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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the quarterly period ended September 30, 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 -- 26,998,919 shares as of October 31, 2004
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NAVARRE CORPORATION
INDEX
PART I. FINANCIAL INFORMATION FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS. (UNAUDITED)
Consolidated Balance Sheets --
September 30, 2004 and March 31, 2004 Page 3
Consolidated Statements of Operations --
Three months and six months ended September 30, 2004 and 2003 Page 4
Consolidated Statements of Cash Flows --
Six months ended September 30, 2004 and 2003 Page 5
Notes to Consolidated Financial Statements Page 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS. PAGE 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. PAGE 21
ITEM 4. CONTROLS AND PROCEDURES. PAGE 21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS. PAGE 21
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS PAGE 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. PAGE 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS. PAGE 22
ITEM 5. OTHER INFORMATION. PAGE 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. PAGE 23
SIGNATURES PAGE 24
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
NAVARRE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
SEPTEMBER 30, 2004 MARCH 31, 2004
---------------------------------------------
(UNAUDITED) (NOTE)
ASSETS
Current assets:
Cash and cash equivalents $ 8,262 $14,495
Note receivable, related parties 1,433 278
Accounts receivable, less allowance for doubtful accounts
and sales returns of $6,681 and $6,351, respectively 105,337 79,948
Inventories 60,017 30,151
Prepaid expenses and other current assets 5,085 4,139
Deferred tax assets 2,543 1,036
---------------------------------------------
Total current assets 182,677 130,047
Property and equipment, net of accumulated depreciation of
$6,821 and $6,650, respectively 6,180 6,914
Other assets:
Note receivable, related parties 500 600
Goodwill 9,738 10,371
Other assets 8,168 6,905
---------------------------------------------
Total assets $207,263 $154,837
=============================================
LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities:
Note payable $ ---- $ 651
Accounts payable 129,628 92,241
Accrued expenses 7,960 6,382
---------------------------------------------
Total current liabilities 137,588 99,274
Commitments and contingencies
Shareholders' equity:
Common stock, no par value:
Authorized shares -- 100,000,000, issued and outstanding
shares--26,943,569 and 25,817,965, respectively 113,994 109,405
Accumulated deficit (44,334) (53,837)
Accumulated other comprehensive income (loss) 15 (5)
---------------------------------------------
Total shareholders' equity 69,675 55,563
---------------------------------------------
Total liabilities and shareholders' equity $207,263 $154,837
=============================================
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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------------------------------------------------------------
Net sales $146,180 $107,459 $274,717 $182,069
Cost of sales 125,279 93,960 234,938 158,521
------------------------------------------------------------------
Gross profit 20,901 13,499 39,779 23,548
Operating expenses:
Selling and marketing 4,292 4,007 8,860 7,158
Distribution and warehousing 2,210 1,381 3,732 2,496
General and administration 8,697 6,004 16,299 11,176
Depreciation and amortization 843 409 1,547 796
------------------------------------------------------------------
16,042 11,801 30,438 21,626
------------------------------------------------------------------
Income from operations 4,859 1,698 9,341 1,922
Other income (expense):
Interest expense (60) (98) (101) (146)
Other income, net 127 123 249 255
------------------------------------------------------------------
Income before income taxes 4,926 1,723 9,489 2,031
Income tax benefit 4 ---- 14 ----
------------------------------------------------------------------
Net income $4,930 $1,723 $9,503 $2,031
==================================================================
Basic income per share $0.18 $0.08 $0.36 $0.09
==================================================================
Diluted income per share $0.17 $0.08 $0.33 $0.09
==================================================================
Basic weighted average common shares outstanding 26,753 21,616 26,465 21,616
==================================================================
Diluted weighted average common shares outstanding 28,884 22,340 28,671 22,250
==================================================================
See accompanying notes to consolidated financial statements.
4
NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED SEPTEMBER 30,
2004 2003
------------------ ------------------
OPERATING ACTIVITIES
Net income $9,503 $2,031
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 1,547 796
Amortization of prepaid rent 33 ----
Amortization of deferred financing costs 96 37
Write off of notes receivable, related parties 100 129
Deferred income taxes (1,507) ----
Changes in operating assets and liabilities:
Accounts and notes receivable (24,975) (16,098)
Inventories (29,866) (6,016)
Prepaid expenses (896) (3,541)
Other assets (1,364) (965)
Accounts payable 37,644 18,617
Accrued expenses 2,282 (156)
------------------ ------------------
Net cash used in operating activities (7,403) (5,166)
INVESTING ACTIVITIES
Note receivable, related parties (1,155) (28)
Net proceeds from sale leaseback 6,401 ----
Purchase of property and equipment (6,494) (162)
Purchase of intangible assets (398) ---
Payment of earn-out payment (88) ---
------------------ ------------------
Net cash used in investing activities (1,734) (190)
FINANCING ACTIVITIES
Proceeds from exercise of common stock options and warrants 3,885 ----
Proceeds from notes payable -- line of credit 13,512 31,442
Repayment of notes payable -- line of credit (13,512) (29,155)
Repayment of notes payable (651) (268)
Debt acquisition costs (350) (250)
------------------ ------------------
Net cash provided by financing activities 2,884 1,769
Effect of exchange rate changes on cash and cash equivalents 20 (10)
------------------ ------------------
Net decrease in cash and cash equivalents (6,233) (3,597)
Cash and cash equivalents at beginning of period 14,495 10,485
------------------ ------------------
Cash and cash equivalents at end of period $8,262 $6,888
================== ==================
Supplemental schedule of noncash investing and financing activities:
Reclassification of stock compensation accrual to shareholders' equity. $ 704 $ ---
Purchase price adjustments effecting: accounts receivable,
prepaid expenses, goodwill and accounts payable. 721 ---
See accompanying notes to consolidated financial statements.
