
Encore (189) -- (189) --
--------- --------- --------- ---------
Consolidated Operating Income (Loss) 637 (298) 714 (1,512)
========= ========= ========= =========
Interest Expense (63) (3) (95) (27)
Other Income 102 333 255 633
--------- --------- --------- ---------
NET INCOME (LOSS) $ 676 $ 32 $ 874 $ (906)
========= ========= ========= =========
NOTE D - NET EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
(In thousands, except per share data)
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
Numerator:
Net income (loss) $ 676 $ 32 $ 874 $ (906)
Denominator:
Denominator for basic earnings per
share--weighted-average shares 21,616 23,201 21,616 23,450
Dilutive securities: Employee Stock Options 76 2 120 --
-------- -------- -------- --------
Denominator for diluted earnings per share
-adjusted weighted-average shares 21,692 23,203 21,736 23,450
======== ======== ======== ========
Basic income (loss) per share $ 0.03 $ 0.00 $ 0.04 $ (0.04)
======== ======== ======== ========
Dilutive income (loss) per share $ 0.03 $ 0.00 $ 0.04 $ (0.04)
======== ======== ======== ========
7
NOTE E - RESTRUCTURING
In December 2001, the Company initiated actions to close a warehouse and
distribution facility in Hawaii and subsequently consolidated the operations
into its Minneapolis facility. These actions resulted in us recording an
aggregate charge of $831,000, including goodwill impairment of $356,000. The
charges include $672,000 classified as restructuring and $159,000 of inventory
write-downs classified in cost of sales. Through September 30, 2002, we have
paid or incurred $811,000 of the $831,000 charge. We anticipate that
substantially all of the restructuring costs will be paid by March 2003.
In thousands INCURRED THROUGH BALANCE AS OF
TOTAL CHARGE SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------ ------------------ ------------------
Inventory write-downs $ 159,000 $ 159,000 --
Severance costs 131,000 121,000 10,000
Impairment charge 356,000 356,000 --
Other 185,000 175,000 10,000
--------------- --------------- ---------------
$ 831,000 $ 811,000 $ 20,000
--------------- --------------- ---------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
GENERAL
Navarre Corporation, a Minnesota corporation formed in 1983, is a premier
provider of distribution, fulfillment and marketing services for a broad range
of home entertainment and multimedia products, including PC software, audio and
video titles, and interactive games. We maintain and leverage strong
relationships on both ends of the content distribution chain, including
relationships with leading national retailers, wholesalers and rackjobbers, as
well as major publishers, music labels, and movie studios. With the acquisition
of Encore, as described below, we are also a publisher of PC Software and video
games.
We are recognized as an industry leader in the distribution of consumer PC
software, interactive video games and independent music labels and artists. Our
product line contains a broad assortment of compact discs, personal computer
software, and DVD/VHS videos sold to over 500 customers through over 12,000
locations throughout the United States. Our broad base of customers includes
(i) wholesale clubs, (ii) mass merchandisers, (iii) computer specialty stores,
(iv) music specialty stores, (v) book stores, (vi) office superstores, and
(vii) electronic superstores. Upon the acquisition of Encore, we operate in two
business segments, Home Entertainment Products and Encore. Home Entertainment
Products consists of two divisions: Navarre Distribution Services (NDS) and
Navarre Entertainment Media (NEM), while our Encore subsidiary engages in
interactive publishing.
Through NDS, we distribute non-proprietary entertainment products including PC
software, major label music, DVD video and video games. We focus on providing
retailers and publishers a wide array of high-quality services, including
vendor-managed inventory, full EDI protocol, packaging, manufacturing,
fulfillment, and marketing, for the broad, efficient distribution of
non-proprietary home entertainment products. We will pursue substantial growth
of NDS in several ways, including (i) by increasing our presence in software
categories such as personal productivity, finance and business to complement our
current strong positioning in the entertainment and education software
categories; (ii) by expanding the presence in distribution of home entertainment
content formats, such as DVD audio/video and video games; and (iii) by
leveraging our unique mix of operational capabilities to deepen relationships
with existing retailers and publisher clients.
