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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 December 31, 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. [X] Yes [ ] 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 February 7, 2003
NAVARRE CORPORATION
INDEX
PART I. FINANCIAL INFORMATION 3
ITEM 1. FINANCIAL STATEMENTS. 3
Consolidated Balance Sheets -
December 31, 2002 and March 31, 2002 3
Consolidated Statements of Income -
Three months and nine months ended December 31, 2002 and 2001 4
Consolidated Statements of Cash Flows -
Nine months ended December 31, 2002 and 2001 5
Notes to Consolidated Financial Statements - December 31, 2002 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. 8
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. 14
ITEM 4. CONTROLS AND PROCEDURES. 14
PART II. OTHER INFORMATION 14
ITEM 1. LEGAL PROCEEDINGS. 14
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. 15
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS. 15
ITEM 5. OTHER INFORMATION. 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. 15
SIGNATURES 16
CERTIFICATIONS 17
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NAVARRE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, 2002 MARCH 31, 2002
----------------- --------------
(UNAUDITED) (NOTE)
ASSETS
Current assets:
Cash $ 14,171 $ 18,966
Accounts receivable, less allowance for doubtful accounts
and sales returns of $8,196 and $2,411 respectively 72,521 42,666
Inventories 25,250 15,316
Prepaid expenses and other current assets 4,895 163
--------- ---------
Total current assets 116,837 77,111
Property and equipment, net of accumulated depreciation of
$5,148 and $5,089, respectively 3,909 3,028
Other assets:
Note receivable, related parties 851 289
Other assets 2,977 657
--------- ---------
Total assets $ 124,574 $ 81,085
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable, current portion $ 1,305 --
Accounts payable and other payables 90,775 54,305
Accrued expenses 3,728 2,430
--------- ---------
Total current liabilities 95,808 56,735
Note payable, long-term 537 --
--------- ---------
Total liabilities 96,345 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 (63,175) (67,054)
--------- ---------
Total shareholders' equity 28,229 24,350
--------- ---------
Total liabilities and shareholders' equity $ 124,574 $ 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 INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2002 2001 2002 2001
--------- --------- --------- ---------
Net sales $ 116,897 $ 116,040 $ 275,735 $ 238,201
Cost of sales 102,810 104,483 242,168 213,312
--------- --------- --------- ---------
Gross profit 14,087 11,557 33,567 24,889
Operating expenses:
Selling and promotion 3,518 2,374 9,449 5,958
Distribution and warehousing 1,814 1,514 4,244 3,928
General and administration 5,271 5,408 15,001 13,551
Depreciation and amortization 456 515 1,131 1,218
--------- --------- --------- ---------
11,059 9,811 29,825 24,655
--------- --------- --------- ---------
Income from operations 3,028 1,746 3,742 234
Other expense:
Interest expense (53) (104) (148) (131)
Other income and expense 30 156 285 789
--------- --------- --------- ---------
Income before impact of investment in NetRadio Corporation 3,005 1,798 3,879 892
Impact of investment in NetRadio Corporation -- 1,480 -- 1,480
--------- --------- --------- ---------
Net income $ 3,005 $ 3,278 $ 3,879 $ 2,372
========= ========= ========= =========
Income per common share:
Basic $ 0.14 $ 0.15 $ 0.18 $ 0.10
========= ========= ========= =========
Diluted $ 0.14 $ 0.15 $ 0.18 $ 0.10
========= ========= ========= =========
Weighted average common and
common equivalent shares outstanding
Basic 21,616 21,686 21,616 22,860
========= ========= ========= =========
Diluted 22,009 21,724 21,814 22,877
========= ========= ========= =========
4
NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED DECEMBER 31,
2002 2001
-------- --------
OPERATING ACTIVITIES
Net income $ 3,879 $ 2,372
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,131 1,218
Impact of investment in NetRadio Corporation -- (1,480)
Write off of notes receivable 193 56
Changes in operating assets and liabilities:
net of amounts acquired
Accounts receivable (25,881) (28,495)
Inventories (8,617) 370
Prepaid expenses and assets (3,217) (360)
Accounts payable and accrued expenses 36,663 24,691
-------- --------
Net cash provided by (used in) operating activities 4,151 (1,628)
INVESTING ACTIVITIES
Acquisition of Encore, net of cash (7,046) --
Note receivable, related parties (755) --
Payments on NetRadio note -- 1,480
Purchase of equipment and leasehold improvements (878) (682)
-------- --------
Net cash provided by (used in) investing activities (8,679) 798
FINANCING ACTIVITIES
Repayment of note (267) --
Repurchase of Navarre common stock -- (2,707)
-------- --------
Net cash used in financing activities (267) (2,707)
Net decrease in cash (4,795) (3,537)
Cash at beginning of period 18,966 19,118
-------- --------
Cash at end of period $ 14,171 $ 15,581
5
NAVARRE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
DECEMBER 31, 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 nine month period
ended December 31, 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
=======
6
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.