5
NAVARRE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 2004
1. 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 and six month periods ended September 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.
Reclassification of these amounts had no effect on previously reported
shareholders' equity or net income.
2. INVENTORIES
Inventories consist of the following:
SEPTEMBER 30, 2004 MARCH 31, 2004
------------------------ ---------------------
Finished products $55,232 $27,826
Raw Materials 4,785 2,325
------------------------ ---------------------
$60,017 $30,151
======================== =====================
3. 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.
6
The preliminary adjusted purchase price allocation was as follows (in
thousands):
Accounts receivable, net of allowances $ 5,957
Inventories 3,071
Prepaid expenses and other current assets 702
Property and equipment 30
Other 572
Identifiable intangible assets 4,420
Goodwill 6,629
Current liabilities (5,836)
-------------------------
Total Purchase Price $15,545
-------------------------
4. BUSINESS SEGMENTS -
Financial information by reportable business segment is included in the
following summary:
(In thousands)
THREE MONTHS ENDED SEPTEMBER 30, 2004 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------------------------------------------------------
Net Sales: $136,049 $22,562 $(12,431) $146,180
Income from operations 2,024 2,835 ---- 4,859
Net income before tax 2,167 2,760 ---- 4,927
Total assets 190,841 49,585 (33,163) 207,263
THREE MONTHS ENDED SEPTEMBER 30, 2003 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------------------------------------------------------
Net sales: $103,455 $9,224 $ (5,220) $107,459
Income from operations 1,564 134 ---- 1,698
Net income (loss) before tax 1,724 (1) ---- 1,723
Total assets 127,776 17,439 (14,309) 130,906
SIX MONTHS ENDED SEPTEMBER 30, 2004 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------------------------------------------------------
Net Sales: $247,537 $52,614 $(25,434) $274,717
Income from operations 2,942 6,399 ---- 9,341
Net income before tax 3,228 6,261 ---- 9,489
Total assets 190,841 49,585 (33,163) 207,263
SIX MONTHS ENDED SEPTEMBER 30, 2003 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
-------------------------------------------------------------------------------------------------------------------
Net Sales: $178,071 $13,876 $(9,878) $182,069
Income from operations 1,858 64 ---- 1,922
Net income (loss) before tax 2,235 (204) ---- 2,031
Total assets 127,776 17,439 (14,309) 130,906
7
5. 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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
-------------- -------------- --------------- -------------
Numerator:
Net income $4,930 $1,723 $9,503 $2,031
============== ============== =============== =============
Denominator:
Denominator for basic earnings per
share--weighted-average shares 26,753 21,616 26,465 21,616
Dilutive securities: Employee stock
options and warrants 2,131 724 2,206 634
-------------- -------------- -------------- -------------
Denominator for diluted earnings per share
-adjusted weighted-average shares 28,884 22,340 28,671 22,250
============== ============== ============== =============
Basic income per share $0.18 $0.08 $0.36 $0.09
============== ============== =============== =============
Dilutive income per share $0.17 $0.08 $0.33 $0.09
============== ============== =============== =============
6. 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 SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
---------------- -------------- -------------- ---------------
Net income, as reported $4,930 $1,723 $9,503 $2,031
Add: Stock-based employee compensation expense ---- 141 ---- 169
Deduct: Stock-based compensation expense determined under fair
value method for all awards, net of tax (209) (211) (346) (411)
---------------- -------------- -------------- ---------------
Net income, pro forma $4,721 $1,653 $9,157 $1,789
================ ============== ============== ===============
Income per share:
Basic -- as reported $0.18 $0.08 $0.36 $0.09
================ ============== ============== ===============
Basic -- pro forma $0.18 $0.08 $0.35 $0.08
================ ============== ============== ===============
Diluted -- as reported $0.17 $0.08 $0.33 $0.09
================ ============== ============== ===============
Diluted -- pro forma $0.16 $0.07 $0.32 $0.08
================ ============== ============== ===============
8
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 second 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 3.59%; volatility
factor of the expected market price of the Company's common stock of 81%;
expected life of the option of five years; and no dividends. The weighted
average fair value of options granted in fiscal 2005 second quarter was $7.26.
