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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 June 30, 2004
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
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange of Which Registered
Common Stock, No Par Value Nasdaq National Market
Securities registered pursuant to Section 12(g) of the Act:
None
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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[ ] 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 -- 26,701,769 shares as of August 6, 2004
NAVARRE CORPORATION
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS. (UNAUDITED)
Consolidated Balance Sheets -
June 30, 2004 and March 31, 2004 Page 3
Consolidated Statements of Operations -
Three months ended June 30, 2004 and 2003 Page 4
Consolidated Statements of Cash Flows -
Three months ended June 30, 2004 and 2003 Page 5
Notes to Consolidated Financial Statements - June 30, 2004 Page 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS. PAGE 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. PAGE 18
ITEM 4. CONTROLS AND PROCEDURES. PAGE 18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. PAGE 18
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASE
OF EQUITY SECURITIES. PAGE 19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. PAGE 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS. PAGE 19
ITEM 5. OTHER INFORMATION. PAGE 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. PAGE 19
SIGNATURES PAGE 20
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
NAVARRE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
JUNE 30, 2004 MARCH 31, 2004
------------- --------------
(UNAUDITED) (NOTE)
ASSETS
Current assets:
Cash $ 12,195 $ 14,495
Note receivable, related parties 594 278
Accounts receivable, less allowance for doubtful accounts
and sales returns of $10,292 and $6,351, respectively 71,485 72,038
Inventories 41,840 30,151
Prepaid expenses and other current assets 5,671 5,175
--------- ---------
Total current assets 131,785 122,137
Property and equipment, net of accumulated depreciation of
$6,351 and $6,650, respectively 4,977 6,914
Other assets:
Note receivable, related parties 550 600
Goodwill 9,750 10,371
Other assets 8,428 6,905
--------- ---------
Total assets $ 155,490 $ 146,927
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable $ -- $ 651
Accounts payable 85,771 84,331
Accrued expenses 6,301 6,377
--------- ---------
Total current liabilities 92,072 91,359
Shareholders' equity:
Common stock, no par value:
Authorized shares - 100,000,000, issued and outstanding
shares - 26,629,369 and 25,817,965, respectively 112,682 109,405
Accumulated deficit (49,264) (53,837)
--------- ---------
Total shareholders' equity 63,418 55,568
--------- ---------
Total liabilities and shareholders' equity $ 155,490 $ 146,927
========= =========
Note: The balance sheet at March 31, 2004 has been derived from the audited
consolidated financial statements at that date but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements.
See accompanying notes to consolidated financial statements.
3
NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30,
2004 2003
--------- ---------
Net sales $ 126,716 $ 73,084
Cost of sales 107,838 63,035
--------- ---------
Gross profit 18,878 10,049
Operating expenses:
Selling and marketing 4,567 3,151
Distribution and warehousing 1,522 1,115
General and administration 7,603 5,172
Depreciation and amortization 704 387
--------- ---------
14,396 9,825
--------- ---------
Income from operations 4,482 224
Other income (expense):
Interest expense (41) (48)
Other income, net 121 132
--------- ---------
Income before taxes 4,562 308
Income tax benefit 11 --
--------- ---------
Net income $ 4,573 $ 308
========= =========
Basic income per share $ .17 $ .01
========= =========
Diluted income per share $ .16 $ .01
========= =========
Basic weighted average common shares outstanding 26,175 21,616
========= =========
Diluted weighted average common shares outstanding 28,377 22,132
========= =========
See accompanying notes to consolidated financial statements.
4
NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30,
2004 2003
-------- --------
OPERATING ACTIVITIES
Net income $ 4,573 $ 308
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 704 387
Write off of notes receivable, related parties 58 65
Deferred income taxes (653) --
Changes in operating assets and liabilities:
Accounts and notes receivable 553 8,422
Inventories (11,689) (1,238)
Prepaid expenses 157 (2,380)
Other assets (901) (906)
Accounts payable 1,440 (9,384)
Accrued expenses (76) (239)
-------- --------
Net cash used in operating activities (5,834) (4,965)
INVESTING ACTIVITIES
Note receivable, related parties (324) (14)
Net proceeds from sale leaseback 6,401 --
Purchase of property and equipment (4,819) (658)
-------- --------
Net cash provided by (used in) investing activities 1,258 (672)
FINANCING ACTIVITIES
Proceeds from exercise of common stock options and
warrants 3,277 4,276
Proceeds from notes payable 5,408 --
Repayment of notes payable (6,059) (1,073)
Debt acquisition costs (350) (250)
-------- --------
Net cash provided by financing activities 2,276 2,953
-------- --------
Net decrease in cash (2,300) (2,684)
Cash at beginning of period 14,495 10,485
-------- --------
Cash at end of period $ 12,195 $ 7,801
======== ========
See accompanying notes to consolidated financial statements.
