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EX-32.2 - EXHIBIT 32.2 - Speed Commerce, Inc. | c25946exv32w2.htm |
EX-31.2 - EXHIBIT 31.2 - Speed Commerce, Inc. | c25946exv31w2.htm |
EX-31.1 - EXHIBIT 31.1 - Speed Commerce, Inc. | c25946exv31w1.htm |
EX-32.1 - EXHIBIT 32.1 - Speed Commerce, Inc. | c25946exv32w1.htm |
EXCEL - IDEA: XBRL DOCUMENT - Speed Commerce, Inc. | Financial_Report.xls |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
for the quarterly period ended December 31, 2011
or
o | 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 incorporation or organization) |
(IRS Employer Identification No.) |
7400 49th Avenue North, Minneapolis, MN 55428
(Address of principal executive offices)
(Address of principal executive offices)
Registrants telephone number, including area code (763) 535-8333
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes
þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). o Yes þ No
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practical date.
Class | Outstanding at January 30, 2012 | |
Common Stock, No Par Value | 37,103,010 shares |
NAVARRE CORPORATION
Index
Page | ||||
3 | ||||
3 | ||||
3 | ||||
4 | ||||
5 | ||||
6 | ||||
27 | ||||
43 | ||||
43 | ||||
44 | ||||
44 | ||||
45 | ||||
45 | ||||
45 | ||||
45 | ||||
45 | ||||
45 | ||||
47 | ||||
2
PART I. FINANCIAL INFORMATION
Item 1. | Consolidated Financial Statements. |
NAVARRE CORPORATION
Consolidated Balance Sheets
(In thousands, except share amounts)
December 31, 2011 | ||||||||
(Unaudited) | March 31, 2011 | |||||||
Assets: |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 1,882 | $ | | ||||
Accounts receivable, net |
92,144 | 57,833 | ||||||
Receivable from the sale of discontinued operations |
| 24,000 | ||||||
Inventories |
32,784 | 24,913 | ||||||
Prepaid expenses |
2,583 | 3,957 | ||||||
Deferred tax assets current, net |
3,462 | 6,436 | ||||||
Other assets current |
20 | | ||||||
Total current assets |
132,875 | 117,139 | ||||||
Property and equipment, net |
7,534 | 9,299 | ||||||
Software development costs, net |
1,231 | 2,202 | ||||||
Other assets: |
||||||||
Intangible assets, net |
1,675 | 2,375 | ||||||
Goodwill |
| 5,709 | ||||||
Deferred tax assets non-current, net |
13,874 | 24,320 | ||||||
Non-current prepaid royalties |
5,117 | 9,667 | ||||||
Other assets |
2,588 | 3,155 | ||||||
Total assets |
$ | 164,894 | $ | 173,866 | ||||
Liabilities and shareholders equity: |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 112,855 | $ | 80,379 | ||||
Checks written in excess of cash balances |
| 8,790 | ||||||
Accrued expenses |
6,944 | 7,768 | ||||||
Contingent payment obligation short-term acquisition (Note 4) |
422 | 526 | ||||||
Note payable acquisition (Note 4) |
| 1,002 | ||||||
Other liabilities short-term |
81 | 103 | ||||||
Total current liabilities |
120,302 | 98,568 | ||||||
Long-term liabilities: |
||||||||
Contingent payment obligation long-term acquisition (Note 4) |
| 422 | ||||||
Other liabilities long-term |
1,629 | 1,795 | ||||||
Total liabilities |
121,931 | 100,785 | ||||||
Commitments and contingencies (Note 13) |
||||||||
Shareholders equity: |
||||||||
Common stock, no par value: |
||||||||
Authorized shares 100,000,000; issued and outstanding
shares 37,048,843 at December 31, 2011 and 36,577,605 at
March 31, 2011 |
163,954 | 162,997 | ||||||
Accumulated deficit |
(121,024 | ) | (90,071 | ) | ||||
Accumulated other comprehensive income |
33 | 155 | ||||||
Total shareholders equity |
42,963 | 73,081 | ||||||
Total liabilities and shareholders equity |
$ | 164,894 | $ | 173,866 | ||||
See accompanying notes to consolidated financial statements.
3
NAVARRE CORPORATION
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net sales |
$ | 153,497 | $ | 147,325 | $ | 364,081 | $ | 366,593 | ||||||||
Cost of sales (exclusive of depreciation) |
145,857 | 129,512 | 330,059 | 317,043 | ||||||||||||
Gross profit |
7,640 | 17,813 | 34,022 | 49,550 | ||||||||||||
Operating expenses: |
||||||||||||||||
Selling and marketing |
5,701 | 5,910 | 15,749 | 16,071 | ||||||||||||
Distribution and warehousing |
2,685 | 2,922 | 7,623 | 8,080 | ||||||||||||
General and administrative |
6,532 | 5,924 | 18,209 | 16,147 | ||||||||||||
Depreciation and amortization |
883 | 983 | 2,782 | 2,865 | ||||||||||||
Goodwill and intangible impairment |
5,996 | | 5,996 | | ||||||||||||
Total operating expenses |
21,797 | 15,739 | 50,359 | 43,163 | ||||||||||||
Income (loss) from operations |
(14,157 | ) | 2,074 | (16,337 | ) | 6,387 | ||||||||||
Other income (expense): |
||||||||||||||||
Interest income (expense), net |
(292 | ) | (506 | ) | (873 | ) | (1,357 | ) | ||||||||
Other income (expense), net |
(171 | ) | (108 | ) | (501 | ) | (539 | ) | ||||||||
Income (loss) from continuing operations before
income tax |
(14,620 | ) | 1,460 | (17,711 | ) | 4,491 | ||||||||||
Income tax expense |
(14,457 | ) | (393 | ) | (13,242 | ) | (1,764 | ) | ||||||||
Net income (loss) from continuing operations |
(29,077 | ) | 1,067 | (30,953 | ) | 2,727 | ||||||||||
Discontinued operations: |
||||||||||||||||
Income from discontinued operations, net of tax |
| 1,849 | | 4,424 | ||||||||||||
Net income (loss) |
$ | (29,077 | ) | $ | 2,916 | $ | (30,953 | ) | $ | 7,151 | ||||||
Basic earnings (loss) per common share: |
||||||||||||||||
Continued operations |
$ | (0.79 | ) | $ | 0.03 | $ | (0.84 | ) | $ | 0.08 | ||||||
Discontinued operations |
| 0.05 | | 0.12 | ||||||||||||
Net income (loss) |
$ | (0.79 | ) | $ | 0.08 | $ | (0.84 | ) | $ | 0.20 | ||||||
Diluted earnings (loss) per common share: |
||||||||||||||||
Continued operations |
$ | (0.79 | ) | $ | 0.03 | $ | (0.84 | ) | $ | 0.07 | ||||||
Discontinued operations |
| 0.05 | | 0.12 | ||||||||||||
Net income (loss) |
$ | (0.79 | ) | $ | 0.08 | $ | (0.84 | ) | $ | 0.19 | ||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
36,977 | 36,471 | 36,805 | 36,405 | ||||||||||||
Diluted |
36,977 | 37,008 | 36,805 | 36,925 |
See accompanying notes to consolidated financial statements.
4
NAVARRE CORPORATION
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Nine Months Ended | ||||||||
December 31, | ||||||||
2011 | 2010 | |||||||
Operating activities: |
||||||||
Net income (loss) |
$ | (30,953 | ) | $ | 7,151 | |||
Adjustments to reconcile net income (loss) to net cash used in operating activities: |
||||||||
Income from discontinued operations |
| (4,424 | ) | |||||
Contingent payment obligation unearned |
(526 | ) | | |||||
Depreciation and amortization |
2,782 | 2,865 | ||||||
Amortization of debt acquisition costs |
448 | 447 | ||||||
Amortization of software development costs |
1,876 | 360 | ||||||
Share-based compensation expense |
933 | 786 | ||||||
Goodwill and intangible impairment |
5,996 | | ||||||
Deferred income taxes |
13,420 | 4,184 | ||||||
Other |
35 | 182 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(34,435 | ) | (16,195 | ) | ||||
Inventories |
(8,006 | ) | (6,394 | ) | ||||
Prepaid expenses |
5,924 | (402 | ) | |||||
Income taxes receivable |
(20 | ) | 94 | |||||
Other assets |
151 | (28 | ) | |||||
Accounts payable |
33,764 | 12,212 | ||||||
Income taxes payable |
(37 | ) | 12 | |||||
Accrued expenses |
(661 | ) | (4,585 | ) | ||||
Net cash used in operating activities |
(9,309 | ) | (3,735 | ) | ||||
Investing activities: |
||||||||
Proceeds from sale of discontinued operations |
22,537 | | ||||||
Repayment of note payable acquisition |
(1,009 | ) | | |||||
Cash paid for acquisition |
| (8,090 | ) | |||||
Purchases of property and equipment |
(593 | ) | (483 | ) | ||||
Investment in software development |
(905 | ) | (693 | ) | ||||
Net cash provided by (used in) investing activities |
20,030 | (9,266 | ) | |||||
Financing activities: |
||||||||
Proceeds from revolving line of credit |
34,902 | 156,923 | ||||||
Payments on revolving line of credit |
(34,902 | ) | (151,010 | ) | ||||
Payment of deferred compensation |
| (1,333 | ) | |||||
Checks written in excess of cash balances |
(8,790 | ) | 2,757 | |||||
Debt acquisition costs |
(165 | ) | | |||||
Other |
116 | 7 | ||||||
Net cash provided by (used in) financing activities |
(8,839 | ) | 7,344 | |||||
Net cash provided by (used in) continuing operations |
1,882 | (5,657 | ) | |||||
Discontinued operations: |
||||||||
Net cash provided by operating activities |
| 6,026 | ||||||
Net cash used in investing activities |
| (362 | ) | |||||
Net cash used in financing activities |
| (7 | ) | |||||
Net increase (decrease) in cash |
1,882 | | ||||||
Cash and cash equivalents at beginning of period |
| | ||||||
Cash and cash equivalents at end of period |
$ | 1,882 | $ | | ||||
Supplemental cash flow information: |
||||||||
Cash and cash equivalents paid for (received from): |
||||||||
Interest |
$ | 475 | $ | 1,306 | ||||
Income taxes, net of refunds |
(5 | ) | 7 | |||||
Supplemental schedule of non-cash investing and financing activities: |
||||||||
Contingent payment obligation unearned |
$ | (526 | ) | $ | | |||
Note payable and contingent payment obligation related to the Punch!