8
Through NEM, we distribute proprietary prerecorded music of primarily
independent artists and labels on CD and DVD audio, and video in DVD and VHS
format, to national and retail music retailers, rackjobbers, and one-stops
throughout the United States and Canada. We offer independent content creators
such as labels, studios and artists, the resources and exposure to generate high
visibility with valuable distribution in a broad array of major outlets
nationwide. We seek to significantly enhance our competitive position in
independent music label distribution in several ways including (i) increased
ownership of content, (ii) exclusive licenses and outright acquisition, (iii)
possible acquisition of competing independent distribution companies, and (iv)
continuing to seek new proprietary distribution opportunities.
We acquired the primary assets of Encore Software, Inc. ("Encore") from the
United States Bankruptcy Court for the Central District of California pursuant
to an Amended and Restated Asset Purchase Agreement between the Company and
Encore effective as of July 10, 2002, as amended by amendment No. 1 to the
Agreement effective as of July 31, 2002 collectively, the ("Purchase
Agreement"). The transaction closed on August 2, 2002. Encore is an interactive
publisher in the video game and PC CD-ROM markets. The assets purchased by the
Company included certain fixed assets, intellectual property, inventory,
receivables, and contract rights related to Encore's business. The assets are
held by a Navarre subsidiary, which has been named Encore Software, Inc. See
Note B, Acquisitions.
FORWARD LOOKING STATEMENTS
Certain information in this Management's Discussion and Analysis section
contains forward looking statements. The statements in this Management's
Discussion and Analysis section that are not strictly historical are "forward
looking" statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to
be covered by the safe harbors created by these sections. The forward looking
statements are subject to risks and uncertainties and the actual results that
the Company achieves may differ materially from these forward looking statements
due to such risks and uncertainties, including (i) developments in the retail
and consumer markets for prerecorded music products, video products and computer
software products; (ii) retail consumer buying patterns; (iii) the ability of
consumers to download or acquire products for free on the internet; (iv) new and
different competition in the Company's traditional and new markets; (v) the
Company's dependence upon seasonality in its business; (vi) the Company's
ability to attract and retain large retail customers that account for a
significant part of its business; (vii) the Company's ability to successfully
act as distributor to on-line retailers; (viii) the Company's ability to manage
its inventory; (ix) the Company's dependence upon content providers including
recording labels and artists and software developers; (x) the Company's ability
to react to changes in the distribution of software and prerecorded music,
including electronic distribution; (xi) the Company's dependence upon bank
financing to satisfy its seasonal working capital requirements; (xii) the
Company's ability to successfully defend itself against litigation and (xiii)
the Company's successful integration of Encore Software into the Company's
business. A detailed statement of risks and uncertainties related to the Company
is included in the Section "Business- Forward Looking Statements" in the
Company's Form 10-K for the year ended March 31, 2002.
9
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of net
sales represented by certain items included in our "Consolidated Statements of
Operations."
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- ---------------------
2002 2001 2002 2001
-------------------- ---------------------
NET SALES:
Home Entertainment:
Distribution Services 77.9% 88.0% 80.9% 88.0%
Entertainment Media 20.6 12.0 18.2 12.0
----- ----- ----- -----
Home Entertainment net sales 98.5 100.0 99.1 100.0
Encore 1.5 -- .9 --
----- ----- ----- -----
Total net sales 100.0 100.0 100.0 100.0
Cost of sales 87.1 89.7 87.7 89.1
----- ----- ----- -----
Gross profit 12.9 10.3 12.3 10.9
Selling and promotion 4.3 2.6 3.8 2.9
Distribution and warehousing 1.4 1.7 1.5 2.0
General and administration 6.0 5.9 6.1 6.7
Depreciation and amortization 0.4 0.5 0.4 0.5
----- ----- ----- -----
Income (loss) from operations 0.8 (0.4) 0.5 (1.2)
Interest expense 0.0 (0.0) 0.0 (0.0)
Other income and expense 0.0 0.4 0.1 0.5
----- ----- ----- -----
--
NET INCOME (LOSS) 0.8% 0.0% 0.6% (0.7)%
===== ===== ===== =====
HOME ENTERTAINMENT
NET SALES
Net sales for the second quarter ended September 30, 2002, increased 29.2% to
$87.5 million from $67.7 million in the same period in fiscal 2002. For the
six-month period ended September 30, 2002, net sales increased 28.9% to $157.5
million from $122.2 million in the same period in fiscal 2002. Net sales for the
second quarter and six-month period increased in both Navarre Distribution
Services and Navarre Entertainment Media. Net sales for NDS for the second
quarter ended September 30, 2002, increased 16.3% to $69.2 million from $59.5
million for the same period in fiscal 2002. For the six-month period ended
September 30, 2002, NDS net sales increased 19.6 % to $128.6 million from $107.5
million for the same period in fiscal 2002. The increase in net sales for NDS
for the second quarter and six-month period was the result of market share
increases of distributed software in a variety of software categories including
entertainment and personal productivity, and significant increases in the volume
of sales of all non-proprietary categories, including video games and DVD video.