5
NAVARRE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
JUNE 30, 2004
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Navarre
Corporation have been prepared in accordance with accounting principles
generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America for
complete consolidated 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 three month period ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the year ending
March 31, 2005. For further information, refer to the consolidated financial
statements and footnotes thereto included in Navarre Corporation's Annual Report
on Form 10-K for the year ended March 31, 2004.
Certain 2004 amounts have been reclassified to conform to the 2005
presentation.
NOTE B - ACQUISITIONS
On November 3, 2003, the Company acquired the assets of BCI Eclipse,
LLC ("BCI"). Under the terms of the acquisition, a newly-formed subsidiary of
Navarre acquired all assets of BCI for approximately $10.4 million in cash and
one million shares of Navarre common stock with a value at closing of $5.1
million. There is also the possibility that, depending on BCI's ability to meet
certain goals with respect to its operating income, the Company will pay certain
additional payments to BCI each year until 2008. The maximum amount each of
these annual payments varies over that period from $87,500 to $350,000. The
assets purchased by the Company included certain fixed assets, intellectual
property, inventory, receivables and contract rights related to BCI's business.
The purchase price was allocated on a preliminary basis using
information available at the time of purchase. The allocation of the purchase
price to the assets acquired will be finalized in fiscal 2005. The Company has
adjusted and will, if appropriate, adjust the allocation of the purchase price
after obtaining more information regarding asset and liability valuation. The
preliminary adjusted allocation has resulted in goodwill of $6.6 million, which
will not be amortized.
The preliminary adjusted purchase price allocation was as follows (in
thousands):
Accounts receivable, net of allowances $ 5,945
Inventories 3,071
Prepaid expenses and other current assets 702
Property and equipment 30
Other 572
Identifiable intangible assets 4,420
Goodwill 6,641
Current liabilities (5,836)
--------
Total Purchase Price $ 15,545
========
6
NOTE C - BUSINESS SEGMENTS
Financial information by reportable business segment is included in the
following summary:
(In thousands)
THREE MONTHS ENDED JUNE 30, 2004 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
----------------------------------------------------------------------------------------------------------
Net sales: $109,668 $30,052 $(13,004) $126,716
Income from operations 918 3,564 -- 4,482
Net income before tax 1,061 3,501 -- 4,562
Total assets 140,827 43,168 (28,505) 155,490
THREE MONTHS ENDED JUNE 30, 2003 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
----------------------------------------------------------------------------------------------------------
Net sales: $ 73,090 $ 4,652 $ (4,658) $ 73,084
Income (loss) from operations 294 (70) -- 224
Net income (loss) before tax 511 (203) -- 308
Total assets 92,712 14,185 (11,880) 95,017
NOTE D - NET EARNINGS 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 JUNE 30,
2004 2003
--------- --------
Numerator:
Net income $ 4,573 $ 308
======= =======
Denominator:
Denominator for basic earnings per
share -- weighted-average shares 26,175 21,616
Dilutive securities: Employee stock options
and warrants 2,202 516
------- -------
Denominator for diluted earnings per share
-adjusted weighted-average shares 28,377 22,132
======= =======
Basic income per share $ .17 $ .01
======= =======
Dilutive income per share $ .16 $ .01
======= =======
7
NOTE E - STOCK-BASED COMPENSATION
The Company has a stock option plan for officers and key employees. The
Company accounts for this plan under the recognition and measurement principles
of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, ("APB 25"), and related interpretations. Therefore, 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. The Company adopted the
disclosure-only provisions of Financial Accounting Standards Board Statement No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The following table
illustrates the effect on net income and net income per share if the Company had
applied the fair value recognition provision of SFAS 123, to stock-based
employee compensation.
(In thousands, except per share data) THREE MONTHS ENDED JUNE 30,
2004 2003
-------- --------
Net income, as reported $ 4,573 $ 308
Add: Stock-based employee compensation expense -- 28
------- -------
Deduct: Stock-based compensation expense determined under fair value method
for all awards (218) (200)
------- -------
Net income, pro forma $ 4,355 $ 136
======= =======
Income per share:
Basic - as reported $ .17 $ .01
------- -------
Basic - pro forma $ .17 $ .01
======= =======
Diluted - as reported $ .16 $ .01
======= =======
Diluted - pro forma $ .15 $ .01
======= =======
Pro forma information regarding net income and income per share is
required by SFAS 123, and has been determined as if the Company had accounted
for its employee stock options under the fair value method of SFAS 123. The fair
value of options granted in fiscal 2005 first quarter were estimated at the date
of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions: risk-free interest rate of 3.55%; volatility
factor of the expected market price of the Company's common stock of 85%;
expected life of the option of five years; and no dividends. The weighted
average fair value of options granted in fiscal 2005 first quarter was $6.40.