purchase price allocation |
| 1,950 | ||||||
Shares received for payment of tax withholding obligations |
161 | 170 | ||||||
Other comprehensive income (loss) related to gain (loss) on foreign
exchange translation |
(122 | ) | 318 |
See accompanying notes to consolidated financial statements.
5
NAVARRE CORPORATION
Notes to Consolidated Financial Statements
(Unaudited)
(Unaudited)
Note 1 Organization and Basis of Presentation
Navarre Corporation (the Company or Navarre), a Minnesota corporation formed in 1983, is a
distributor, provider of complete logistics solutions for traditional
and e-commerce retail channels and publisher of computer software. The
Company operates through two business segments distribution and publishing.
Through the distribution business, the Company distributes computer software, consumer
electronics and accessories, video games and home videos and also provides fee-based logistical
services. The distribution business focuses on providing a range of value-added services, including
vendor-managed inventory, electronic and internet-based ordering and gift card fulfillment. The
Company has relationships with certain of its customers and vendors whereby the Company provides
fee-based services, which are recognized on a net basis within sales.
Through the publishing business, the Company owns or licenses various widely-known computer
software brands through Encore Software, Inc. (Encore). In addition to retail publishing, Encore
also sells directly to consumers through its e-commerce websites.
The Company also formerly published and sold anime content through FUNimation Productions,
Ltd. (FUNimation). The Company sold FUNimation on
March 31, 2011, and accordingly, the results of
operations, assets and liabilities of FUNimation for all periods presented are classified as
discontinued operations (see Note 3).
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 significant inter-company accounts and transactions have been eliminated in consolidation.
In the opinion of the Company, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included.
Because of the impairments and other charges recorded during fiscal 2012 and the seasonal
nature of the Companys business, the operating results and cash flows for the three and nine month
periods ended December 31, 2011 are not necessarily indicative of the results that may be expected
for the fiscal year ending March 31, 2012. For further information, refer to the consolidated
financial statements and footnotes thereto included in Navarre Corporations Annual Report on Form
10-K for the year ended March 31, 2011.
Basis of Consolidation
The consolidated financial statements include the accounts of Navarre Corporation and its
wholly-owned subsidiaries (collectively referred to herein as the Company). The results of
operations and assets and liabilities of FUNimation for all periods presented are classified as
discontinued operations (see Note 3).
Reclassifications
Certain balance sheet classifications included in the consolidated financial statements have
been reclassified from the prior years presentations to conform to the current year presentation.
Fair Value of Financial Instruments
The carrying value of the Companys current financial assets and liabilities, because of their
short-term nature, approximates fair value.
6
Revenue Recognition
Revenue on products shipped, including consigned products owned by the Company, is recognized
when title and risk of loss transfers, delivery has occurred, the price to the buyer is
determinable and collectability is reasonably assured. Service revenues are recognized upon
delivery of the services and represented less than 10% of total net sales for the three and nine
month periods ended December 31, 2011 and 2010. The Company provides fee-based services to certain
of its customers and vendors, which are recognized on a net basis within sales. Under certain
conditions, the Company permits its customers to return or destroy products. The Company records a
reserve for sales returns, product destructions and allowances against amounts due to reduce the
net recognized receivables to the amounts the Company reasonably believes will be collected. These
reserves are based on the application of the Companys historical or anticipated gross profit
percent against average sales returns and product destructions, sales discounts percent against
average gross sales and specific reserves for marketing programs.
The Companys distribution customers, at times, qualify for certain price protection benefits
from the Companys vendors. The Company serves as an intermediary to settle these amounts between
vendors and customers. The Company accounts for these amounts as reductions of revenue with
corresponding reductions in cost of sales.
The Companys publishing business, at times, provides certain price protection, promotional
monies, volume rebates and other incentives to customers. The Company records these amounts as
reductions in revenue.
Recently Issued Accounting Pronouncements
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) (ASU 2011-04).
ASU 2011-04 includes updated accounting guidance to amend existing requirements for fair value
measurements and disclosures. The guidance expands the disclosure requirements around fair value
measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the
level in the fair value hierarchy of items that are not measured at fair value but whose fair value
must be disclosed. It also clarifies and expands upon existing requirements for fair value
measurements of financial assets and liabilities as well as instruments classified in shareholders
equity. ASU 2011-04 is effective for the first interim or annual reporting period beginning after
December 15, 2011. The Company does not expect the adoption of ASU 2011-04 to have material impact
on its consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of
Comprehensive Income (ASU 2011-05). ASU 2011-05 requires that all non-owner changes in
stockholders equity be presented either in a single continuous statement of comprehensive income
or in two separate but consecutive statements and eliminates the option for companies to present
components of other comprehensive income as part of the statement of changes in stockholders
equity. This guidance is effective for fiscal years, and interim periods within those years,
beginning after December 15, 2011. The Company does not believe
this pronouncement will have a material impact on
its consolidated financial statements.
ASU 2011-05 also requires reclassification adjustments and the effect of those adjustments on
net income and other comprehensive income to be presented on the face of the financial statement
where the components of net income and other comprehensive income are presented. In December 2011,
the FASB issued ASU No. 2011-12, Comprehensive Income (Topic 220) Deferral of the Effective Date
for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other
Comprehensive Income in Accounting Standards Update No. 2011-05
(ASU 2011-12). ASU 2011-12 defers the effective date
of changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. ASU
2011-12 is effective for fiscal years, and interim periods within those years, beginning after
December 15, 2011. The Company does not expect the adoption of ASU
2011-12 will have a material impact on
its results of operations, financial condition, or cash flows.
7
Note 2 Impairments and Other Charges
During October 2011, the Company implemented a series of initiatives, including a reduction in
workforce and simplification of business structures and processes across the Companys operations.
In conjunction with the series of initiatives, the Company reviewed its portfolio of businesses to identify
poor performing activities and areas where continued business investments would not
meet its requirements for financial returns (collectively, Restructuring Plan).
This assessment resulted in the Company abandoning inventory and
other investments that were determined to not
meet its requirements for financial returns.
These actions are
intended to increase operating efficiencies and provide additional resources to invest in product
lines and service categories in order to execute the Companys long-term growth strategy plan.
The Company expects substantially all restructuring activities to be completed by March 31, 2012. The
Restructuring Plan includes:
| The elimination of approximately 90 positions across all areas of the Company, |
||
| The relocation of Encore operations from Los Angeles, California to the corporate
headquarters in Minneapolis, Minnesota, and |
||
| Vacating a leased property in Minneapolis, Minnesota, that was utilized for warehouse
and manufacturing assembly space. |
Net assets impacted included inventories, prepaid royalties, goodwill, intangibles and software development
costs.
Inventory. The total inventory charges related to the distribution segment were $441,000
during the three and nine months ended December 31, 2011. The total inventory charges related to
the publishing segment were $1.3 million during the three and nine months ended December 31, 2011.
The Company records inventory at the lower of cost or market. When it is determined that the
market value is lower than the cost, the Company establishes a reserve for the difference between
carrying value and estimated realizable value. The Company determines the estimated realizable
value by
evaluating the nature and quantity of inventory on hand as compared to expected future sales volumes in addition to corroboration
of estimated sales values with market participants.
Prepaid Royalties. The Company makes prepayments to licensors for the licensing of content.