Net sales for NEM for the second quarter ended September 30, 2002, increased
123.2% to $18.3 million from $8.2 million for the same period in fiscal 2002.
For the six-month period ended September 30, 2002, NEM net sales increased 96.6%
to $28.9 million from $14.7 million for the same period in fiscal 2002. The
increase in net sales for NEM for the second quarter and six-month period was
the result of our ability to acquire or license a deeper range of proprietary
independent music and video content.
10
GROSS PROFIT
Gross profit for the second quarter ended September 30, 2002, increased 40.6% or
$2.8 million to $9.7 million from $6.9 million for the same period in fiscal
2002. For the six-month period ended September 30, 2002, gross profit increased
33.1% or $4.4 million to $17.7 million from $13.3 million for the same period in
fiscal 2002. As a percentage of net sales, gross profit for the second quarter
ended September 30, 2002 increased to 11.1% from 10.2% for the same period in
fiscal 2002 and for the six-month period ended September 30, 2002, gross profit
as a percentage of net sales increased to 11.2% from 10.9% for the same period
in fiscal 2002. Gross profit from NDS net sales for the second quarter ended
September 30, 2002 was $7.0 million or 10.1% as a percentage of net sales
compared with $6.0 million or 10.1% as a percentage of net sales in the same
period in fiscal 2002. For the six-month period ended September 30, 2002, NDS
gross profit increased to $13.4 million or 10.4% as a percentage of net sales
from $11.0 million or 10.2% as a percentage of net sales for the same period in
fiscal 2002. The increase in gross profit and as a percentage of net sales for
NDS resulted from a greater sales mix of higher margin product. The gross margin
may continue to fluctuate slightly depending upon the make-up of product sales
each quarter. Gross profit from NEM net sales for the second quarter ended
September 30, 2002 was $2.7 million or 14.8% as a percentage of net sales
compared with $0.9 million or 11.7% as a percentage of net sales in the same
period in fiscal 2002. For the six-month period ended September 30, 2002, NEM
gross profit increased to $4.3 million or 14.9% as a percentage of net sales
from $2.3 million or 16.0% as a percentage of net sales for the same period in
fiscal 2002. The decrease in gross profit as a percentage of net sales for NEM
for the six-month period ended September 30, 2001 was due to a reduction in the
reserve for returns caused by the timing of shipments for certain products that
occurred in first quarter of fiscal 2003.
OPERATING EXPENSES
Selling and promotion expense for the second quarter ended September 30, 2002
increased to $2.5 million from $1.7 million for the same period in fiscal 2002.
For the six-month period ended September 30, 2002, selling and promotion expense
increased to $4.7 million from $3.6 million for the same period in fiscal 2002.
As a percentage of net sales, selling and promotion expense for the second
quarter ended September 30, 2002 increased to 2.9% from 2.6% for the same period
in fiscal 2002. For the six-month period ended September 30, 2002, as a
percentage of net sales, selling and promotion expense increased to 3.0% from
2.9% for the same period in fiscal 2002. The increase in selling and promotion
expense is due to a higher level of sales while the increase as a percentage of
net sales for the second quarter and six-month period ended September 30, 2002
was due to a slight increase in marketing costs for this period compared to the
same period in fiscal 2002.