NOTE F - BANK FINANCING AND DEBT
On June 21, 2004, the Company finalized an amendment and restatement of
its Credit Agreement with GE Commercial Finance. Under the terms of the amended
and restated agreement a new $10 million revolving credit facility has been
established for use by the Company in connection with equity or asset-based
acquisitions. The revised agreement also permits the Company to utilize up to
$10 million of the existing $40 million revolving credit facility for such
acquisitions. Previously, this $40 million facility was restricted for use only
in connection with the Company's working capital needs. In addition, the
agreement has been extended to December 2007. As of June 30, 2004 and March 31,
2004, respectively, the Company had no balance under this facility. The
Company's ability to borrow is based upon its compliance with certain
requirements and financial covenants. The Company is in compliance with these
covenants as of June 30, 2004.
NOTE G - INCOME TAXES
For first quarter fiscal 2005, the Company recorded a tax net benefit
of $11,000, a net affect of recording tax expense and the reversal of a portion
of the deferred tax asset valuation allowance. The Company is utilizing existing
net operating loss carry forwards in fiscal 2005. At March 31, 2004 the Company
has net operating loss carryforwards of approximately $10.9 million which will
begin to expire in 2014 subject to limitations under Section 382 of the Internal
Revenue Code. Of this amount, approximately $1.2 million of future net operating
loss utilization will result in tax benefits associated with stock option
exercises that will not
8
reduce tax expense but rather will increase equity. At March 31, 2004, the
Company had a remaining valuation allowance of $6.7 million and it is possible
that fiscal 2005 results could include the reversal of additional amounts of tax
valuation reserves, which would be recorded as a reduction of income tax expense
to the extent it becomes more probable than not that the valuation allowance is
not needed.
NOTE H - CONTINGENCIES
In the normal course of our business, we are involved in a number of
routine litigation matters that are incidental to the operation of our business.
These matters generally include, among other things, 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 our financial position or liquidity, but an
adverse decision in more than one of the matters could be material to our
consolidated results of operations.
NOTE I - SALE/LEASEBACK OF WAREHOUSE FACILITY
During June 2004, the Company entered into an agreement for the sale
and leaseback of its warehouse adjacent to the Company's headquarters building
in New Hope, Minnesota, for net proceeds of $6.4 million. The initial term of
the lease is 15 years, with options to renew for three additional five year
periods. The lease is classified as an operating lease.
The $1.4 million difference between property and equipment sold and the
net proceeds has been established as prepaid rent and will be amortized over the
life of the lease. Rental payments under the lease approximate $659,000 for the
first year, with an annual increase of 2.75% each year thereafter.
The following is a schedule of estimated future rental payments (in
thousands):
2005 $ 659
2006 $ 677
2007 $ 696
2008 $ 715
2009 $ 735
Thereafter $ 8,556
NOTE J - LICENSE AND DISTRIBUTION AGREEMENT
On March 29, 2004, the Company entered into a license and distribution
agreement ("Agreement") with Riverdeep Inc. ("Riverdeep"). The Agreement
contains provisions for a license fee and a guaranteed royalty. The Company will
incur royalty expense for the license fee based on product sales for the year.
However, payment will not begin until the license fee royalties have exceeded
the guaranteed royalty (see below). License fee royalties were $2.5 million for
the three-month period ended June 30, 2004 and are reflected in cost of sales in
the consolidated statement of operations.
The Company is required to advance $13 million of guaranteed royalty
payments for the period from March 31, 2004 to March 31, 2005. At June 30, 2004,
$3 million has been paid and is reflected in prepaid assets in the consolidated
balance sheet. The guaranteed royalty is non-refundable, but is offset by
royalties earned by Riverdeep for an initial period of one year from March 31,
2004 and for an additional 42 months to fully recoup the guaranteed royalty, if
necessary. The Company will monitor these prepaid assets for potential
impairment based on activity with Riverdeep.
9
NOTE K - GOODWILL AND INTANGIBLE ASSETS
As of June 30, 2004 and March 31, 2004, goodwill amounted to $9.8
million and $10.4 million, respectively. During fiscal 2005 further purchase
price adjustments were made relating to the BCI acquisition resulting in a
reduction to goodwill of $621,000.
Other identifiable intangible assets, net of amortization, of approximately $5.9
million and $6.1 million as of June 30, 2004 and March 31, 2004, respectively,
are being amortized over useful lives ranging from three to seven years and are
as follows (in thousands):
AS OF JUNE 30, 2004
----------------------------------
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION
-------------- ------------
Masters $6,401 $ 546
Other 705 615
------ --------
$7,106 $ 1,161
====== ========
AS OF MARCH 31, 2004
----------------------------------
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION
-------------- ------------
Masters $6,230 $ 220
Other 705 592
------ -------
$6,935 $ 812
====== =======
Aggregate amortization expense for the first fiscal quarter 2005 and
2004 were $349,000 and $22,000, respectively.