The prepayment is reduced by royalties earned by the licensor after the sale of the product. The
Company evaluates its prepaid royalties for impairment when changes in events and circumstances
indicate that the carrying value might exceed the current fair value. The Company determines fair
value utilizing current market values and future market trends. Based on the Companys review of
its business activities and the identification of investments that would not meet requirements for
financial returns, the Company recorded an impairment charge related to the publishing segment for
prepaid royalty amounts that will not be recouped of $5.8 million during the three and nine month periods ended
December 31, 2011, which is included in cost of sales within the Consolidated Statements of
Operations.
Software Development. The Company incurs software development costs for software to be sold,
leased or marketed in the publishing business. Software development costs include third-party
contractor fees and overhead costs. The Company tests for possible impairment whenever events or
changes in circumstances, such as a reduction in expected cash flows, indicate that the carrying
amount of the asset may not be recoverable. Based on the expected cash flows related to the
publishing segment software development, the Company recorded an impairment charge of $1.2 million
during the three and nine month periods ended December 31, 2011, which is included in cost of sales
within the Consolidated Statements of Operations.
Severance and other related costs. The Company completed a Company-wide reduction in force during the
three months ended December 31, 2011. In addition, the Company incurred expenses related to the CEO
transition which commenced during the first quarter of fiscal 2012. For the three months ended
December 31, 2011, the total severance and related costs were $2.3 million, of which $1.6 million
were associated with the distribution business and $614,000 with the publishing business. For the
nine months ended December 31, 2011, the total severance and related costs were $4.1 million, of
which $3.3 million were associated with the distribution business and $809,000 with the publishing
business. The Company records one-time termination benefit arrangement costs at the date of
communication to employees as long as the plan establishes the benefits that employees will receive
upon termination in sufficient detail to enable employees to determine the type and amount of
benefits the employee would receive if involuntarily terminated. The Company records severance
costs when the payment of the benefits is probable and reasonably estimable. Other related costs
are recorded when the expense is incurred.
Goodwill and intangibles.
During the three months ended December 31, 2011, the Company concluded that indicators of potential impairment were present due to the Restructuring
Plan announced in October 2011 which included a review of its portfolio of businesses for where continued business investments
would not meet its requirements for financial returns. The Company conducted goodwill and intangible impairment tests during the three months ended December
31, 2011 based on present facts and circumstances known and its business strategy in light of the Restructuring Plan, and existing industry and economic conditions, as well as
taking into consideration future expectations.
The Company recognizes the excess cost of an acquired entity over
the net amount assigned to the fair value of the assets acquired and liabilities assumed as
goodwill. The Company reviews goodwill for impairment annually for
each reporting unit, or when events or changes in circumstances indicate that the carrying
value of the goodwill might exceed its current fair value. Factors which may cause impairment
include negative industry or economic trends and significant underperformance relative to
historical or projected future operating results. The Company determines fair value using widely
accepted valuation techniques, including discounted cash flow and market multiple analysis. The
goodwill impairment charge for the publishing segment was $5.7 million during the three and nine
months ended December 31, 2011.
8
The fair value of the indefinite lived intangible assets is determined for the impairment test
using the relief from royalty valuation technique, which is a variation of the income approach. The
Company determined that the Punch! trademark was impaired as of December 31, 2011. The intangible
impairment charge for the publishing segment was $306,000 during the three and nine months ended
December 31, 2011.
The following table summarizes the impairment and other charges included in the Companys
Consolidated Statement of Operations for the three months ended December 31, 2011 (in thousands):
Software | ||||||||||||||||||||||||||||||||
Development | Prepaid | Goodwill | Severance | Severance | ||||||||||||||||||||||||||||
Costs - | Royalties - | and intangibles - | Inventory- | and other- | Inventory- | and other- | ||||||||||||||||||||||||||
Publishing | Publishing | Publishing | Publishing | Publishing | Distribution | Distribution | Total | |||||||||||||||||||||||||
Cost of sales |
$ | 1,238 | $ | 5,826 | $ | | $ | 1,287 | $ | 2 | $ | 441 | $ | | $ | 8,794 | ||||||||||||||||
Selling and marketing |
| | | | 86 | | 213 | 299 | ||||||||||||||||||||||||
Distribution and
warehousing |
| | | | | | 146 | 146 | ||||||||||||||||||||||||
General and
administrative |
| | | | 526 | | 1,290 | 1,816 | ||||||||||||||||||||||||
Goodwill and
intangible
impairment |
| | 5,996 | | | | | 5,996 | ||||||||||||||||||||||||
Total |
$ | 1,238 | $ | 5,826 | $ | 5,996 | $ | 1,287 | $ | 614 | $ | 441 | $ | 1,649 | $ | 17,051 | ||||||||||||||||
The following table summarizes the impairment and other charges included in the Companys
Consolidated Statement of Operations for the nine months ended December 31, 2011 (in thousands):
Software | ||||||||||||||||||||||||||||||||
Development | Prepaid | Goodwill | Severance | Severance | ||||||||||||||||||||||||||||
Costs - | Royalties - | and intangibles - | Inventory- | and other- | Inventory- | and other- | ||||||||||||||||||||||||||
Publishing | Publishing | Publishing | Publishing | Publishing | Distribution | Distribution | Total | |||||||||||||||||||||||||
Cost of sales |
$ | 1,238 | $ | 5,826 | $ | | $ | 1,287 | $ | 2 | $ | 441 | $ | | $ | 8,794 | ||||||||||||||||
Selling and marketing |
| | | | 86 | | 213 | 299 | ||||||||||||||||||||||||
Distribution and
warehousing |
| | | | | | 146 | 146 | ||||||||||||||||||||||||
General and
administrative |
| | | | 721 | | 2,952 | 3,673 | ||||||||||||||||||||||||
Goodwill and
intangible
impairment |
| | 5,996 | | | | | 5,996 | ||||||||||||||||||||||||
Total |
$ | 1,238 | $ | 5,826 | $ | 5,996 | $ | 1,287 | $ | 809 | $ | 441 | $ | 3,311 | $ | 18,908 | ||||||||||||||||
9
The accrued expense activity related to impairments and other charges was as follows (in
thousands):
Royalty and | ||||||||||||||||
Severance | Software | Severance | ||||||||||||||
and other- | Development- | and other- | ||||||||||||||
Publishing | Publishing | Distribution | Total | |||||||||||||
Accrued expense balance at March 31, 2011 |
$ | | $ | | $ | | $ | | ||||||||
Provision |
809 | 1,092 | 3,081 | 4,982 | ||||||||||||
Cash payments |
379 | | 2,571 | 2,950 | ||||||||||||
Accrued expense balance at December 31, 2011 |
$ | 430 | $ | 1,092 | $ | 510 | $ | 2,032 | ||||||||
The
Company expects to incur additional restructuring costs of
approximately $6.0 million during the three months ended March 31, 2012 by
segment as follows: Distribution $5.0 million and Publishing $1.0 million.
Of the expected additional restructuring costs, $1.6 million relates
to employee severance costs, $4.0 million relates to facility termination
costs and approximately $400,000 relates to other charges.
Of the aggregate total
expected impairment and restructuring costs of $25.0 million, approximately $2.6 million was cash
expenditures during the three months ended December 31, 2011 and
the Company expects $8.2 million will be cash expenditures which
is expected to occur no later than the three months ended June 30, 2012.
Note 3 Discontinued Operations
Sale Transaction
On March 31, 2011, the Company sold its wholly-owned subsidiary, FUNimation, for $24.0
million. The proceeds were received in full during fiscal 2012 and therefore recorded as a
receivable on the Companys Consolidated Balance Sheets at March 31, 2011. In connection with the
sale, the Company entered into an agreement to act as FUNimations exclusive distributor in the
United States on a continuing basis, and act as FUNimations logistics and fulfillment
services provider (see Note 23).
The Company has presented all results of operations, assets and liabilities of FUNimation for
all periods presented as discontinued operations, and the consolidated financial statements,
including the notes, have been reclassified to reflect such segregation for all periods presented.
Prior to reclassification, the discontinued operations were reported in the publishing operating
segment. The Company elected to allocate a portion of the consolidated interest expense related to
the revolving line of credit, based on a percentage of its assets, to the discontinued operations.
The Company used the proceeds received upon the sale of FUNimation to reduce the Companys
borrowings and for general working capital needs.