7. 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 was
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 was extended to December 2007. The Company had no balance under this
facility as of September 30, 2004 and March 31, 2004, respectively. The
Company's ability to borrow is based upon its compliance with certain
requirements and financial covenants. The Company exceeded its capital
expenditure covenant as of September 30, 2004 due to the increase in building
and picking system costs. However, as of September 30, 2004, the Company has
received a waiver and amendment for this covenant violation. The Company is in
compliance with all other covenants as of September 30, 2004.
8. INCOME TAXES
For the three-month and six-months ended September 30, 2004, the
Company recorded a net tax benefit of $4,000 and $14,000, respectively; 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 had net
operating loss carryforwards of approximately $10.9 million which will begin to
expire if unused 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 reduce tax expense but rather will increase
equity. At September 30, 2004 and March 31, 2004, the Company had a remaining
valuation allowance of $3.2 million and $6.7 million, respectively, 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 likely than not that the
valuation allowance is not needed.
9. CONTINGENCIES
On July 7, 2004, ValueVision Media, Inc. ("ValueVision") commenced an
action against the Company in Hennepin County District Court for the State of
Minnesota, alleging among other things that the Company breached a 1997 Stock
Purchase Agreement and Conversion Agreement between the parties and NetRadio
Corporation ("NetRadio"). ValueVision's Complaint seeks damages in excess of
$50,000, restitution and an order of specific performance requiring Navarre to
convert ValueVision's shares of NetRadio stock into Navarre common stock based
upon a January 30, 2002 notice of default and the conversion formula set forth
in the Conversion Agreement that is filed as exhibit 10.19 to the Company's Form
10-K for the year ended March 31, 1997.
On August 9, 2004, the Company answered the Complaint, denied liability
and asserted defenses. Among other defenses, the Company believes that
ValueVision's alleged rights under the Stock Purchase Agreement and Conversion
Agreement terminated pursuant to the express terms and conditions of the Stock
Purchase Agreement and the Conversion Agreement upon the occurrence of the
initial public offering of NetRadio. This position is supported by, among other
things, certain statements that appear in the prospectus that is on file in
connection with NetRadio's initial public offering. At the time that this
prospectus was filed, a representative of ValueVision sat on the board of
directors of NetRadio and consented to the filing of this prospectus.
The parties are in the process of conducting discovery and no trial
date has been set. The Company intends to vigorously defend against the claims
asserted by ValueVision. Because of the status of the proceeding and the
contingencies and uncertainties associated with litigation, it is difficult, if
not impossible, to predict a result in this proceeding.
9
In the normal course of our business, we are involved in a number of
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.
10. 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 was 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 rental payments for the period
ending March 31, 2005 (in thousands):
2005 $ 659
2006 $ 677
2007 $ 696
2008 $ 715
2009 $ 735
Thereafter $ 8,556
11. RIVERDEEP INC. 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 $1.5 million and
$4.0 million for the three-month and six-month periods ended September 30, 2004,
respectively; and are reflected in cost of sales in the consolidated statement
of operations.
The Company is required to advance from $9 million up to $13 million of
guaranteed royalty payments to Riverdeep for the period from April 1, 2004 to
March 31, 2005. At September 30, 2004, $5.4 million has been paid. Of the amount
paid, $1.4 million is reflected in prepaid assets in the consolidated balance
sheet as of September 30, 2004. 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.
12. GOODWILL AND INTANGIBLE ASSETS
As of September 30, 2004 and March 31, 2004, goodwill amounted to $9.7
million and $10.4 million, respectively. During fiscal 2005 further purchase
price adjustments of $721,000 less the annual earn-out payment of $88,000 were
made relating to the BCI acquisition resulting in a reduction to goodwill of
$633,000.
10
Other identifiable intangible assets, net of amortization, of
approximately $5.8 million and $6.1 million as of September 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 SEPTEMBER 30, 2004
------------------------
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET
--------------------------- --------------------- ---------------------
Masters $6,628 $ 897 $5,731
Other 705 637 68
--------------------------- --------------------- ---------------------
$7,333 $1,534 $5,799
=========================== ===================== =====================
AS OF MARCH 31, 2004
--------------------
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET
--------------------------- --------------------- ---------------------
Masters $6,230 $ 220 $6,010
Other 705 592 113
--------------------------- --------------------- ---------------------
$6,935 $ 812 $6,123
=========================== ===================== =====================
Aggregate amortization expense for the three-month and six-month
periods ended September 30, 2004 were $373,000 and $722,000, respectively and
for the three-month and six-month periods ended September 30, 2003 were $22,000
and $45,000, respectively.