The following is a schedule of estimated future amortization expense
(in thousands):
2005 $1,404
2006 $1,299
2007 $1,198
2008 $1,062
2009 $1,029
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
EXECUTIVE SUMMARY
Our consolidated net sales for the first quarter of fiscal 2005
increased 73.4% to $126.7 million compared to $73.1 million in the same period
for fiscal 2004. This growth in net sales was achieved through increases in both
of our business segments. Our gross profit increased to $18.9 million or 14.9%
of net sales in the first quarter fiscal 2005 compared with $10.0 million or
13.7 % of net sales for same period in fiscal 2004. The increase in gross profit
and as a percent of net sales for the first quarter in fiscal 2005 was due to
the greater percentage of Publishing revenues during the quarter. We expect
margins to remain in this range due to our evolving mixture of Publishing and
Distribution revenues. Total operating expenses for the first quarter in fiscal
2005 were $14.4 million or 11.4% of net sales, compared with $9.8 million or
13.4% of net sales in the same period for fiscal 2004. Net income increased to
$4.6 million or $0.16 per diluted share compared to $308,000 or $0.01 per
diluted share for last year.
OVERVIEW
Navarre Corporation, a Minnesota corporation formed in 1983, publishes
and distributes a broad range of home entertainment and multimedia products,
including PC software, audio and video titles and interactive games. Our
business is divided into two business segments -- Distribution and Publishing.
Through these business segments we maintain and leverage strong relationships
throughout the publishing and distribution chain.
Our broad base of customers includes: (i) wholesale clubs, (ii) mass
merchandisers, (iii) other third-party distributors, (iv) computer specialty
stores, (v) music specialty stores, (vi) book stores, (vii) office superstores,
and (viii) electronic superstores. Our customer base includes over 500
individual customers with over 18,000 locations, certain of which are
international locations.
Through our Distribution business we distribute and provide fulfillment
services in connection with a variety of finished goods that are provided by our
vendors, which include a variety of publishers, independent and major music
labels, and movie studios. These vendors provide us with PC software, CD and DVD
audio, DVD and VHS video, video games and accessories. Our Distribution business
focuses on providing retailers and publishers with high-quality services for the
broad, efficient distribution of these products, including vendor-managed
inventory, Electronic Data Interchange services, fulfillment services, and
retailer-oriented marketing services.
Through our Publishing business we are the exclusive licensee or owner
of PC software, CD and DVD audio, DVD and VHS video, and video game titles. Our
Publishing business licenses, packages, markets and sells these products to
third-party distributors, directly to retailers, as well as to Navarre's
Distribution business.
Much of our growth in the Publishing segment over the last two fiscal
years was accomplished by acquisition and outsourcing. In July 2002, we
purchased the primary assets of Encore Software, Inc., a publisher of
entertainment and education PC products. In November 2003 we purchased the
primary assets of BCI Eclipse, LLC, a provider of niche DVD/video products. On
March 29, 2004, we entered into an exclusive five-year licensing and
distribution agreement with Riverdeep that we expect will increase this
segment's revenues and profits. This rapid growth (and expected growth) may make
this segment's results in future periods more uncertain and less predictable.
FORWARD-LOOKING STATEMENTS / IMPORTANT RISK FACTORS
We make written and oral statements from time to time regarding our
business and prospects, such as projections of future performance, statements of
management's plans and objectives, forecasts of market trends, and other matters
that are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21F of the Securities Exchange Act of 1934.
Statements containing the words or phrases
11
"will likely result," "are expected to," "will continue," "is anticipated,"
"estimates," "projects," "believes," "expects," "anticipates," "intends,"
"target," "goal," "plans," "objective," "should" or similar expressions identify
forward-looking statements, which may appear in documents, reports, filings with
the Securities and Exchange Commission, including this Report on Form 10-Q, news
releases, written or oral presentations made by officers or other
representatives made by us to analysts, shareholders, investors, news
organizations and others and discussions with management and other
representatives of us. For such statements, we claim the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
Our future results, including results related to forward-looking
statements, involve a number of risks and uncertainties. No assurance can be
given that the results reflected in any forward-looking statements will be
achieved. Any forward-looking statement made by or on behalf of us speaks only
as of the date on which such statement is made. Our forward-looking statements
are based on assumptions that are sometimes based upon estimates, data,
communications and other information from suppliers, government agencies and
other sources that may be subject to revision. Except as required by law, we do
not undertake any obligation to update or keep current either (i) any
forward-looking statement to reflect events or circumstances arising after the
date of such statement, or (ii) the important factors that could cause our
future results to differ materially from historical results or trends, results
anticipated or planned by us, or which are reflected from time to time in any
forward-looking statement which may be made by or on behalf of us.