NOTE C - BUSINESS SEGMENTS
Financial information by reportable business segment is included in the
following summary:
THREE MONTHS ENDED NINE MONTHS ENDED
(In thousands) DECEMBER 31, DECEMBER 31,
2002 2001 2002 2001
--------- --------- --------- ---------
NET SALES
Home Entertainment Products $ 116,126 $ 116,040 $ 273,606 $ 238,201
Encore 4,755 -- 8,512 --
Intercompany elimination (3,984) -- (6,383) --
--------- --------- --------- ---------
CONSOLIDATED $ 116,897 $ 116,040 $ 275,735 $ 238,201
========= ========= ========= =========
OPERATING INCOME (LOSS)
Home Entertainment Products $ 2,901 $ 1,746 $ 3,804 $ 234
Encore 127 -- (62) --
--------- --------- --------- ---------
CONSOLIDATED INCOME FROM OPERATIONS $ 3,028 $ 1,746 $ 3,742 $ 234
========= ========= ========= =========
Interest expense $ (53) $ (104) $ (148) $ (131)
Other income 30 156 285 789
Impact of investment in NetRadio -- 1,480 -- 1,480
--------- --------- --------- ---------
NET INCOME $ 3,005 $ 3,278 $ 3,879 $ 2,372
========= ========= ========= =========
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2002 2001 2002 2001
--------- --------- --------- ---------
Numerator:
Net income $ 3,005 $ 3,278 $ 3,879 $ 2,372
Denominator:
Denominator for basic earnings per
share--weighted-average shares 21,616 21,686 21,616 22,860
Dilutive securities: Employee stock options 393 38 198 17
--------- --------- --------- ---------
Denominator for diluted earnings per share
-adjusted weighted-average shares 22,009 21,724 21,814 22,877
========= ========= ========= =========
Basic income per share $ 0.14 $ 0.15 $ 0.18 $ 0.10
========= ========= ========= =========
Dilutive income per share $ 0.14 $ 0.15 $ 0.18 $ 0.10
========= ========= ========= =========
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 December 31, 2002, we have paid
or incurred $793,000 of the $831,000 charge. We anticipate that substantially
all of the restructuring costs will be paid by March 2003.