The following is a schedule of estimated amortization expense for the
period ending March 31, 2005 (in thousands):
2005 $1,404
2006 $1,299
2007 $1,198
2008 $1,062
2009 $1,029
13. OTHER COMPREHENSIVE INCOME
The Company reports accumulated other comprehensive income as a
separate item in the shareholders' equity section of the consolidated balance
sheet. Other comprehensive income consists of foreign currency translation
adjustments. For the three-month and six-month periods ended September 30, 2004
and September 30, 2003, the amounts were de minimis.
14. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation Number ("FIN") 46 (revised December 2003),
Consolidated of Variable Interest Entities ("FIN 46R"), which addresses how a
business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. The Company is required to apply FIN 46R to
variable interest entities ("VIEs") created after December 31, 2003. For
variable interests in VIEs created before January 1, 2004, FIN 46R will be
applied beginning on January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets, liabilities
and noncontrolling interests of the VIEs initially would be measured at their
carrying amounts, with any differences between the net amounts added to the
balance sheet and any previously recognized interest being recognized as the
cumulative effect of a change in accounting principle. If determining the
carrying amounts is not practicable, fair value at the date FIN 46R first
applies may be used to
11
measure the assets, liabilities and noncontrolling interest of the VIEs. As of
September 30, 2004, the Company had no entities within the scope of the
statement.
FSAB Statement No. 150 (the "Statement"), Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity, was
issued in May 2003. The Statement establishes standards for the classification
and measurement of certain financial instruments with characteristics of both
liabilities and equity. The Statement also includes required disclosures for
financial instruments within its scope. For the Company, the Statement was
effective for instruments entered into or modified after May 31, 2003, and
otherwise was effective as of January 1, 2004, except for mandatorily redeemable
financial instruments. For certain mandatorily redeemable financial instruments,
the Statement will be effective for the Company on January 1, 2005. The
effective date has been deferred indefinitely for certain other types of
mandatorily redeemable financial instruments. As of September 30, 2004, the
Company had no financial instruments within the scope of the Statement.
15. INVESTMENTS
The Company has a 45% interest in Mix and Burn, Inc., a start-up
company developing a music listening and CD burning station. The Company has
also authorized a line of credit not to exceed $2.5 million, which expires
January 31, 2005. At September 30, 2004, the note receivable from Mix and Burn,
Inc. was $1.4 million and is reflected as "Notes receivable, related parties."
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
EXECUTIVE SUMMARY
Our consolidated net sales for the second quarter of fiscal 2005
increased 36.0% to $146.2 million compared to $107.5 million in the same period
for fiscal 2004. This growth in net sales was achieved through increases in both
of our business segments - Distribution and Publishing. Our gross profit
increased to $20.9 million or 14.3% of net sales in the second quarter fiscal
2005 compared with $13.5 million or 12.6% of net sales for same period in fiscal
2004. The increase in gross profit and as a percent of net sales for the second
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 second quarter in fiscal 2005 were $16.0 million or 11.0% of
net sales, compared with $11.8 million or 11.0% of net sales in the same period
for fiscal 2004. Net income for the second quarter fiscal 2005 increased to $4.9
million or $0.17 per diluted share compared to $1.7 million or $0.08 per diluted
share for the same period last year.
Our consolidated net sales for the six months ended September 30, 2004
increased 50.9% to $274.7 million, as compared with $182.1 million for the first
six months of fiscal 2004. This growth in net sales was achieved through
increases in both of our business segments. We reported gross margin of $39.8
million or 14.5% as a percent of net sales, as compared with $23.5 million or
12.9% as a percent of net sales in the comparable period last year. The increase
in gross profit and as a percent of net sales for the six months of fiscal 2005
was due to the greater percentage of Publishing revenues during the period.
Total operating expenses for the six-month period were $30.4 million or 11.1% as
compared with $21.6 million or 11.8% in the last year's six-month period. Net
income for the period increased 368.0% to $9.5 million, compared with $2.0
million in the comparable period last year. Fully diluted earnings per share for
the six months ended September 30, 2004 were $0.33 per share, compared with
$0.09 per share in the comparable period 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.
12
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 segment 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 segment
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 segment we are the exclusive licensee or owner
of PC software, CD and DVD audio, DVD and VHS video, and video game titles. Our
Publishing segment licenses, packages, markets and sells these products to
third-party distributors, directly to retailers, as well as to Navarre's
Distribution segment.
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 in fiscal 2005. 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 "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
13
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, 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 our
reports to the Securities and Exchange Commission, including in particular our
Annual Report on Form 10-K for the year ended March 31, 2004. Investors and
shareholders are urged to read this document carefully. We 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.