In addition to other matters identified or described by us from time to
time in filings with the SEC, there are several important factors that could
cause our future results to differ materially from historical results or trends,
results anticipated or planned by us, or results that are reflected from time to
time in any forward-looking statement that may be made by or on behalf of us.
Some of these important factors, but not necessarily all important factors,
include the following: the loss of our founder, Eric H. Paulson, Chairman of the
Board, President and Chief Executive Officer, who has been with the Company
since its inception in 1983 could affect the depth, quality and effectiveness of
our management; the Company's dependence upon a limited number of large
customers that account for a significant part of its business could have a
material adverse effect on our sales and profitability; the loss of a
significant vendor could adversely effect the products we have available to
distribute, and correspondingly, could negatively affect our sales; the failure
to finance our significant working capital needs could adversely effect a number
of aspects related to our business such as our ability to obtain products to
sell or finance accounts receivables and it could also negatively affect our
ability to remain current on amounts due to our vendors; the loss of a software
developer or manufacturer could negatively change our product offering and
accordingly reduce our revenues; the continued growth and breadth of our
exclusive distribution business could be negatively affected if we failed to
secure new distribution agreements with recording artists; a decrease in the
popularity of PC software could negatively affect our revenues; excessive
product returns or inventory obsolescence could significantly reduce our sales
or profitability; our acquisition strategy could result in disruptions to our
business by, among other things, distracting management time and diverting
financial resources; we operate in a highly competitive industry and compete
with large national firms and further competition could, among other things,
reduce our sales volume or margins or both; technology developments,
particularly in the electronic downloading arena, may adversely affect our
sales, margins, liquidity and results of operations; increased counterfeiting
and free or low cost music downloads may negatively affect the demand for our
products and services; our business presently is dependent on traditional
methods of music, CD and DVD product distribution and any significant change in
traditional distribution methods could negatively affect consumer demand for the
products we distribute; we cannot offer any assurance that significant growth
will occur in our Publishing segment; we may not be able to adequately adjust
our cost structure in a timely fashion in response to a decrease in demand,
which may cause our profitability to suffer; we are dependent on a variety of
information systems and a failure of these systems could disrupt our business
and harm our reputation and net sales; we have significant credit exposure to
our reseller customers and negative trends in their businesses could cause us
significant credit loss; we are subject to the risk that our inventory values
may decline and protective terms under supplier agreements may not adequately
cover the decline in values; future terrorist or military actions could result
in disruption to our operations or loss of assets,
12
in certain markets or globally; we are dependent on third-party shipping
companies for the delivery of our products; our stock price has experienced
significant volatility and continued fluctuation could impair our ability to
raise capital and make an investment in our securities undesirable; the exercise
of outstanding warrants and options may adversely affect our stock price; and
our anti-takeover provisions, right to issue preferred stock and our staggered
board may discourage takeover attempts that could be beneficial for our
shareholders.
A detailed statement of risks and uncertainties is contained in the
Company's reports to the Securities and Exchange Commission, including in
particular the Company's Annual Report on Form 10-K for the year ended March 31,
2004. Investors and shareholders are urged to read this document carefully. The
Company undertakes no obligation to revise any forward-looking statements in
order to reflect events or circumstances that may arise after the date of this
Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES
We consider our critical accounting policies to be those related to
revenue recognition, allowance for doubtful accounts, goodwill impairment, cost
associated with exit activities, tax matters and capitalized software
development costs as discussed in the section with this title in Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our Annual Report on Form 10-K for the year ended March 31, 2004.
No material changes occurred to these policies in the periods covered by this
report.
RECONCILIATION OF GAAP NET SALES TO NET SALES BEFORE INTER-COMPANY ELIMINATIONS
In evaluating our financial performance and operating trends,
management considers information concerning our net sales before inter-company
eliminations that are not calculated in accordance with generally accepted
accounting principles ("GAAP") in the United States of America. A reconciliation
of these non-GAAP numbers is included in the table below. We believe that the
non-GAAP numbers calculated before inter-company eliminations provides a useful
analysis of our ongoing operating trends and in comparing operating performance
period to period. The following table represents a reconciliation of GAAP net
sales to net sales before inter-company eliminations:
(In thousands) THREE MONTHS ENDED JUNE 30,
(Unaudited) 2004 2003
--------- ---------
Net sales
Distribution $ 109,668 $ 73,090
Publishing 30,052 4,652
--------- ---------
Net sales before inter-company eliminations 139,720 77,742
Inter-company eliminations (13,004) (4,658)
--------- ---------
Net sales as reported $ 126,716 $ 73,084
========= =========
13
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 JUNE 30,
2004 2003
------ ------
Net sales:
Distribution 86.5% 100.0%
Publishing 23.7 6.4
Inter-company sales (10.2) (6.4)
------ ------
Total net sales 100.0 100.0
Cost of sales 85.1 86.3
------ ------
Gross profit, exclusive of
amortization and depreciation 14.9 13.7
Selling and marketing 3.6 4.3
Distribution and warehousing 1.2 1.5
General and administrative 6.0 7.1
Depreciation and amortization 0.6 0.5
------ ------
Total operating expenses 11.4 13.4
------ ------
Income from operations 3.5 0.3
Interest expense 0.0 (0.1)
Other income 0.1 0.2
Income tax benefit 0.0 --
------ ------
Net income 3.6 0.4
====== ======
DISTRIBUTION SEGMENT
The Distribution segment distributes software, video games,
accessories, major label music, and DVD video, as well as independent music.