In thousands INCURRED THOUGH BALANCE AS OF
TOTAL CHARGE DECEMBER 31, 2002 DECEMBER 31, 2002
------------ ----------------- -----------------
Inventory write-downs $159,000 $159,000 --
Severance costs 131,000 131,000 --
Impairment charge 356,000 356,000 --
Other 185,000 147,000 38,000
-------- -------- --------
$831,000 $793,000 $ 38,000
-------- -------- --------
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 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
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 NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2002 2001 2002 2001
----- ----- ----- -----
NET SALES:
Home Entertainment:
Distribution Services 85.5% 77.9% 82.9% 83.1%
Entertainment Media 13.8 22.1 16.3 16.9
----- ----- ----- -----
Home Entertainment net sales 99.3 100.0 99.2 100.0
Encore .7 -- .8 --
----- ----- ----- -----
Total net sales 100.0 100.0 100.0 100.0
Cost of sales 87.9 90.0 87.8 89.6
----- ----- ----- -----
Gross profit 12.1 10.0 12.2 10.4
Selling and promotion 3.1 2.0 3.4 2.5
Distribution and warehousing 1.5 1.3 1.5 1.6
General and administration 4.5 4.6 5.5 5.7
Depreciation and amortization 0.3 0.4 0.4 0.5
----- ----- ----- -----
Income from operations 2.6 1.5 1.3 0.1
Interest expense 0.0 (0.1) 0.0 (0.1)
Other income and expense 0.0 0.1 0.1 0.3
Impact of investment in NetRadio -- 1.3 -- 0.6
----- ----- ----- -----
NET INCOME 2.6% 2.8% 1.4% 1.0%
===== ===== ===== =====
HOME ENTERTAINMENT
NET SALES
Net sales for the third quarter ended December 31, 2002, increased .1% to $116.1
million from $116.0 million in the same period in fiscal 2002. This was the
result of an increase in net sales for NDS and a decrease in net sales for NEM
for the third quarter ended December 31, 2002. For the nine-month period ended
December 31, 2002, net sales increased 14.9% to $273.6 million from $238.2
million in the same period in fiscal 2002. The increase for the nine-month
period ended December 31, 2002 was due to increases in net sales for both NDS
and NEM. Net sales for NDS for the third quarter ended December 31, 2002,
increased 10.7% to $100.0 million from $90.3 million for the same period in
fiscal 2002. For the nine-month period ended December 31, 2002 NDS net sales
increased 15.5% to $228.6 million from $197.9 million for the same period in
fiscal 2002. The increase in net sales for NDS for the third quarter was driven
by increased e-commerce revenues. The increase for the nine-month period was the
result of market share increases of distributed software in a variety of
software categories including entertainment and personal productivity, and
increases in the volume of sales of all non-proprietary categories, including
video games and DVD video. Net sales for NEM for the third quarter ended
December 31, 2002, decreased 37.4% to $16.1 million from $25.7 million for the
same period in fiscal 2002. The decrease in sales for NEM for the third quarter
ended December 31, 2002 reflects the impact of sales from a sizeable new release
during the same period in fiscal 2002. For the nine-month period ended December
31, 2002 NEM net sales increased 11.7% to $45.0 million from $40.3 million for
the same period in fiscal 2002. The increase in net sales for NEM for the
nine-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 third quarter ended December 31, 2002, increased 9.5% or
$1.1 million to $12.7 million from $11.6 million for the same period in fiscal
2002. For the nine-month period ended December 31, 2002, gross profit increased
22.1% or $5.5 million to $30.4 million from $24.9 million for the same period in
fiscal 2002. As a percentage of net sales, gross profit for the third quarter
ended December 31, 2002 increased to 10.9% from 10.0% for the same period in
fiscal 2002 and for the nine-month period ended December, 2002, gross profit as
a percentage of net sales increased to 11.1% from 10.4% for the same period in
fiscal 2002. The increase in both periods was the result of a more favorable
product mix resulting from the fact that the most popular software and music
products constituted a lower percentage of net sales in the fiscal 2003 periods.
The Company generally experiences a lower margin on its sales of the most
popular and widely distributed music and software products because they are
available in the greatest number of channels through a variety of vendors,
resulting in greater price competition and lower margins for industry
participants, including the Company. Gross profit from NDS net sales for the
third quarter ended December 31, 2002 was $10.2 million or 10.2% as a percentage
of net sales compared with $8.8 million or 9.7% as a percentage of net sales in
the same period in fiscal 2002. For the nine-month period ended December 31,
2002, NDS gross profit increased to $23.6 million or 10.3% as a percentage of
net sales from $19.8 million or 10.0% as a percentage of net sales for the same
period in fiscal 2002. The increase in gross profit dollars and the increase as
a percentage of net sales for third quarter and nine-month period ended December
31, 2002 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 third quarter ended
December 31, 2002 was $2.5 million or 15.5% as a percentage of net sales
compared with $2.7 million or 10.8% as a percentage of net sales in the same
period in fiscal 2002. For the nine-month period ended December 31, 2002, NEM
gross profit increased to $6.9 million or 15.3% as a percentage of net sales
from $5.1 million or 12.7% as a percentage of net sales for the same period in
fiscal 2002. The increase in gross profit as a percentage of net sales for NEM
for the third quarter and nine-month period ended December 31, 2002 was
attributable to a greater sales mix of higher margin product compared to last
fiscal year.