The summary of operating results from discontinued operations for the three and nine months
ended December 31, 2010 was as follows (in thousands):
Three Months Ended | Nine Months Ended | |||||||
December 31, | December 31, | |||||||
2010 | 2010 | |||||||
Net sales |
$ | 8,918 | $ | 25,627 | ||||
Interest expense |
109 | 328 | ||||||
Net income from discontinued operations, before income taxes |
$ | 2,899 | $ | 6,958 | ||||
Income tax expense |
(1,050 | ) | (2,534 | ) | ||||
Net income from discontinued operations, net of taxes |
$ | 1,849 | $ | 4,424 | ||||
10
Note 4 Acquisition
Punch! Software, LLC
On May 17, 2010, the Company completed the acquisition of substantially all of the assets of
Punch! Software, LLC, (Punch!) a leading provider of home and landscape architectural design
software in the United States. Total consideration included: $8.1 million in cash at closing, a
$1.1 million note payable on the first anniversary of the closing with interest at a rate of 0.67%
per annum, plus up to two performance payments (contingent consideration) of up to $1.25 million
each (undiscounted), based on the Company achieving
minimum annual net sales of $8.0 million in connection with the acquired assets. If earned,
these payments were and are payable on the first and second anniversary of the closing date. The
combined fair value of the contingent consideration of $948,000 was estimated by applying the
income approach. That measure is based on significant inputs that are not observable in the market.
Key assumptions include (1) a discount rate range of 20%-25% and (2) a probability adjusted level
of revenues between $7.7 million and $9.4 million. The Company did not achieve the minimum annual
sales target of $8.0 million in the first year and therefore the first anniversary contingent
payment of $526,000 was reversed during the first quarter of fiscal 2012.
The acquisition of Punch! expanded the Companys content ownership. The goodwill of $5.7
million arising from the acquisition consists largely of the synergies and economies of scale
expected from combining the operations of the Company and Punch!. All goodwill was assigned to the
Companys publishing business. All of the goodwill recognized is expected to be deductible for
income tax purposes over a 15 year tax period. This transaction did not qualify as an acquisition
of a significant business pursuant to Regulation S-X and financial statements for the acquired
business were not filed. Operating results from the date of acquisition are included within the
publishing business.
As discussed in Note 2, the goodwill was fully impaired during the three months ended December
31, 2011. In addition, the Company determined that the Punch! trademark was impaired at December
31, 2011 and recognized an impairment charge of $306,000 during the three months ended December 31,
2011.
The purchase price was allocated based on estimates of the fair value of assets acquired and
liabilities assumed as follows (in thousands):
Consideration: |
||||
Cash |
$ | 8,090 | ||
Note payable |
1,002 | |||
Contingent payment obligation short-term |
422 | |||
Contingent payment obligation unearned and unpaid |
526 | |||
Fair value of total consideration transferred |
$ | 10,040 | ||
The Punch! purchase price was allocated as follows: |
$ | 1,114 | ||
Accounts receivable |
$ | 1,114 | ||
Inventory |
815 | |||
Prepaid expenses |
94 | |||
Property and equipment |
18 | |||
Purchased intangibles |
2,787 | |||
Goodwill |
5,690 | |||
Accounts payable |
(469 | ) | ||
Accrued expenses |
(9 | ) | ||
$ | 10,040 | |||
Net sales of Punch!, included in the Consolidated Statements of Operations for the three and
nine months ended December 31, 2011 were $0.9 million and $3.8 million, respectively, compared to
$1.5 million and $4.6 million for the three and nine months ended December 31, 2010, respectively.
Although the Company has made reasonable efforts to calculate the precise impact that the Punch!
acquisition had on the Companys net income (loss) for these periods, the Company has deemed it
impracticable to determine such amounts.
Acquisition-related costs (included in selling, general, and administrative expenses in the
Consolidated Statements of Operations) for the three and nine months ended December 31, 2010 were
zero and $185,000, respectively.
Note 5 Accounts Receivable
Accounts receivable consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Trade receivables |
$ | 95,092 | $ | 60,151 | ||||
Vendor receivables |
2,670 | 2,039 | ||||||
Other receivables |
59 | 344 | ||||||
97,821 | 62,534 | |||||||
Less: allowance for doubtful accounts and sales discounts |
3,222 | 2,674 | ||||||
Less: allowance for sales returns, net margin impact |
2,455 | 2,027 | ||||||
Total |
$ | 92,144 | $ | 57,833 | ||||
11
Note 6 Inventories
Inventories, net of reserves, consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Finished products |
$ | 31,928 | $ | 22,144 | ||||
Consigned inventory |
2,003 | 1,992 | ||||||
Raw materials |
1,606 | 1,596 | ||||||
35,537 | 25,732 | |||||||
Less: inventory reserve |
2,753 | 819 | ||||||
Total |
$ | 32,784 | $ | 24,913 | ||||
Note 7 Prepaid Expenses
Prepaid expenses consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Prepaid royalties |
$ | 1,477 | $ | 2,591 | ||||
Other prepaid expenses |
1,106 | 1,366 | ||||||
Current prepaid expenses |
2,583 | 3,957 | ||||||
Non-current prepaid royalties |
5,117 | 9,667 | ||||||
Total prepaid expenses |
$ | 7,700 | $ | 13,624 | ||||
Note 8 Property and Equipment
Property and equipment consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Furniture and fixtures |
$ | 1,159 | $ | 1,160 | ||||
Computer and office equipment |
18,487 | 18,173 | ||||||
Warehouse equipment |
10,078 | 10,078 | ||||||
Leasehold improvements |
2,244 | 1,944 | ||||||
Construction in progress |
234 | 240 | ||||||
Total |
32,202 | 31,595 | ||||||
Less: accumulated depreciation and amortization |
24,668 | 22,296 | ||||||
Net property and equipment |
$ | 7,534 | $ | 9,299 | ||||
Depreciation expense was $751,000 and $2.4 million for the three and nine months ended
December 31, 2011, respectively and $851,000 and $2.6 million for the three and nine months ended
December 31, 2010, respectively.
12
Note 9 Capitalized Software Development Costs
The Company incurs software development costs for software to be sold, leased or marketed in
the publishing business. Software development costs include third-party contractor fees and
overhead costs. The Company capitalizes these costs once technological feasibility is achieved.
Capitalization ceases and amortization of costs begins when the software product is available for
general release to customers. The Company amortizes capitalized software development costs by the
greater of the ratio of gross revenues of a product to the total current and anticipated future
gross revenues of that product or the straight-line method over the remaining estimated economic
life of the product. The Company tests for possible impairment whenever events or changes in
circumstances, such as a reduction in expected cash flows, indicate that the carrying amount of the
asset may not be recoverable. If indicators exist, the Company compares the undiscounted cash flows
related to the asset to the carrying value of the asset. As discussed in Note 2, the Company
recorded an impairment charge of $1.2 million during the three and nine month periods ended
December 31, 2011 based on the expected future cash flows, which is included in cost of sales within the Consolidated Statements of
Operations. There were no impairment charges recorded during the three and nine month periods ended
December 31, 2010.
Software development costs consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Software development costs |
$ | 3,931 | $ | 3,025 | ||||
Less: accumulated amortization |
2,700 | 823 | ||||||
Software development costs, net |
$ | 1,231 | $ | 2,202 | ||||
Amortization expense was $1.4 million and $1.9 million for the three and nine months
(including an impairment charge of $1.2 million) ended December 31, 2011, respectively and $140,000
and $359,000 for the three and nine months ended December 31, 2010, respectively and is included in
cost of sales in the Consolidated Statements of Operations.
Note 10 Goodwill and Intangible Assets
Goodwill
The Company performs an impairment test of goodwill annually, or when events or a change in
circumstances indicate that the carrying value might exceed the current fair value. Certain factors
may result in the need to perform an impairment test other than annually, including significant
underperformance of the Companys business relative to expected operating results, significant
adverse economic and industry trends, and a decision to divest an individual business within a
reporting unit.
The Companys reporting units are composed of either a discrete business or an aggregation of
businesses with similar economic characteristics. For the purpose of performing the required
goodwill impairment tests, the Company applies a present value (discounted cash flow) method to
determine the fair value of the goodwill of the publishing business. The publishing business had a
goodwill balance of $5.7 million at March 31, 2011. There is no goodwill associated with the
distribution business.
If the fair value of the reporting unit is determined, based on qualitative factors, to be
more likely than not less than the carrying amount of the reporting unit, then the Company is
required to perform the goodwill impairment test. Goodwill impairment is determined using a
two-step process.
| The first step is to identify if a potential impairment exists by
comparing the fair value of the business with its carrying amount,
including goodwill. If the fair value of a reporting unit exceeds its
carrying amount, goodwill of the reporting unit is not considered to
have a potential impairment and the second step of the process is not
necessary. However, if the carrying amount of a reporting unit exceeds
its fair value, the second step is performed to determine if goodwill
is impaired and to measure the amount of impairment loss to recognize,
if any. |
||
| The second step, if necessary, compares the implied fair value of
goodwill with the carrying amount of goodwill. If the implied fair
value of goodwill exceeds the carrying amount, then goodwill is not
considered impaired. However, if the carrying amount of goodwill
exceeds the implied fair value, an impairment loss is recognized in an
amount equal to that excess. |
The Company estimates the fair value of the publishing business, using various
valuation techniques, with the primary technique being a discounted cash flow analysis. A
discounted cash flow analysis requires the Company to make various assumptions about sales,
operating margins, growth rates and discount rates. Assumptions about discount rates are based on a
weighted-average cost of capital derived from observable market inputs and comparable company data.