Fiscal 2005 First Quarter Results Compared With Fiscal 2004 First Quarter
Net Sales
Net sales for the Distribution segment were $109.7 million for the
first quarter of fiscal 2005 compared to $73.1 million for fiscal 2004 first
quarter. The 50.1% increase in net sales for fiscal 2005 was principally due to
strong increases in sales across all of our distribution product groups. In
particular, software continues to expand its market share presence across all
categories. Internet security and anti-virus products remained strong in light
of continued virus outbreaks. Sales increased in this product group to $76.1
million during the first quarter of fiscal 2005. Major label music, DVD video
and video games grew to $15.6 million in first quarter of fiscal 2005 due to
increased publisher and customer rosters and benefited from strong releases
throughout the quarter. Independent music also grew to $18.0 million in first
quarter of fiscal 2005 due to its increased label and artist roster and its
continued focus on catalog sales across all music genres. Future sales increases
will be dependent upon the Company's ability to continue to add new, appealing
content.
Gross Profit
Gross profit for the Distribution segment was $11.1 million or 10.1% as
a percent of net sales for the first quarter fiscal 2005 compared to $8.2
million or 11.2% as a percent of net sales for first quarter fiscal 2004. The
decrease in gross profit as a percent of net sales for first quarter fiscal 2005
was due to lower margins from the growth of our video game distribution
business. Video game distribution generally has a lower margin
14
throughout the industry, however, video games are sold on a one-way basis with
no returns by the customer allowed; therefore, the lower handling costs of the
product offset some of the lower margins as it relates to profitability. In
addition, we experienced lower margins with the continuation of the expansion of
our market share in software categories such as business and productivity which
generally have lower gross margins as much of the product is considered legacy
product; however, these product categories tend to sell at higher dollar price
points and generally have fewer returns. We expect gross profit to fluctuate
slightly depending upon the make-up of product sales each quarter as we continue
to expand market share in business and productivity software and video games.
Operating Expenses
Total operating expenses for the Distribution segment were $10.1
million or 9.3% as a percent of net sales for first quarter fiscal 2005 compared
to $7.9 million or 10.8% as a percent of net sales for first quarter fiscal
2004.
Selling and marketing expenses for the Distribution segment were $2.7
million or 2.4% as a percent of net sales for first quarter fiscal 2005 compared
to $2.2 million or 3.0% as a percent of net sales for first quarter fiscal 2004.
The decrease as a percent of net sales for first quarter fiscal 2005 resulted
from our improved efforts to reduce freight costs. Freight cost, as a percent of
sales, decreased to 1.5% in the first quarter fiscal 2005 compared to 1.7% for
first quarter fiscal 2004. The Company manages selling and marketing expenses on
a percentage basis and would expect them to remain in the 2.5-2.8% of net sales
range.
Distribution and warehousing expenses for the Distribution segment were
$1.5 million or 1.4% as a percent of net sales for first quarter fiscal 2005
compared to $1.1 million or 1.5% as a percent of net sales for first quarter
fiscal 2004. The decrease as a percentage of net sales resulted from overall
improved efficiency of warehousing expenses such as "one way" video game
business, higher priced software categories such as business and productivity,
and in part, efficiencies associated with a higher level of sales. The Company
will continue to seek efficiencies in this area, but will continue to manage
expenses at approximately 1.5% of net sales.
General and administrative expenses for the Distribution segment
consist principally of executive, accounting and administrative personnel and
related expenses, including professional fees. General and administrative
expenses for the Distribution segment were $5.7 million or 5.2% as a percent of
net sales for first quarter fiscal 2005 compared to $4.4 million or 6.0% as a
percent of net sales for first quarter fiscal 2004. The increase in general and
administrative expenses for the first quarter of fiscal 2005 resulted from an
increase in IT expense of $236,000 which is based on sales volume, and $470,000
for executive, accounting and administrative personnel required as our business
grows. The decrease as a percent of net sales for general and administrative
expenses for first quarter fiscal 2005 was attributable to our continued
increased efforts to control expenses as a percent of net sales. While overall
general and administrative expenses are expected to increase, we feel that the
increase will be at a rate less than our sales growth rate, thus allowing us to
leverage our existing infrastructure. We expect that general and administrative
expenses will continue to be managed in a 4.8-5.2% range.