14
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:
THREE MONTHS ENDED SIX MONTHS ENDED
(Unaudited) SEPTEMBER 30, SEPTEMBER 30,
(In thousands) 2004 2003 2004 2003
-------------- -------------- --------------- ---------------
Net sales
Distribution $136,049 $103,455 $247,537 $178,071
Publishing 22,562 9,224 52,614 13,876
-------------- -------------- --------------- ---------------
Net sales before inter-company eliminations 158,611 112,679 300,151 191,947
Inter-company eliminations (12,431) (5,220) (25,434) (9,878)
-------------- -------------- --------------- ---------------
Net sales as reported $146,180 $107,459 $274,717 $182,069
============== ============== =============== ===============
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage
of net sales represented by certain items included in our "Consolidated
Statements of Operations."
THREE MONTHS ENDED SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 2004 2003
------------- ----------- ------------- -----------
Net sales:
Distribution 93.1% 96.3% 90.1% 97.8%
Publishing 15.4 8.6 19.2 7.6
Inter-company sales (8.5) (4.9) (9.3) (5.4)
------------- ----------- ------------- -----------
Total net sales 100.0 100.0 100.0 100.0
Cost of sales 85.7 87.4 85.5 87.1
------------- ----------- ------------- -----------
Gross profit, exclusive of
amortization and depreciation 14.3 12.6 14.5 12.9
Selling and marketing 2.9 3.7 3.2 3.9
Distribution and warehousing 1.5 1.3 1.4 1.4
General and administrative 6.0 5.6 5.9 6.1
Depreciation and amortization 0.6 0.4 0.6 0.4
------------- ----------- ------------- -----------
Total operating expenses 11.0 11.0 11.1 11.8
------------- ----------- ------------- -----------
Income from operations 3.3 1.6 3.4 1.1
Interest expense 0.0 (0.1) 0.0 (0.1)
Other income 0.1 0.1 0.1 0.1
Income tax benefit 0.0 --- 0.0 ---
------------- ----------- ------------- -----------
Net income 3.4 1.6 3.5 1.1
============= =========== ============= ===========
15
DISTRIBUTION SEGMENT
The Distribution segment distributes software, video games,
accessories, major label music, and DVD video, as well as independent music.
Fiscal 2005 Second Quarter Results Compared With Fiscal 2004 Second Quarter
Net Sales
Net sales for the Distribution segment were $136.0 million for the
second quarter of fiscal 2005 compared to $103.5 million for the second quarter
of fiscal 2004. The 31.5% increase in net sales for second quarter fiscal 2005
was due to increases in sales in the software, video games, DVD and major label
product groups. Software continues to expand its market share presence across
all categories and increased to $97.3 million during the second quarter of
fiscal 2005 from $74.6 million in the same period last year. Internet security
and anti-virus products remained strong in light of continued virus outbreaks.
Major label music, DVD video and video games grew to $25.0 million in second
quarter of fiscal 2005 from $10.1 million in the same period last year due to
increased publisher and customer rosters and from strong releases throughout the
quarter. Independent music sales decreased to $13.8 million in second quarter of
fiscal 2005 from $18.8 million for second quarter of fiscal 2004 due to timing
of new releases. There were more new releases for this quarter a year ago than
there were this year. 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 $13.9 million or 10.2% as
a percent of net sales for the second quarter fiscal 2005 compared to $10.8
million or 10.4% as a percent of net sales for second quarter fiscal 2004. The
decrease in gross profits as a percent of net sales for second quarter fiscal
2005 was related to the prior year having a much greater amount of higher margin
independent music business during the comparable quarter. The independent music
business is much more dependent upon the release schedule of its exclusive
labels. We also experienced lower margins from the growth of our video game
distribution business. Video game distribution generally has a lower margin
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. 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, however, we would expect the range of
margin to be 10% to 11%.
Operating Expenses
Total operating expenses for the Distribution segment were $11.9
million or 8.7% as a percent of net sales for second quarter fiscal 2005
compared to $9.2 million or 8.9% as a percent of net sales for second quarter
fiscal 2004.
Selling and marketing expenses for the Distribution segment were $2.6
million or 1.9% as a percent of net sales for second quarter fiscal 2005
compared to $2.3 million or 2.2% as a percent of net sales for second quarter
fiscal 2004. The decrease as a percent of net sales for second quarter fiscal
2005 resulted from our improved efforts to reduce freight costs. Freight costs,
as a percent of sales, decreased to 1.2% in the second quarter fiscal 2005
compared to 1.6% for second quarter fiscal 2004. We continue to manage and seek
to improve our selling and marketing expenses as a percentage of sales.
Distribution and warehousing expenses for the Distribution segment were
$2.2 million or 1.6% as a percent of net sales for second quarter fiscal 2005
compared to $1.4 million or 1.3% as a percent of net sales for second quarter
fiscal 2004. The increase as a percentage of net sales resulted from
implementation costs of $435,000 incurred with our new distribution facilities
and systems. We expect these warehousing and systems initiatives will position
our operating capabilities to support our expected growth and are expected to
improve efficiencies in this area.