OPERATING EXPENSES
Total operating expenses for the third quarter ended December 31, 2002 were
generally flat at $9.8 million compared to $9.8 for the same period in fiscal
2002. For the nine-month period ended December 31, 2002, total operating
expenses increased to $26.6 million compared to $24.7 million for the same
period in fiscal 2002.
Selling and promotion expense for the third quarter ended December 31, 2002
increased to $3.3 million from $2.4 million for the same period in fiscal 2002.
For the nine-month period ended December 31, 2002, selling and promotion expense
increased to $7.9 million from $6.0 million for the same period in fiscal 2002.
As a percentage of net sales, selling and promotion expense for the third
quarter ended December 31, 2002 increased to 2.8% from 2.0% for the same period
in fiscal 2002. For the nine-month period ended December 31, 2002, as a
percentage of net sales, selling and promotion expense increased to 2.9% from
2.5% for the same period in fiscal 2002. The increase in selling and promotion
expense for the third quarter and nine-month period ended December 31, 2002, is
due to a higher level of sales.
The increase as a percentage of net sales for the third quarter and nine-month
period ended December 31, 2002 was attributable to our taking an expense in the
third quarter in connection with our purchase of specialty product display sales
racks when revenue from that distribution method failed to achieve expected
results.
Distribution and warehousing expense for the third quarter ended December 31,
2002 increased to $1.8 million from $1.5 million for the same period in fiscal
2002. For the nine-month period ended December 31, 2002,
11
distribution and warehousing expense increased to $4.2 million from $3.9 million
for the same period in fiscal 2002. As a percentage of net sales, distribution
and warehousing expense for the third quarter ended December 31, 2002 increased
to 1.6% from 1.3% for the same period in fiscal 2002. For the nine-month period
ended December 31, 2002, as a percentage of net sales, distribution and
warehousing expense decreased to 1.5% from 1.6% for the same period in fiscal
2002. The increase in distribution and warehousing expense as a percentage of
net sales for the third quarter ended December 31, 2002 was due to the cost of
handling of higher returns than experienced last year during the same period.
The decrease in distribution and warehousing expense for the nine-month period
ended December 31, 2002 was due to the overall improved management of the
warehousing expenses reflecting in part to efficiencies associated with a higher
level of sales.
General and administration expenses for the third quarter ended December 31,
2002 decreased to $4.4 million from $5.4 million for the same period in fiscal
2002. For the nine-month period ended December 31, 2002, general and
administration expenses remained at $13.6 million compared to $13.6 million for
the same period in fiscal 2002. As a percentage of net sales, general and
administration expenses for the third quarter ended December 31, 2002 decreased
to 3.8% from 4.7% for the same period in fiscal 2002. The decrease in general
and administration expenses for the third quarter ended December 31, 2002 was
primarily due from the reduction of our bad debt expense. For the nine-month
period ended December 31, 2002, as a percentage of net sales, general and
administration expenses decreased to 5.0% from 5.7% for the same period in
fiscal 2002. The decrease in general and administration expenses and as a
percentage of net sales for the nine-month period ended December 31, 2002 was
due to increased overall efficiencies coupled with higher levels of sales.
Depreciation and amortization was $333,000 for the third quarter ended December
31, 2002 compared to $515,000 for the same period in fiscal 2002. For the
nine-month period ended December 31, 2002, depreciation and amortization was
$934,000 compared to $1.2 million for the same period in fiscal 2002.
Operating income for Home Entertainment was $2.9 million for the third quarter
ended December 31, 2002 compared to $1.7 million for the same period in fiscal
2002. For the nine-month period ended December 31, 2002, operating income was
$3.8 million compared to $233,000 for the same period in fiscal 2002.
ENCORE SOFTWARE, INC.
Encore had net sales of $4.7 million for the three-month period ended December
31, 2002 and $8.5 million for the five-month period ended December 31, 2002.