Depreciation and amortization for the Distribution segment was $311,000
for first quarter fiscal 2005 compared to $250,000 for first quarter fiscal
2004.
The net operating income for the Distribution segment was $918,000 for
first quarter fiscal 2005 compared to $294,000 million for first quarter fiscal
2004.
15
PUBLISHING SEGMENT
The Publishing segment includes Encore Software and BCI Eclipse. We
acquired the assets of BCI Eclipse, LLC on November 3, 2003 and the assets of
Encore Software, Inc. on July 31, 2002.
Fiscal 2005 First Quarter Results Compared With Fiscal 2004 First Quarter
Net Sales
Net sales for the Publishing segment were $30.1 million (before
inter-company sales elimination of $13.0 million) for first quarter fiscal 2005
compared to $4.7 million (before inter-company sales elimination of $4.7
million) for first quarter fiscal 2004. Of the growth (after inter-company
eliminations), $10.1 million was due to the addition of the licensing and
distribution agreement for the Riverdeep product portfolio for Encore and $7.1
million from BCI.
Gross Profit
Gross profit for the Publishing segment was $7.8 million or 26.0% as a
percent of net sales for first quarter fiscal 2005 compared to $1.9 million or
40.1% as a percent of net sales for first quarter fiscal 2004. The gross margin
decrease was due to lower margins on sales from a distribution arrangement with
a major retailer carrying lower than average profit margins.
Operating Expenses
Operating expenses for the Publishing segment were $4.3 million for
first quarter fiscal 2005 compared to $1.9 million for first quarter fiscal
2004. The expense increase in fiscal 2004 was due to the addition of BCI in
November 2003.
The Publishing segment had an operating income of $3.6 million for
first quarter fiscal 2005 compared to an operating loss of $70,000 for first
quarter fiscal 2004.
We expect significant growth in this segment with the inclusion of BCI
Eclipse results of operations for a full year and with the addition of
approximately $45-$55 million in revenues expected to be generated from
distribution of Riverdeep products during fiscal 2005.
CONSOLIDATED OTHER INCOME AND EXPENSE
Interest expense was $41,000 for first quarter fiscal 2005 compared to
$48,000 for first quarter fiscal 2004. The decrease in interest expense for
fiscal 2005 resulted from not utilizing our line of credit. Other income, which
consists principally of interest income on available cash balances, was $121,000
for first quarter fiscal 2005 compared to $132,000 for first quarter fiscal
2004.
CONSOLIDATED TAX BENEFIT
For first quarter fiscal 2005, we recorded a tax net benefit of
$11,000, a net affect of recording tax expense and the reversal of a portion of
deferred tax asset valuation allowance. We are utilizing existing net operating
loss carry forwards in fiscal 2005. As of March 31, 2004, we had approximately
$10.9 million of net operating losses remaining and a remaining valuation
allowance of $6.7 million. It is possible that our fiscal 2005 results could
include the reversal of additional amounts of tax valuation reserves, which
would be
16
recorded as a reduction of income tax expense to the extent that it becomes more
probable than not that the valuation allowance is not needed.
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. It is our policy not to enter into
derivative financial instrument transactions. We do not anticipate that an
increase in inflation would have a material impact on our net sales and revenue,
nor on our income for operations.
LIQUIDITY AND CAPITAL RESOURCES
We have historically financed our working capital needs through cash
generated from operations, bank borrowings, proceeds from the 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 June
30, 2004, we had net accounts receivable of $71.5 million, inventory of $41.8
million, accounts payable of $85.8 million and no bank debt.
Cash flow used by operations of $5.8 million was primarily the result
of net income of $4.6 million and depreciation and amortization of $704,000,
offset by net reductions in working capital of $11.1 million for first quarter
fiscal 2005. Investing activities provided $1.3 million of cash primarily from
the proceeds from the sales-leaseback of $6.4 million offset by the purchase of
property and equipment of $4.8 million in connection with our new warehouse.
Financing activities provided cash of $2.3 million during the period primarily
from the proceeds from the exercise of options and warrants of $3.3 million
offset by net repayments of note payable of $651,000.
In June 2004, the Company completed a new warehouse adjacent to the
Company's headquarters building in New Hope, Minnesota. The Company funded the
construction from its working capital line and a $4.6 million construction loan
from The Business Bank. Upon completion, the Company sold the building to NL
Ventures IV New Hope, LP for $6.4 million under a sale leaseback transaction and
paid off amounts owed to the Business Bank. The Company entered into a 15-year
lease for the new building at approximately $55,000 per month and extended its
current lease for a period of 15 years for the headquarters building.