Distribution and warehousing expense for the second quarter ended September 30,
2002 increased to $1.3 million from $1.2 million for the same period in fiscal
2002. For the six-month periods ended September 30, 2002 and 2001, distribution
and warehousing expense remained the same at $2.4 million. As a percentage of
net sales, distribution and warehousing expense for the second quarter ended
September 30, 2002 decreased to 1.5% from 1.7% for the same period in fiscal
2002. For the six-month period ended September 30, 2002, as a percentage of net
sales, distribution and warehousing expense decreased to 1.5% from 2.0% for the
same period in fiscal 2002. The decrease in distribution and warehousing expense
as a percentage of net sales for the second quarter and six-month period ended
September 30, 2002 were due to the overall improved management of the
warehousing expenses reflecting in part efficiencies associated with a higher
level of sales.
11
General and administration expenses for the second quarter ended September 30,
2002 increased to $4.7 million from $4.0 million for the same period in fiscal
2002. For the six-month period ended September 30, 2002, general and
administration expenses increased to $9.1 million from $8.1 million for the same
period in fiscal 2002. As a percentage of net sales, general and administration
expenses for the second quarter ended September 30, 2002 decreased to 5.4% from
5.9% for the same period in fiscal 2002. For the six-month period ended
September 30, 2002, as a percentage of net sales, general and administration
expenses decreased to 5.8% from 6.7% for the same period in fiscal 2002. The
decrease in general and administration expenses as a percentage of net sales for
the second quarter and six-month period ended September 30, 2002 was due to
increased overall efficiencies coupled with higher levels of sales.
Depreciation and amortization was $312,000 for the second quarter ended
September 30, 2002 compared to $361,000 for the same period in fiscal 2002. For
the six-month period ended September 30, 2002, depreciation and amortization was
$602,000 compared to $703,000 for the same period in fiscal 2002.
Operating income for Home Entertainment was $826,000 for the second quarter
ended September 30, 2002 compared to an operating loss of $298,000 for the same
period in fiscal 2002. For the six-month period ended September 30, 2002,
operating income was $903,000 compared to an operating loss of $1.5 million for
the same period in fiscal 2002.
ENCORE SOFTWARE, INC.
Encore had net sales of $3.8 million for the second quarter ended September 30,
2002. The second quarter represented two months of sales, since our acquisition
of Encore on August 2, 2002. Encore had gross profit of $1.8 million, selling
and promotion expense of $1.3 million, general and administration expense of
$592,000 and depreciation expense of $73,000 for an operating loss for the
period ended September 30, 2002 of $189,000.
Interest expense for the second quarter ended September 30, 2002 was $63,000
compared to $3,000 for the same period in fiscal 2002. For the six-month period
ended September 30, 2002, interest expense was $95,000 compared to $27,000 for
the same period in fiscal 2002. The increase for the second quarter and
six-month period ended September 30, 2002 resulted from our use of our line of
credit for the Encore acquisition.
Other income, which consists principally of interest income, was $102,000 for
the second quarter ended September 30, 2002 compared to $333,000 for the same
period in fiscal 2002. For the six-month period ended September 30, 2002,
interest income was $255,000 compared to $633,000 for the same period in fiscal
2002. The decrease for the six-month period ended September 30, 2002 resulted
from not having a principal balance on the NetRadio note and from lower interest
rates.
Due to the accumulated losses from prior years, we have not recorded any
provision for taxes.
We had net income for the second quarter ended September 30, 2002 of $676,000
compared to $32,000 for the same period in fiscal 2002. For the six-month period
ended September 30, 2002, we had net income of $874,000 compared to a loss of
$906,000 for the same period in fiscal 2002.
MARKET RISK
Although we are subject to some interest rate risk, because we currently have
limited borrowings under our bank credit facility, we believe a 10% increase or
reduction in interest rates would not have a material effect on future earnings,
fair values or cash flows.