Assumptions about sales, operating margins, and growth rates are based on managements forecasts,
business plans, economic projections, anticipated future cash flows and marketplace data.
Assumptions are also made for varying perpetual growth rates for periods beyond the long-term
business plan period.
13
During the three months ended December 31, 2011, the Company concluded that indicators of
potential impairment were present due to the Restructuring Plan announced in October 2011 which included a review of its portfolio of businesses for where continued business investments would
not meet its requirements for financial returns. The Company conducted impairment tests during the
three months ended December 31, 2011 based on present facts and circumstances known and its
business strategy in light of the Restructuring Plan, and existing industry and economic
conditions, as well as taking into consideration future expectations. Accordingly, during the
three and nine months ended December 31, 2011, the Company recorded pre-tax, non-cash goodwill
impairment charges of $5.7 million, which is included in goodwill and intangible impairment in the Consolidated Statements of Operations.
These pre-tax, non-cash charges had no impact on the Companys compliance with financial covenants
in its credit agreement. There were no impairment charges recorded during the three and nine month
periods ended December 31, 2010.
After recording the above impairment, the Companys publishing segment had a goodwill balance
of zero at December 31, 2011.
Indefinite Lived Intangible Assets
Indefinite lived intangible assets include the Punch! trademark, which is not amortized. The
Company makes annual assessments, or as events or circumstances indicate that the asset might be
impaired, to evaluate realizability of carrying values.
The fair value of the indefinite lived intangible assets is determined for the impairment test
using the relief from royalty valuation technique, which is a variation of the income approach. As
discussed in Note 2, the Company recorded pre-tax, non-cash impairment charges of $306,000 during
the three and nine months ended December 31, 2011 which is included in goodwill and intangible impairment in the Consolidated Statements
of Operations. There were no impairment charges recorded during the three and nine month periods
ended December 31, 2010.
Definite Lived Intangible Assets
The Company evaluates its definite lived intangible amortizing assets for impairment when
changes in events and circumstances indicate that the carrying value might exceed the current fair
value. The Company determines fair value utilizing current market values and future market trends.
There were no impairment charges recorded during the three and nine month periods ended December
31, 2011 and 2010.
Intangible assets
Other identifiable intangible assets, with zero residual value, are being amortized (except
for the trademarks which have an indefinite life) over useful lives of five years for developed
technology, eight years for customer relationships, three years for customer list and seven years
for the domain name and were valued as follows (in thousands):
As of December 31, 2011 | ||||||||||||
Gross carrying | Accumulated | |||||||||||
amount | amortization | Net | ||||||||||
Developed technology |
$ | 1,940 | $ | 705 | $ | 1,235 | ||||||
Customer relationships |
80 | 19 | 61 | |||||||||
Customer list |
167 | 96 | 71 | |||||||||
Domain name |
70 | 56 | 14 | |||||||||
Trademarks (not amortized) |
294 | | 294 | |||||||||
Total intangible assets |
$ | 2,551 | $ | 876 | $ | 1,675 | ||||||
As of March 31, 2011 | ||||||||||||
Gross carrying | Accumulated | |||||||||||
amount | amortization | Net | ||||||||||
Developed technology |
$ | 1,940 | $ | 373 | $ | 1,567 | ||||||
Customer relationships |
80 | 10 | 70 | |||||||||
Customer list |
167 | 51 | 116 | |||||||||
Domain name |
70 | 48 | 22 | |||||||||
Trademarks (not amortized) |
600 | | 600 | |||||||||
Total intangible assets |
$ | 2,857 | $ | 482 | $ | 2,375 | ||||||
14
Aggregate amortization expense for the three and nine months ended December 31, 2011 was
$131,000 and $395,000, respectively. Aggregate amortization expense for the three and nine months
ended December 31, 2010 was $133,000 and $311,000, respectively.
The following is a schedule of estimated future amortization expense (in thousands):
Remainder of fiscal 2012 |
$ | 132 | ||
2013 |
484 | |||
2014 |
386 | |||
2015 |
353 | |||
Thereafter |
26 | |||
Total |
$ | 1,381 | ||
Debt issuance costs
Debt issuance costs are included in Other Assets and are amortized over the life of the
related debt. Debt issuance costs consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Debt issuance costs |
$ | 1,955 | $ | 1,790 | ||||
Less: accumulated amortization |
1,293 | 845 | ||||||
Net debt issuance costs |
$ | 662 | $ | 945 | ||||
Amortization expense of $149,000 and $448,000 for each of the three and nine months ended
December 31, 2011 and December 31, 2010, was included in interest expense in the accompanying
Consolidated Statements of Operations.
Note 11 Accrued Expenses
Accrued expenses consisted of the following (in thousands):
December 31, | March 31, | |||||||
2011 | 2011 | |||||||
Compensation and benefits |
$ | 2,092 | $ | 2,217 | ||||
Legal disputes and contingencies |
250 | 2,854 | ||||||
Severance |
940 | | ||||||
Royalties |
1,387 | 303 | ||||||
Rebates |
1,351 | 1,246 | ||||||
Interest |
46 | 96 | ||||||
Other |
878 | 1,052 | ||||||
Total |
$ | 6,944 | $ | 7,768 | ||||
Note 12 401(k) Plan
The Company has a defined contribution 401(k) profit-sharing plan for eligible employees,
which is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as
amended. The plan covers substantially all full-time employees.
Employees are entitled to make tax deferred contributions of up to 100% of their eligible
compensation, subject to annual IRS limitations. The Company matches 50% of employees
contributions up to the first 4% of their base pay, annually. The Companys contributions charged
to expense were $31,000 and $134,000 for the three and nine months ended December 31, 2011,
respectively and $104,000 and $277,000 for the three and nine months ended December 31, 2010,
respectively. The Companys matching contributions vest over three years.
15
Note 13 Commitments and Contingencies
Contingent payment Punch! acquisition
At March 31, 2011, the Company accrued a $1.0 million note payable related to a deferred
payment due on the first anniversary of the Punch! acquisition closing, plus interest at a rate of
0.67% per annum. The obligation was paid in full during the first quarter of fiscal 2012.
Additionally, at March 31, 2011, the Company accrued $948,000 for two potential contingent
performance payments of up to $1.25 million each (undiscounted), based on the Company achieving
minimum annual net sales of $8.0 million in connection with the acquired assets. The two contingent
payments were and are payable on the first and second anniversary of the closing date. The
combined fair value of the contingent consideration of $948,000 was estimated by applying the
income approach. That measure is based on significant inputs that are not observable in the market.
Key assumptions include (1) a discount rate range of 20%-25% and (2) a probability adjusted level
of revenues between $7.7 million and $9.4 million (see further disclosure in Note 4). The Company
did not achieve the minimum annual sales target of $8.0 million required for the first anniversary
contingent payment and therefore the initial contingent payment of $526,000 was reversed during the
first quarter of fiscal 2012.
Changes in the carrying value of the contingent payment obligation are as follows (in
thousands):
Balance, March 31, 2011 |
$ | 948 | ||
Reversal of unearned contingent payment |
(526 | ) | ||
Balance, December 31, 2011 |
$ | 422 | ||
Leases
The Company leases its facilities and a portion of its office and warehouse equipment. The
terms of the lease agreements generally range from 3 to 15 years, with certain leases containing
options to extend the lease up to an additional 10 years. The Company does not believe that
exercise of the renewal options are reasonably assured at the inception of the lease agreements,
and therefore, considers the initial base term to be the lease term. The leases require payment of
real estate taxes and operating costs in addition to base rent. Total base rent expense was
$613,000 and $1.8 million for each of the three and nine months ended December 31, 2011 and December 31, 2010, respectively.
Lease terms vary, but generally provide for fixed and escalating rentals which range from an
additional $0.06 per square foot to a 3% annual increase over the life of the lease.
The following is a schedule of future minimum rental payments required under non-cancelable
operating leases as of December 31, 2011 (in thousands):
Remainder of fiscal 2012 |
$ | 616 | ||
2013 |
2,510 | |||
2014 |
2,160 | |||
2015 |
2,157 | |||
2016 |
2,023 | |||
Thereafter |
4,853 | |||
Total(1) |
$ | 14,319 | ||
(1) | Minimum rental payments have not been reduced by minimum sublease
rentals of $370,000 due to the Company under noncancelable subleases. |
Guarantee
On May 29, 2007, FUNimation entered into an office lease in Flower Mound, Texas. In order to
obtain the lease, the Company, as the parent of the FUNimation subsidiary at that time, guaranteed
the full and prompt payment of the lease obligations and as of March 31, 2011, the Company
continued to be the guarantor. On April 14, 2011, the Company entered into an agreement to be
released from the office lease guarantee by providing a five-year, standby letter of credit for
$1.5 million, which is reduced by $300,000 each subsequent year. The standby letter of credit can
be drawn down, to the extent in default, if the full and prompt payment of the lease is not
completed by FUNimation. There was no indication that FUNimation would not be able to pay the
required future lease payments totaling $3.7 million and $4.1 million at December 31, 2011 and
March 31, 2011, respectively. Therefore, at December 31, 2011 and March 31, 2011, the Company did
not believe a future draw on the standby letter of credit was probable and an accrual related to
any future obligation was not considered necessary at such times.