After the elimination of inter-company sales, net sales for the three-month
period ended December 31, 2002 were $771,000 and $2.1 million for the five-month
period ended December 31, 2002. Encore had gross profit of $1.4 million for the
three-month period ended December 31, 2002 and $3.1 million for the five-month
period ended December 31, 2002. Selling and promotion expense for the
three-month period ended December 31, 2002 was $264,000 and $1.5 million for the
five-month period ended December 31, 2002. General and administration expense
for the three-month period ended December 31, 2002 was $857,000 and $1.4 million
for the five-month period ended December 31, 2002. For the three-month period
ended December 31, 2002, depreciation expense was $123,000 and $197,000 for the
five-month period ended December 31, 2002. Operating income for Encore was
$127,000 for the three-month period ended December 31, 2002 and an operating
loss of $62,000 for the five-month period ended December 31, 2002.
CONSOLIDATED OTHER INCOME/EXPENSE
Interest expense for the third quarter ended December 31, 2002 was $53,000
compared to $104,000 for the same period in fiscal 2002. The decrease for the
third quarter ended December 31, 2002 resulted from not having to utilize our
credit facility during the period. For the nine-month period ended December 31,
2002, interest expense was $148,000 compared to $131,000 for the same period in
fiscal 2002. The increase in the nine-month period ended December 31, 2002
resulted from our use of our line of credit for the Encore acquisition during
the second quarter.
12
Other income and expense, which consists principally of interest income, was
$30,000 for the third quarter ended December 31, 2002 compared to $156,000 for
the same period in fiscal 2002. For the nine-month period ended December 31,
2002, it was $285,000 compared to $789,000 for the same period in fiscal 2002.
The decrease for the third quarter and nine-month period resulted from not
having a principal balance on the NetRadio note at any time during fiscal 2002
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 third quarter ended December 31, 2002 of $3.0 million
compared to $3.3 million for the same period in fiscal 2002. For the nine-month
period ended December 31, 2002, we had net income of $3.9 million compared to
$2.4 million 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.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our working capital needs through bank borrowings,
sale of equity securities and management of the various components of our
working capital including accounts receivable, inventory and accounts payable.
The level of borrowings has historically fluctuated significantly during the
year. At December 31, 2002, we had net accounts receivable of $72.5 million,
inventory of $25.3 million, accounts payable of $90.8 million and no borrowings
under our $30 million credit facility. In connection with our acquisition of
Encore, to date, we have outstanding debt of $1.8 million.
Cash provided by operating activities was $4.2. Net of amounts acquired,
accounts receivable increased by $25.9 million, inventories increased by $8.6
million and accounts payable and accrued expense increased by $36.7 million. Due
to the seasonal nature of our business and the holiday selling season, accounts
receivable, inventory and accounts payable typically increase during the first
three quarters of our fiscal year and decrease after the holiday season.
Investing activities used $8.7 million of cash primarily related to the
acquisition of Encore and for the purchase of furniture, equipment and leasehold
improvements. Cash decreased by $4.8 million during the period.
We acquired the primary assets of Encore Software, Inc. during the second fiscal
quarter. 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.
As described in Note B, Encore's results of operations for the five months ended
December 31, 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.
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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.
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 United States District Court for the District of
Minnesota 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 thereafter reached a settlement of the
lawsuit prior to trial, and the matter was dismissed with prejudice and on the
merits as a part of that settlement by Order dated December 7, 2002.
14
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.
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
Exhibit 99.1 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to 18 USC Section 1350.
(b) Reports on Form 8-K
We filed Amendment No.1 on Form 8-K/A dated December 4, 2002 reporting
the financial statements for the acquisition of Encore Software, Inc. assets and
pro forma information, pursuant to Item 2 and 7 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: February 7, 2003 /s/ Eric H. Paulson
------------------------
Eric H. Paulson
Chairman of the Board,
President and
Chief Executive Officer
Date: February 7, 2003 /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: February 7, 2003 /s/ Eric H. Paulson
-----------------------
Eric H. Paulson
Chairman of the Board,
President and
Chief Executive Officer
17
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: February 7, 2003 /s/ James Gilbertson
-----------------------
James Gilbertson
Vice President and
Chief Financial Officer
18