12
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our working capital needs through bank borrowings
and sale of equity securities. The level of borrowings has historically
fluctuated significantly during the year. At September 30, 2002, we had net
accounts receivable of $59.4 million, inventory of $32.6 million, accounts
payable of $82.4 million and no borrowings under our bank credit facility. In
connection with our acquisition of Encore, we incurred debt of $2.1 million.
We used cash of $1.4 million for operating activities. Net of amounts acquired,
accounts receivable increased by $12.8 million, inventories increased by $16.0
million and accounts payable and accrued expense increased by $27.6 million. Due
to the seasonal nature of our business and the holiday selling season, inventory
and accounts receivable typically increase during the first three quarters of
our fiscal year. Investing activities used $8.3 million of cash primarily
related to the acquisition of Encore and for the purchase of furniture,
equipment and leasehold improvements. Cash decreased by $9.8 million during the
period.
We acquired the primary assets of Encore Software, Inc. ("Encore") from the
United States Bankruptcy Court for the Central District of California pursuant
to an Amended and Restated Asset Purchase Agreement between the Company and
Encore effective as of July 10, 2002, as amended by amendment No. 1 to the
Agreement effective as of July 31, 2002. The transaction closed on August 2,
2002. The assets purchased included certain fixed assets, intellectual property,
inventory, receivables, and contract rights related to Encore's business.
Pursuant to the Purchase Agreement, we paid approximately $7.4 million in cash
and agreed to pay or assumed $2.1 million in debt, which includes Encore's debt
to Comerica Bank in the amount of approximately $1.6 million and secured by the
assets of Encore. The $2.1 million in debt does not include a note for $650,000
that was contingent upon Sony's approval for Encore to manufacture the PS2
version of Dragon's Lair by no later than October 17, 2002. Approval was not
received by that date and therefore Navarre has no further obligation on that
$650,000 note.
As described above, on July 31, 2002, we purchased the primary assets of Encore
Software, Inc. On August 14, 2002, we filed a Form 8-K describing the
transaction. Pursuant to Item 7 of Form 8-K, we elected to file financial
statements for the acquired business and pro forma financial information within
60 days on a amended Form 8-K pursuant to Items 7(a)(4), (b)(1) and (2) of Form
8-K. We have been advised that Encore's external auditor KPMG, has been unable
to complete its audit of the fiscal years ended December 31, 2001, 2000 and
1999. Consequently, we have been unable to submit an amended Form 8-K. We intend
to file an amended Form 8-K as soon as the information is available.
As described in Note B, Encore's results of operations for the two months ended
September 30, 2002, have been included in our consolidated results of operations
in accordance with SFAS 141. We also have included the acquired net assets of
Encore based on their estimated fair values. As of the acquisition date, the
purchase price was allocated on a preliminary basis using information currently
available.
Although we believe we have sufficient cash and working capital to meet our
short-term liquidity and capital requirements, we anticipate we could utilize
our credit facility during the next twelve months to meet seasonal working
capital needs.
ITEM 3. 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 this Form 10-Q.
13
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
The Company's Chief Executive Officer, Eric H. Paulson, and Chief Financial
Officer, James Gilbertson, have reviewed the Company's disclosure controls and
procedures within 90 days prior to the filing of this report. Based upon this
review, these officers believe that the Company's disclosure controls and
procedures are effective in ensuring that material information related to the
Company is made known to them by others within the Company.
(b) Changes in Internal Controls.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect these controls during the quarter
covered by this report or from the end of the reporting period to the date of
this Form 10-Q.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of our business, we are involved in a number of routine
litigation matters that are incidental to the operation of its business. These
matters generally include collection matters with regard to products distributed
by us and accounts receivable owed to us. We currently believe that the
resolution of any of these pending matters will not have a material adverse
effect on its financial position or results of operation. In addition, we are
subject to the litigation listed below.
MIKE SPALLA D/B/A JINGLE CATS MUSIC
In April 2001, Mike Spalla, d/b/a Jingle Cats Music ("Plaintiff") commenced an
action against Navarre in United States District Court for the District of
Minnesota, Case No. 01-CV-598, alleging, among other things, breach of contract,
and seeking an accounting, injunctive relief, and damages in an amount in excess
of $75,000 in connection with the distribution agreement between Plaintiff and
Navarre. Navarre answered Plaintiff's Complaint, denied liability, and asserted
affirmative defenses and counterclaims against Plaintiff.