16
Litigation and Proceedings
In the normal course of business, the Company is involved in a number of
litigation/arbitration matters that are incidental to the operation of the Companys business. These proceedings
generally include, among other things, various matters with regard to products distributed by the
Company and the collection of accounts receivable owed to the Company. The Company does not
currently believe that the resolution of any of those pending matters will have a material adverse
effect on the Companys financial position or liquidity, but an adverse decision in more than one
of these matters could be material to the Companys consolidated results of operations.
Because of the preliminary status of many of these various legal proceedings,
as well as the contingencies and uncertainties associated with these types of matters, it is difficult,
if not impossible, to predict the exposure to the Company with respect to many of these proceedings.
However, the Company is able to make an estimate of the probable costs for the resolution of certain legal claims and
as of March 31, 2011, approximately $2.9 million was accrued with respect to such claims.
During the nine months ended December 31, 2011, these claims have been settled and no amounts are accrued as of
December 31, 2011. The accrual estimates have been developed in consultation with internal and outside counsel handling the Companys defense
in these matters and were based upon an analysis of potential results, assuming a combination of litigation and
settlement strategies. There is a reasonable possibility that a change in the estimates, including factors involved in determining such
estimates, may occur, and the Company will adjust the accrual at such future date, if necessary.
SEC Investigation
On February 17, 2006, the Company received an inquiry from the Division of Enforcement of the
U.S. Securities and Exchange Commission (the SEC) requesting certain documents and information.
This information request, and others received after that date, related to information regarding the
Companys restatements of previously-issued financial statements, certain write-offs, reserve
methodologies and revenue recognition practices. The Company cooperated fully with the SECs
requests in connection with this non-public investigation. On November 7, 2011, the Company
received correspondence from the SEC stating that its investigation
into the Company was
complete and that it did not intend to recommend any enforcement action.
Note 14 Capital Leases
The Company leases certain equipment under non-cancelable capital leases. At December 31, 2011
and March 31, 2011, leased capital assets included in property and equipment were as follows (in
thousands):
December 31, 2011 | March 31, 2011 | |||||||
Computer and office equipment |
$ | 381 | $ | 332 | ||||
Less: accumulated amortization |
289 | 224 | ||||||
Property and equipment, net |
$ | 92 | $ | 108 | ||||
Amortization expense for the three and nine months ended December 31, 2011 was $34,000 and
$65,000, respectively, and $13,000 and $38,000, respectively, for the three and nine months ended
December 31, 2010. Future minimum lease payments, excluding additional costs such as insurance and
maintenance expense payable by the Company under these agreements, by year and in the aggregate are
as follows (in thousands):
Minimum Lease | ||||
Commitments | ||||
Remainder of fiscal 2012 |
$ | 25 | ||
2013 |
70 | |||
2014 |
13 | |||
Total minimum lease payments |
$ | 108 | ||
Less: amounts representing interest at rates ranging from 6.9% to 9.4% |
6 | |||
Present value of minimum capital lease payments, reflected in the
balance sheet as current and non-current capital lease obligations of
$81,000 and $21,000, respectively |
$ | 102 | ||
Note 15 Bank Financing and Debt
On November 12, 2009, the Company entered into a three year, $65.0 million revolving credit
facility (the Credit Facility) with Wells Fargo Foothill, LLC as agent and lender, and Capital
One Leverage Financing Corp. as a participating lender. On December 29, 2011, the Credit Facility
was amended to eliminate the participating lender, reduce the revolving credit facility limit to
$50.0 million, provide for an additional $20.0 million under the Credit Facility under certain
circumstances and extend the maturity date to December 29, 2016. The Credit Facility is secured
by a first priority security interest in all of the Companys assets, as well as the capital stock
of its subsidiary companies. Additionally, the Credit Facility, as amended, calls for monthly
interest payments at the banks base rate (as defined in the Credit Facility) plus 1.25%, or LIBOR
plus 2.25%, at the Companys discretion.
17
At both December 31, 2011 and March 31, 2011 the Company had zero outstanding on the Credit
Facility. Amounts available under the Credit Facility are subject to a borrowing base formula.
Changes in the assets within the borrowing base formula can impact the amount of availability.
Based on the Credit Facilitys borrowing base and other requirements at such dates, the Company had
excess availability of $43.5 million and $33.3 million at December 31, 2011 and March 31, 2011,
respectively.
In association with, and per the terms of the Credit Facility, the Company also pays and has
paid certain facility and agent fees. Weighted-average interest on the Credit Facility was 4.25%
and 7.5% at December 31, 2011 and March 31, 2011, respectively. Such interest amounts have been,
and continue to be, payable monthly.
Under the Credit Facility, 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 Companys overall financial stability as well as limitations on capital expenditures,
a minimum ratio of EBITDA to fixed charges, limitations on prepaid royalties and a minimum borrowing base
availability requirement. At December 31, 2011, the Company was in compliance with all covenants
under the Credit Facility. The Company currently believes it will be in compliance with all
covenants in the Credit Facility within the next twelve months.
Letter of Credit
On April 14, 2011, the Company was released from the FUNimation office lease guaranty by
providing a five-year, standby letter of credit for $1.5 million, which is reduced by $300,000 each
subsequent year. The standby letter of credit can be drawn down, to the extent in default, if the
full and prompt payment of the lease is not completed by FUNimation. No claims have been made
against this financial instrument. There was no indication that FUNimation would not be able to pay
the required future lease payments totaling $3.7 million and $4.1 million at December 31, 2011 and
March 31, 2011, respectively. Therefore, at December 31, 2011 and March 31, 2011, the Company did
not believe a future draw on the standby letter of credit was probable and an accrual related to
any future obligation was not considered necessary at such times.
Note 16 Shareholders Equity
The Companys Articles of Incorporation authorize 10,000,000 shares of preferred stock, no par
value. No preferred shares are issued or outstanding.
The Company did not repurchase any shares during either of the nine months ended December 31,
2011 or 2010.
Note 17 Private Placement Warrants
As of March 31, 2011, the Company had warrants to purchase 1,596,001 shares of common stock
outstanding. The warrants had a term of five years and were exercisable at $5.00 per share. The
Company had the right to require exercise of the warrants if, among other things, the volume
weighted average price of the Companys common stock exceeded $8.50 per share for each of 30
consecutive trading days. In addition, the warrants provided the investors the option to require
the Company to repurchase the warrants for a purchase price, payable in cash within five (5)
business days after such request, equal to the Black-Scholes value of any unexercised warrant
shares, but only if, while the warrants were outstanding, the Company initiated a change in control
transactions. The warrants expired on September 21, 2011 without any exercises.
Note 18 Share-Based Compensation
The Company has two equity compensation plans: the Navarre Corporation 1992 Stock Option Plan
and the Navarre Corporation 2004 Stock Plan (collectively, the Plans). The 1992 Plan expired on
July 1, 2006, and no further grants are allowed under this Plan, however, there are outstanding
options remaining under this Plan. The 2004 Plan provides for equity awards, including stock
options, restricted stock and restricted stock units. Eligible participants under the Plans are all
employees (including officers and directors), non-employee directors, consultants and independent
contractors. These Plans are described in detail in the Companys Annual Report filed on Form 10-K
for the fiscal year ended March 31, 2011.
18
Stock Options
A summary of the Companys stock option activity as of December 31, 2011 and changes during
the nine months ended December 31, 2011 are summarized as follows:
Weighted | ||||||||
average | ||||||||
Number of | exercise | |||||||
options | price | |||||||
Options outstanding, beginning of period: |
3,789,834 | $ | 3.24 | |||||
Granted |
1,046,500 | 1.69 | ||||||
Exercised |
(269,001 | ) | 0.69 | |||||
Forfeited or expired |
(1,656,833 | ) | 4.23 | |||||
Options outstanding, end of period |
2,910,500 | $ | 2.36 | |||||
Options exercisable, end of period |
1,387,502 | $ | 2.98 | |||||
Shares available for future grant, end of period |
2,901,157 |
The weighted-average fair value of options granted during the nine months ended December 31,
2011 was $1.1 million and the total fair value of options exercisable was $2.5 million at December
31, 2011. The weighted-average remaining contractual term for options outstanding was 7.9 years and
for options exercisable was 6.3 years at December 31, 2011.