16
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 $6.6 million or 4.9% as a percent of
net sales for second quarter fiscal 2005 compared to $5.3 million or 5.1% as a
percent of net sales for second quarter fiscal 2004. The decrease as a percent
of net sales for general and administrative expenses for second 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.
Depreciation and amortization for the Distribution segment was $420,000
for second quarter fiscal 2005 compared to $269,000 for second quarter fiscal
2004.
The net operating income for the Distribution segment was $2.0 million
for second quarter fiscal 2005 compared to $1.6 million for second quarter
fiscal 2004.
Fiscal 2005 Six-Months Results Compared With Fiscal 2004 Six-Months
Net Sales
Net sales for the Distribution segment were $247.5 million for the
six-month period for fiscal 2005 compared to $178.1 million for same period for
fiscal 2004. The 39.0% increase in net sales for fiscal 2005 was principally due
to increases in sales in all product groups. Sales increased in the software
product group to $175.2 million during the six-month period for fiscal 2005
compared to $133.3 million for same period for fiscal 2004. Major label music,
DVD video and video games grew to $40.5 million for the six-month period for
fiscal 2005 compared to $15.6 million for same period for fiscal 2004 due to
increased publisher and customer rosters and from strong releases throughout the
period. Independent music also grew to $31.8 million for the six-month period of
fiscal 2005 compared to $29.2 million for same period for fiscal 2004 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 our
ability to continue to add new, appealing content.
Gross Profit
Gross profit for the Distribution segment was $25.0 million or 10.1% as
a percent of net sales for the six-month period for fiscal 2005 compared to
$19.0 million or 10.7% as a percent of net sales for same period for fiscal
2004. The decrease in gross profit as a percent of net sales for the six-month
period for fiscal 2005 was due to several factors. The prior year had a much
greater amount of higher margin independent music business during the comparable
period this year. The independent music business is much more dependent upon the
release schedule of its exclusive labels. We also experienced lower margins from
the growth of our video game distribution business. Video game distribution
generally has a lower margin 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. 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. 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 all categories.
Operating Expenses
Total operating expenses for the Distribution segment were $22.0
million or 8.9% as a percent of net sales for the six-month period for fiscal
2005 compared to $17.1 million or 9.6% as a percent of net sales for the same
period for fiscal 2004.
Selling and marketing expenses for the Distribution segment were $5.3
million or 2.1% as a percent of net sales for the six-month period for fiscal
2005 compared to $4.5 million or 2.5% as a percent of net sales for the same
period for fiscal 2004. The decrease as a percent of net sales for the six-month
period for fiscal 2005 resulted from our
17
improved efforts to reduce freight costs. Freight cost, as a percent of sales,
decreased to 1.3% in the six-month period for fiscal 2005 compared to 1.7% for
the same period for fiscal 2004. We continue to manage and seek to improve our
selling and marketing expenses on a percentage of sales.
Distribution and warehousing expenses for the Distribution segment were
$3.7 million or 1.5% as a percent of net sales for the six-month period for
fiscal 2005 compared to $2.5 million or 1.4% as a percent of net sales for same
period for fiscal 2004. The increase as a percentage of net sales resulted from
implementation costs of $435,000 incurred with our new distribution facilities
and systems. We expect these warehousing and systems initiatives will position
our operating capabilities to support our expected growth and are expected to
improve efficiencies in this area.
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 $12.3 million or 5.0% as a percent of
net sales for six-month period for fiscal 2005 compared to $9.6 million or 5.4%
as a percent of net sales for same period for fiscal 2004. The decrease as a
percent of net sales for general and administrative expenses for six-month
period for 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.
Depreciation and amortization for the Distribution segment was $731,000
for six-month period for fiscal 2005 compared to $519,000 for the same period
for fiscal 2004.
The net operating income for the Distribution segment was $2.9 million
for six-month period for fiscal 2005 compared to $1.9 million for same period
for fiscal 2004.
PUBLISHING SEGMENT
The Publishing segment includes Encore and BCI. We acquired the assets
of BCI Eclipse, LLC ("BCI") on November 3, 2003 and the assets of Encore
Software, Inc. ("Encore") on July 31, 2002. On March 29, 2004, we entered into a
license and distribution agreement with Riverdeep Inc. The Agreement contains
provisions for a license fee and a guaranteed royalty.
Fiscal 2005 Second Quarter Results Compared With Fiscal 2004 Second Quarter
Net Sales
Net sales for the Publishing segment were $22.6 million (before
inter-company sales elimination of $12.4 million) for second quarter fiscal 2005
compared to $9.2 million (before inter-company sales elimination of $5.2
million) for second quarter fiscal 2004. Of the growth (after inter-company
eliminations), $7.4 million was due to the addition of the licensing agreement
for the Riverdeep product portfolio for Encore and $6.1 million from BCI. The
Riverdeep licensing agreement became effective April 1, 2004.