On August 21, 2002, the U.S. District Court handed down its decision granting in
part and denying in part Navarre's motion for summary judgment, resulting in a
dismissal of some of Plaintiff's claims. Plaintiff and Navarre reached a
settlement of the lawsuit prior to trial, and the matter will be dismissed with
prejudice as a part of that settlement.
BOB GRADY MUSIC AND WILSON MEADOWS
Plaintiffs Bob Grady Music and Wilson Meadows commenced this action on January
29, 2001, by service and filing of a complaint against us in the United States
District Court for the Northern District of Georgia, Case No. 1 01-CV-0252
(JOF). Plaintiffs allege claims for copyright infringement and unfair
competition in violation of Plaintiffs' right of publicity, and seek damages in
an amount in excess of $150,000. Plaintiffs' claims arise from our distribution
of Wilson Meadows' "Memories" musical album.
14
On March 13, 2001, we answered Plaintiffs' complaint, denying liability and
asserting affirmative defenses. The parties have engaged in and completed
discovery. Each side has moved for summary judgment in its favor, and briefing
on the summary judgment motions was completed as of April 29, 2002. The court
has not set a hearing date or rendered a decision in connection with the
motions. No trial date has been set with respect to the matter. We intend to
vigorously defend ourselves in connection with this lawsuit.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
The Company's Annual Meeting of Shareholders was held on September 5, 2002. At
the meeting, the following action was taken:
The following persons were re-elected as directors of the Company for three-year
terms ending at the Annual meeting of Shareholders held in 2005:
NAMES VOTES FOR VOTES WITHHOLD
----- ---------- --------------
Eric H. Paulson 19,857,197 412,745
James G. Sippl 20,067,407 202,535
ITEM 5. OTHER INFORMATION
Subsequent to our acquisition of the assets of Encore Software, Inc, on August
24, 2002, we entered into a five-year agreement with Michael Bell, to serve as
Chief Executive Officer of Encore Software, Inc. On the same date, we also
entered into a stock purchase agreement with Mr. Bell under which he acquired
20,000 of the 100,000 outstanding shares of Encore. In connection with the stock
purchase, a stock buy and sell agreement was entered into between Mr. Bell and
Encore. The agreement restricts Mr. Bell's ability to transfer the shares for
ten years without the written consent from Encore and Navarre Corporation. After
the ten-year period, Encore maintains the right of first refusal on any sale of
Mr. Bell's shares. Mr. Bell has a right under which he can cause Encore to
repurchase up to 10,000 shares of his Encore stock at a price determined by a
formula based on nets sales and EBITA. This right to sell his shares is limited
to four percent of the 10,000 shares on September 30, 2002, increasing to ten
percent on January 1, 2003, and increasing at a rate of five percent each
quarter until it reaches one hundred percent on July 1, 2007.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
Exhibit 10.1 Amendment No. 2 to Credit Agreement, dated August 2, 2002
Exhibit 99.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 18 USC Section 1350.
(b) Reports on Form 8-K
On August 14, 2002, we filed a Form 8-K dated July 31, 2002 reporting
the acquisition of Encore Software, Inc. assets pursuant to Item 2 of Form 8-K.
15
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NAVARRE CORPORATION
(Registrant)
Date: November 14, 2002 /s/ Eric H. Paulson
--------------------------
Eric H. Paulson
Chairman of the Board,
President and
Chief Executive Officer
Date: November 14, 2002 /s/ James Gilbertson
--------------------------
James Gilbertson
Vice President and
Chief Financial Officer
16
CERTIFICATIONS
I, Eric H. Paulson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Navarre Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I am responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 /s/ Eric H. Paulson
-------------------------------------
Eric H. Paulson
Chairman of the Board,
President and
Chief Executive Officer
I, James Gilbertson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Navarre Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I am responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 /s/ James Gilbertson
-------------------------------------
James Gilbertson
Vice President and
Chief Financial Officer