The aggregate intrinsic value represents the total pretax intrinsic value, based on the
Companys closing stock price of $1.54 as of December 31, 2011, which theoretically could have been
received by the option holders had all option holders exercised their options as of that date. The
total intrinsic value of stock options exercised during the nine months ended December 31, 2011 was
$311,000. The aggregate intrinsic value for options outstanding was $167,000, and for options
exercisable was $155,000 at December 31, 2011.
As of December 31, 2011, total compensation cost related to non-vested stock options not yet
recognized was $1.4 million, which is expected to be recognized over the next 1.5 years on a
weighted-average basis.
During each of the nine months ended December 31, 2011 and 2010, the Company received cash
from the exercise of stock options totaling $184,000 and $44,000, respectively. There was no excess
tax benefit recorded for the tax deductions related to stock options during either of the nine
months ended December 31, 2011 or 2010.
Restricted Stock
Restricted stock granted to employees typically has a vesting period of three years and
expense is recognized on a straight-line basis over the vesting period, or when the performance
criteria have been met. The value of the restricted stock is established by the market price on the
date of grant or if based on performance criteria, on the date it is determined the performance
criteria will be met. Restricted stock awards vesting is based on service criteria or achievement
of performance targets. All restricted stock awards are settled in shares of the Companys common
stock.
19
A summary of the Companys restricted stock activity as of December 31, 2011 and of changes
during the nine months ended December 31, 2011 is summarized as follows:
Weighted | ||||||||
average | ||||||||
grant date | ||||||||
Shares | fair value | |||||||
Unvested, beginning of period: |
584,335 | $ | 1.96 | |||||
Granted |
526,000 | 1.67 | ||||||
Vested |
(300,752 | ) | 1.63 | |||||
Forfeited |
(262,334 | ) | 1.74 | |||||
Unvested, end of period |
547,249 | $ | 1.75 | |||||
The weighted-average fair value of restricted stock awards granted during the nine months
ended December 31, 2011 was $881,000.
The total fair value of shares vested during the nine months ended December 31, 2011 and 2010
was $490,000 and $536,000, respectively.
The weighted-average remaining vesting period for restricted stock awards outstanding at
December 31, 2011 was 1.6 years.
As of December 31, 2011, total compensation cost related to non-vested restricted stock awards
not yet recognized was $821,000, which amount is expected to be recognized over the next 1.5 years
on a weighted-average basis. There was no excess tax benefit recorded for the tax deductions
related to restricted stock during either of the nine month periods ended December 31, 2011 or
2010.
Share-Based Compensation Valuation and Expense Information
The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value
of an option award. The fair value of options granted during the three and nine months ended
December 31, 2011 and 2010 was calculated using the following assumptions:
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Expected life (in years) |
6.0 | 5.0 | 5.0 | 5.0 | ||||||||||||
Expected average volatility |
67 | % | 72 | % | 68 | % | 72 | % | ||||||||
Risk-free interest rate |
0.91-1.49 | % | 1.04 | % | 0.91-2.24 | % | 1.46-2.60 | % | ||||||||
Expected dividend yield |
0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % |
Expected life uses historical employee exercise and option expiration data to estimate the
expected life assumption for the Black-Scholes grant-date valuation. The Company believes that this
historical data is currently the best estimate of the expected term of a new option. The Company
uses a weighted-average expected life for all awards and has identified one employee population.
Expected volatility uses the Company stocks historical volatility for the same period of time as
the expected life. The Company has no reason to believe its future volatility will differ from the
past. The risk-free interest rate is based on the U.S. Treasury rate in effect at the time of the
grant for the same period of time as the expected life. Expected dividend yield is zero, as the
Company historically has not paid dividends. The Company used a forfeiture rate of 4.63% during the
three and nine months ended December 31, 2011 and 2010.
Share-based compensation expense related to employee stock options, restricted stock and
restricted stock units, net of estimated forfeitures, for the three and nine months ended December
31, 2011 was $509,000 and $933,000, respectively, and $318,000 and $786,000, respectively, for the
three and nine months ended December 31, 2010. These amounts were included in general and
administrative expenses in the Consolidated Statements of Operations. No amount of share-based
compensation was capitalized.
20
Note 19 Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted earnings (loss) per share
(in thousands, except per share data):
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Numerator: |
||||||||||||||||
Net income (loss) from continuing operations |
$ | (29,077 | ) | $ | 1,067 | $ | (30,953 | ) | $ | 2,727 | ||||||
Income from discontinued operations, net |
| 1,849 | | 4,424 | ||||||||||||
Net income (loss) |
$ | (29,077 | ) | $ | 2,916 | $ | (30,953 | ) | $ | 7,151 | ||||||
Denominator: |
||||||||||||||||
Denominator for basic earnings (loss) per shareweighted-average shares |
36,977 | 36,471 | 36,805 | 36,405 | ||||||||||||
Dilutive securities: Employee stock options, restricted stock and warrants |
| 537 | | 520 | ||||||||||||
Denominator for diluted earnings (loss) per shareadjusted
weighted-average shares |
36,977 | 37,008 | 36,805 | 36,925 | ||||||||||||
Basic earnings (loss) per common share: |
||||||||||||||||
Continuing operations |
$ | (0.79 | ) | $ | 0.03 | $ | (0.84 | ) | $ | 0.08 | ||||||
Discontinued operations |
| 0.05 | | 0.12 | ||||||||||||
Net income (loss) |
$ | (0.79 | ) | $ | 0.08 | $ | (0.84 | ) | $ | 0.20 | ||||||
Diluted earnings (loss) per common share: |
||||||||||||||||
Continuing operations |
$ | (0.79 | ) | $ | 0.03 | $ | (0.84 | ) | $ | 0.07 | ||||||
Discontinued operations |
| 0.05 | | 0.12 | ||||||||||||
Net income (loss) |
$ | (0.79 | ) | $ | 0.08 | $ | (0.84 | ) | $ | 0.19 | ||||||
Approximately 3.0 million and 2.9 million of the Companys stock options and non-vested
restricted stock were excluded from the calculation of diluted earnings per share for the three and
nine months ended December 31, 2011, respectively, and 2.7 million and 2.6 million stock options
and non-vested restricted stock were excluded from the calculation of diluted earnings per share
for the three and nine months ended December 31, 2010, respectively, because the exercise prices of
such stock options and the grant-date fair value of such restricted stock were greater than the
average price of the Companys common stock and therefore their inclusion would have been
anti-dilutive.
Approximately 1.6 million warrants were also excluded from the calculation of diluted earnings
per share for both the three and nine months ended December 31, 2010 because the exercise prices of
such warrants was greater than the average price of the Companys common stock and therefore their
inclusion would have been anti-dilutive. The warrants expired on September 21, 2011 without any
exercises.
Note 20 Comprehensive Income (Loss)
Other comprehensive income (loss) pertains to net unrealized gains and losses on foreign
exchange rate translation of the Companys balance sheet pertaining to foreign operations. These
net unrealized gains and losses are not included in net income (loss) but rather are recorded in
accumulated other comprehensive income (loss) within shareholders equity.
Comprehensive income (loss) consisted of the following (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net income (loss) |
$ | (29,077 | ) | $ | 2,916 | $ | (30,953 | ) | $ | 7,151 | ||||||
Net unrealized gain (loss) on foreign exchange rate translation, net of tax |
145 | 189 | (122 | ) | 318 | |||||||||||
Comprehensive income (loss) |
$ | (28,932 | ) | $ | 3,105 | $ | (31,075 | ) | $ | 7,469 | ||||||
The changes in other comprehensive income (loss) are non-cash items.
Accumulated other comprehensive income (loss) balances, net of tax effects, were other
comprehensive income of $33,000 and $155,000 at December 31, 2011 and March 31, 2011, respectively.
21
Note 21 Income Taxes
For the three months ended December 31, 2011, the Company recorded income tax expense from
continuing operations of $14.5 million, compared to income tax expense from continuing operations
of $393,000 for the three months ended December 31, 2010. The effective income tax rate applied to
continuing operations for the three months ended December 31, 2011 was negative 98.9%, compared to 26.9%
for the three months ended December 31, 2010. For the nine months ended December 31, 2011, the
Company recorded income tax expense from continuing operations of $13.2 million, compared to income
tax expense from continuing operations of $1.8 million for the nine months ended December 31, 2010.
The effective income tax rate applied to continuing operations for the nine months ended December
31, 2011 was negative 74.8%, compared to 39.3% for the nine months ended December 31, 2010. The change in
the effective tax rate for the three and nine months ended December 31, 2011 is principally
attributable to the fact that the Company recorded a valuation allowance, described below, against its deferred tax
assets of $18.9 million during the three months ended December 31, 2011.
For the three months ended December 31, 2010, the Company recorded income tax expense from
discontinued operations of $1.1 million at an effective tax rate of 36.2%. For the nine months
ended December 31, 2010, the Company recorded income tax expense from discontinued operations of
$2.5 million at an effective tax rate of 36.4%.