Gross Profit
Gross profit for the Publishing segment was $7.0 million or 31.0% as a
percent of net sales for second quarter fiscal 2005 compared to $2.7 million or
29.2% as a percent of net sales for second quarter fiscal 2004. Generally we
expect gross margins in the Publishing segment to be in the 35% to 40% range;
however the quarters have been slightly affected by a distribution agreement
that went into effect in August 2003. This distribution agreement, which carries
a margin of 11% to 12%, was originally run through Encore as they held the
original customer relationship. To better align the customer relationship with
our structure, from July 2004 all revenues from this agreement will now flow
through the Distribution segment.
18
Operating Expenses
Operating expenses for the Publishing segment were $4.1 million for
second quarter fiscal 2005 compared to $2.6 million for second quarter fiscal
2004. The expense increase in second quarter fiscal 2005 was due to the addition
of BCI in November 2003.
The Publishing segment had an operating income of $2.9 million for
second quarter fiscal 2005 compared to an operating income of $134,000 for
second quarter fiscal 2004.
We expect significant growth in this segment with the inclusion of BCI
results of operations for a full year and with the addition of revenues expected
to be generated from the Riverdeep products during fiscal 2005.
Fiscal 2005 Six-Months Results Compared With Fiscal 2004 Six-Months
Net Sales
Net sales for the Publishing segment were $52.6 million (before
inter-company sales elimination of $25.4 million) for the six-month period for
fiscal 2005 compared to $13.9 million (before inter-company sales elimination of
$9.9 million) for the same period for fiscal 2004. Of the growth (after
inter-company eliminations), $17.5 million was due to the addition of the
licensing and distribution agreement for the Riverdeep product portfolio for
Encore and $13.2 million from BCI.
Gross Profit
Gross profit for the Publishing segment was $14.8 million or 28.1% as a
percent of net sales for the six-month period for fiscal 2005 compared to $4.6
million or 32.9% as a percent of net sales for the same period for 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 as
described previously.
Operating Expenses
Operating expenses for the Publishing segment were $8.4 million for
six-month period for fiscal 2005 compared to $4.5 million for same period for
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 $6.4 million for
six-month period for fiscal 2005 compared to an operating income of $64,000 for
the same period for fiscal 2004.
CONSOLIDATED OTHER INCOME AND EXPENSE
Interest expense was $60,000 for second quarter fiscal 2005 compared to
$98,000 for second quarter fiscal 2004. Interest expense was $101,000 for the
six-month period for fiscal 2005 compared to $146,000 for the same period for
fiscal 2004. The decrease in interest expense for fiscal 2005 resulted from not
utilizing our line of credit as often as we did last year. Other income, net,
which consists principally of interest income on available cash balances, was
$127,000 for second quarter fiscal 2005 compared to $123,000 for second quarter
fiscal 2004 and $249,000 for the six-month period for fiscal 2005 compared to
$255,000 for the same period for fiscal 2004.
CONSOLIDATED TAX BENEFIT
We recorded a tax net benefit of $4,000 for the second quarter and $14,000 for
the six-month period for fiscal 2005, 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.
As of September 30, 2004 and March 31, 2004 we had a valuation allowance of $3.2
million and $6.7 million, respectively. It is possible that our fiscal 2005
results could include the
19
reversal of additional amounts of tax valuation reserves, which would be
recorded as a reduction of income tax expense to the extent that it becomes more
likely 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 from 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 and at
September 30, 2004, we had net accounts receivable of $105.3 million, inventory
of $60.0 million, and accounts payable of $129.6 million and no bank debt.
Cash flow used by operations of $7.4 million was primarily the result
of net income of $9.5 million and depreciation and amortization of $1.6 million
offset by a reduction of deferred income tax of $1.5 million and net reductions
in working capital of $17.2 million for second quarter fiscal 2005. Investing
activities used $1.7 million of cash primarily from the proceeds from the
sales-leaseback of $6.4 million offset by the purchase of property and equipment
of $6.5 million in connection with our new warehouse. Financing activities
provided cash of $2.9 million during the period primarily from the proceeds from
the exercise of options and warrants of $3.9 million offset by net repayments of
note payable of $651,000.
In June 2004, we completed construction of a new warehouse adjacent to
our headquarters building in New Hope, Minnesota. We funded the construction
from its working capital line and a $4.6 million construction loan from The
Business Bank. Upon completion, we 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. We 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 our 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 us with an aggregate revolving acquisition availability
of up to $20 million. Our ability to borrow is based upon its compliance with
certain requirements and financial covenants (see below).
In association with GE Commercial Finance credit facility agreement, we
also pay certain facility and agent fees. During the quarter ended September 30,
2004, the maximum amount we borrowed under the credit facility was $3.7 million.