In October 2001, we entered into a credit agreement with General
Electric Capital Corporation, a/k/a GE Commercial Finance, for a three-year $30
million credit facility for use in connection with the Company's working capital
needs. In June 2004 this credit agreement was amended and restated to, among
other things, extend the term of the agreement to December of 2007 and to
provide for two senior secured facilities: a $10 million revolving acquisition
facility, and a $40 million revolving working capital facility. Additionally,
$10 million of the $40 million revolving working capital facility may be used by
the company for acquisitions, providing the Company with an aggregate revolving
acquisition availability of up to $20 million. The Company's ability to borrow
is based upon its compliance with certain requirements and financial covenants.
In association with GE Commercial Finance credit facility agreement, we
also pay certain facility and agent fees. During first quarter fiscal year 2005,
the maximum amount the Company borrowed under the credit facility was $2.6
million. As of June 30, 2004 and March 31, 2004, respectively, the Company had
no balance under this facility. Interest paid under this facility was $41,000
and $48,000 for first quarter fiscal 2005 and 2004, respectively.
Under this agreement the Company is required to meet certain financial
and non-financial covenants. The financial covenants include a variety of
financial metrics that are used to determine the overall financial stability of
the Company and include limitations on the Company's capital expenditures, a
minimum ratio of
17
EBITDA to fixed charges, and a minimum of indebtedness to EBITDA. The Company
was in compliance with the covenants as of June 30, 2004. We anticipate that we
may borrow amounts under this credit facility from time to time during fiscal
2005 to meet our seasonal working capital requirements.
We currently believe funds generated from the expected results of
operations and available cash and cash equivalents and borrowings under our $40
million credit facility will be sufficient to satisfy our working capital
requirements and finance organic expansion plans and strategic initiatives for
this fiscal year, and otherwise in the long-term absent significant
acquisitions. We have stated our plans to grow through acquisitions, however,
and such opportunities will likely require the use of equity or debt capital,
some combination thereof, or other financing.
CONTRACTUAL OBLIGATIONS
The following table presents information regarding contractual
obligations that exist as of June 30, 2004 by fiscal year (in thousands).
PAYMENT DUE BY PERIOD
2-3 4-5 MORE THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
Operating leases $21,160 $ 1,829 $2,621 $2,460 $14,250
License and distribution agreement $10,000 $10,000 -- -- --
======= ======= ====== ====== =======
Total $31,160 $11,829 $2,621 $2,460 $14,250
======= ======= ====== ====== =======
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
Our management, including the Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of the design and operation
of our disclosure controls and procedures at the end of the period covered by
this quarterly report. Based on their evaluation, the Chief Executive Officer
and Chief Financial Officer have concluded that these disclosure controls and
procedures were effective as of June 30, 2004. There were no changes in our
internal controls over financial reporting that occurred during the most recent
fiscal quarter that have materially affected, or are reasonably likely to
affect, the Company's internal controls over financial reporting.
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 our business.
These matters generally include, among other things, 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 our financial position or liquidity, but an
adverse decision in more than one of the matters could be material to our
consolidated results of operations.
18
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASE OF EQUITY
SECURITIES.
During the first quarter of fiscal 2005, 515,000 warrants were
exercised related to our Form of Registration Rights Agreement dated as of
December 15, 2003 among the Corporation and the various purchasers (File No.
333-111733). On April 28, 2004, the Company registered for resale by the selling
shareholders the shares of common stock and the shares of common stock issuable
upon exercise of the warrants issued in the private placement under a
registration statement on Form S-3. Net proceeds of $2.3 million were used for
general working capital needs.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
There were no matters submitted to a vote of security holders
during the three-month period ended June 30, 2004.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
31 (a) Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14
and 15d-14 of the Exchange Act).
31 (b) Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14
and 15d-14 of the Exchange Act).
32 (a) Certifications of the Chief Executive Officer pursuant Section
906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
32 (b) Certifications of the Chief Financial Officer pursuant Section
906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
(b) Reports on Form 8-K
On April 13, 2004, we filed a current report on Form 8-K with the
Securities and Exchange Commission announcing that our subsidiary Encore
Software, Inc. entered into an exclusive co-publishing agreement with Riverdeep,
Inc.
On May 26, 2004, we filed a current report on Form 8-K with the
Securities and Exchange Commission announcing the appointment of Timothy R.
Gentz to serve as a board director.
On June 21, 2004, we filed a current report on Form 8-K with the
Securities and Exchange Commission announcing that we finalized an amendment and
restatement of our Credit Agreement with GE Commercial Finance.
19
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: August 13, 2004 /s/ Eric H. Paulson
--------------------------
Eric H. Paulson
Chairman of the Board,
President and
Chief Executive Officer
Date: August 13, 2004 /s/ James Gilbertson
--------------------------
James Gilbertson
Vice President and
Chief Financial Officer
20