As of September 30, 2004 and March 31, 2004, respectively, we had no balance
under this facility. Interest paid under this facility was $60,000 and 98,000
for second quarter and $101,000 and $146,000 for the six-month period for fiscal
2005 and 2004, respectively.
Under this agreement we are 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 our capital expenditures, a minimum ratio of
EBITDA to fixed charges, and a minimum of indebtedness to EBITDA. We exceeded
our capital expenditure covenant as of September 30, 2004 due to the increase in
building and picking system costs. However, as of September 30, 2004, we have
received a waiver
20
and amendment for this covenant violation. 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, such
opportunities which may exceed our existing GE Commercial Finance acquisition
line 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 March 31, 2004 by fiscal year (in thousands).
PAYMENT DUE BY PERIOD
2-3 4-5 MORE THAN 5
TOTAL 1 YEAR YEARS YEARS 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 September 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
On July 7, 2004, ValueVision Media, Inc. ("ValueVision") commenced an
action against the Company in Hennepin County District Court for the State of
Minnesota, alleging among other things that the Company breached a 1997 Stock
Purchase Agreement and Conversion Agreement between the parties and NetRadio
Corporation ("NetRadio"). ValueVision's Complaint seeks damages in excess of
$50,000, restitution and an order of specific performance requiring Navarre to
convert ValueVision's shares of NetRadio stock into Navarre common stock based
upon a January 30, 2002 notice of default and the conversion formula set forth
in the Conversion Agreement that is filed as exhibit 10.19 to the Company's Form
10-K for the year ended March 31, 1997.
On August 9, 2004, the Company answered the Complaint, denied liability
and asserted defenses. Among other defenses, the Company believes that
ValueVision's alleged rights under the Stock Purchase Agreement and Conversion
Agreement terminated pursuant to the express terms and conditions of the Stock
Purchase Agreement and the Conversion Agreement upon the occurrence of the
initial public offering of NetRadio. This position is supported by, among other
things, certain statements that appear in the prospectus that is on file in
connection with NetRadio's initial public offering. At the time that this
prospectus was filed, a representative of ValueVision sat on the board of
directors of NetRadio and consented to the filing of this prospectus.
The parties are in the process of conducting discovery and no trial
date has been set. The Company intends to vigorously defend against the claims
asserted by ValueVision. Because of the status of the proceeding and the
contingencies and uncertainties associated with litigation, it is difficult, if
not impossible, to predict a result in this proceeding.
21
In the normal course of our business, we are involved in a number of
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.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
During the six-month period ending September 30, 2004, 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
Our Annual Meeting of Shareholders was held on September 13, 2004. At the
meeting, the following action was taken:
The following persons were re-elected as directors of the Company for two-year
terms ending at the Annual meeting of Shareholders held in 2006:
NAMES VOTES FOR VOTES WITHHOLD
-------------------------------- ----------------------- ---------------------
James Gilbertson 21,302,298 2,024,177
Dickinson G. Wiltz 21,309,969 2,016,506
The following persons were re-elected as directors of the Company for three-year
terms ending at the Annual meeting of Shareholders held in 2006:
NAMES VOTES FOR VOTES WITHHOLD
-------------------------------- ----------------------- ---------------------
Keith A. Benson 21,986,544 1,339,931
Charles E. Cheney 21,388,143 1,938,332
Timothy R. Gentz 22,087,863 1,238,612
Tom F. Weyl 21,982,319 1,344,156
22
The approval of Grant Thornton LLP as the Company's independent auditors for
fiscal year 2005 was approved by a vote of 23,236,322 shares in favor, 63,528
shares against 26,625 shares abstained and no broker non-votes.
Approval of the Navarre Corporation 2004 Stock Option Plan was approved by a
vote of 12,035,209 shares in favor, 2,614,772 shares against, 61,322 shares
abstained and 8,615,172 broker non-votes. The amendment required the affirmative
vote of a majority of the holders present and voting.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
(a) The following exhibits are included herein:
10.54 Amended and Restated Credit Agreement dated June 18, 2004 between Navarre and General Electric
Capital Corporation.
10.55 Amendment No. 1 and Limited Waiver with Respect to Amended and Restated Credit Agreement dated
August 25, 2004.
10.56 Amendment No. 2 and Limited Waiver with Respect to Amended and Restated Credit Agreement dated
October 18, 2004.
10.57 Lease dated October 8, 2004, between Encore Software, Inc. and Kilroy Realty, L.P., with
respect to a a office facility in El Segundo, California.
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).
23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NAVARRE CORPORATION
(Registrant)
Date: November 12, 2004 /s/ Eric H. Paulson
--------------------------------
Eric H. Paulson
Chairman of the Board,
President and
Chief Executive Officer
Date: November 12, 2004 /s/ James Gilbertson
--------------------------------
James Gilbertson
Vice President and
Chief Financial Officer
24