Deferred tax assets are evaluated by considering historical levels of income, estimates of
future taxable income streams and the impact of tax planning strategies. A valuation allowance is
recorded to reduce deferred tax assets when it is determined that it is more likely than not, based
on the weight of available evidence, the Company would not be able to realize all or part of its
deferred tax assets. An assessment is required of all available evidence, both positive and
negative, to determine the amount of any required valuation allowance.
As a result of the current market conditions and their impact on the Companys future outlook,
management has reviewed its deferred tax assets and concluded that the uncertainties related to the
realization of some of its assets, have become unfavorable. As of December 31, 2011, the Company
had a net deferred tax asset position before valuation allowance of $36.2 million which is composed
of temporary differences, primarily related to net operating loss carryforwards, which will begin
to expire in fiscal 2029. The Company also has a foreign tax credit carryforwards at December 31,
2011 which will begin to expire in 2016. The Company has considered the positive and negative
evidence for the potential utilization of the net deferred tax asset and has concluded that it is
more likely than not that the Company will not realize the full amount of net deferred tax assets.
Accordingly, a valuation allowance of $18.9 million has been recorded
as of December 31, 2011, which is included in income tax expense for the three and nine months ended December 31,
2011. The Company carried no valuation allowance against these deferred tax assets at March 31,
2011.
The Company recognizes interest accrued related to unrecognized income tax benefits (UTBs)
in the provision for income taxes. At March 31, 2011, interest accrued was approximately $168,000,
which was net of federal and state tax benefits and total UTBs net of deferred federal and state
tax benefits that would impact the effective tax rate if recognized were $612,000. During the nine
months ended December 31, 2011, $122,000 of UTBs were reversed, which was net of $123,000 of
deferred federal and state income tax benefits. At December 31, 2011, interest accrued was $177,000
and total UTBs, net of deferred federal and state income tax benefits that would impact the
effective tax rate if recognized, were $490,000.
The Companys federal income tax returns for tax years ending in 2007 through 2011 remain
subject to examination by tax authorities. The Company files in numerous state jurisdictions with
varying statutes of limitations. The Company does not anticipate that the total unrecognized tax
benefits will significantly change prior to March 31, 2012.
Note 22 Related Party Transactions
On April 6, 2011, the Board of Directors of the Company terminated the employment of the
President and Chief Executive Officer, Cary L. Deacon. The Company recognized approximately $1.4
million in expense during the first nine months of fiscal 2012 related to severance costs arising
out of the termination of Mr. Deacons employment.
22
Note 23 Variable Interest Entity
On March 31, 2011, the Company sold its wholly-owned subsidiary, FUNimation. At both December
31, 2011 and March 31, 2011, the Company assessed its variable interest in FUNimation including the
terms of the exclusive distribution and logistics and fulfillment services agreements, employment
matter indemnification (maximum exposure of $250,000), and the office lease guarantee (released and
replaced with a $1.5 million standby letter of credit) to determine if FUNimation met the
definition of a variable interest entity (VIE). Based on the Companys evaluation it was
determined that FUNimation was a VIE. Consolidating any VIEs within the Companys financial results
is required if the Company is found to be the primary beneficiary. However, because the Company did
not have the power to direct the activities of the VIE that most significantly impacted their
economic performance, nor did the Company have the obligation to absorb the significant losses or
the right to receive significant benefits from the VIE, it was determined that the Company was not
the primary beneficiary. Therefore, the results of FUNimation were not consolidated into the
Companys financial results (see further disclosure regarding the letter of credit in Note 13).
Note 24 Business Segments
The Company identifies its segments based on its organizational structure, which is primarily
by business activity. Operating profit represents earnings before interest expense, interest
income, income taxes and allocations of corporate costs to the respective divisions. Inter-company
sales are made at market prices. The Companys corporate office maintains a majority of the
Companys cash and revolving line of credit under its cash management policy.
Navarre operates two business segments: distribution and publishing.
Through the distribution business, the Company distributes computer software, consumer
electronics and accessories, video games and home video and also provides complete distribution logistics
solutions. The distribution business focuses on providing vendors and retailers with a range of
value-added services, including vendor-managed inventory, electronic and internet-based ordering,
and gift card fulfillment.
Through the publishing business, the Company owns or licenses various widely-known computer
software brands through Encore. In addition to retail publishing, Encore also sells directly to
consumers through its websites. The publishing business packages, brands, markets and sells
published software directly to retailers, third party distributors, and to the Companys
distribution business.
The Company also formerly published and sold anime content through FUNimation Productions,
Ltd. (FUNimation). The Company sold FUNimation on March 31, 2011, and accordingly, the results of
operations of FUNimation for all periods presented are classified as discontinued operations (see Note 3).
23
Financial information by reportable segment is included in the following summary for the three
and nine months ended December 31, 2011 and 2010 (in thousands):
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Three months ended December 31, 2011 |
||||||||||||||||
Net sales |
$ | 150,801 | $ | 7,661 | $ | (4,965 | ) | $ | 153,497 | |||||||
Loss from operations |
(67 | ) | (14,090 | ) | | (14,157 | ) | |||||||||
Loss from continuing operations, before income tax |
(704 | ) | (13,916 | ) | | (14,620 | ) | |||||||||
Depreciation and amortization expense |
698 | 185 | | 883 | ||||||||||||
Goodwill and intangible impairment |
| 5,996 | | 5,996 | ||||||||||||
Capital expenditures |
18 | | | 18 | ||||||||||||
Total assets |
152,751 | 13,787 | (1,644 | ) | 164,894 |
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Three months ended December 31, 2010 |
||||||||||||||||
Net sales (1) |
$ | 144,402 | $ | 8,311 | $ | (5,388 | ) | $ | 147,325 | |||||||
Income from operations |
802 | 1,272 | | 2,074 | ||||||||||||
Income (loss) from continuing operations, before income tax (2) |
805 | 1,421 | (766 | ) | 1,460 | |||||||||||
Depreciation and amortization expense |
820 | 163 | | 983 | ||||||||||||
Capital expenditures |
48 | | | 48 | ||||||||||||
Total assets (3) |
137,006 | 30,532 | (4,578 | ) | 162,960 |
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Nine months ended December 31, 2011 |
||||||||||||||||
Net sales |
$ | 356,572 | $ | 21,183 | $ | (13,674 | ) | $ | 364,081 | |||||||
Loss from operations |
(3,976 | ) | (12,361 | ) | | (16,337 | ) | |||||||||
Loss from continuing operations, before income tax |
(5,876 | ) | (11,835 | ) | | (17,711 | ) | |||||||||
Depreciation and amortization expense |
2,268 | 514 | | 2,782 | ||||||||||||
Goodwill and intangible impairment |
| 5,996 | | 5,996 | ||||||||||||
Capital expenditures |
533 | 60 | | 593 | ||||||||||||
Total assets |
152,751 | 13,787 | (1,644 | ) | 164,894 |
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Nine months ended December 31, 2010 |
||||||||||||||||
Net sales (1) |
$ | 359,116 | $ | 24,021 | $ | (16,544 | ) | $ | 366,593 | |||||||
Income from operations |
2,510 | 3,877 | | 6,387 | ||||||||||||
Income from continuing operations, before income tax (2) |
2,516 | 4,297 | (2,322 | ) | 4,491 | |||||||||||
Depreciation and amortization expense |
2,457 | 408 | | 2,865 | ||||||||||||
Capital expenditures |
426 | 57 | | 483 | ||||||||||||
Total assets (3) |
137,006 | 30,532 | (4,578 | ) | 162,960 |
(1) | For the three and nine months ended December 31, 2010, $8.9 million and $25.6 million,
respectively, net sales from discontinued operations were excluded from publishing sales
above. |
|
(2) | Eliminations represent the interest expense previously allocated to FUNimation, but which
amount was not allowed to be allocated to discontinued operations at the time of the
discontinued operations reclassification. |
|
(3) | At December 31, 2010, $36.1 million in assets of discontinued operations were excluded from
total publishing assets above. |
24
Product Line Data
The following table provides net sales by product line for each business segment for the three
and nine months ended December 31, 2011 and 2010 (in thousands):
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Three months ended December 31, 2011 |
||||||||||||||||
Software |
$ | 103,863 | $ | 7,661 | $ | (4,965 | ) | $ | 106,559 | |||||||
Consumer electronics and accessories |
32,640 | | | 32,640 | ||||||||||||
Video games |
10,784 | | | 10,784 | ||||||||||||
Home video |
3,514 | | | 3,514 | ||||||||||||
Consolidated |
$ | 150,801 | $ | 7,661 | $ | (4,965 | ) | $ | 153,497 | |||||||
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Three months ended December 31, 2010 |
||||||||||||||||
Software |
$ | 112,257 | $ | 8,311 | $ | (5,388 | ) | $ | 115,180 | |||||||
Consumer electronics and accessories |
11,308 | | | 11,308 | ||||||||||||
Video games |
8,750 | | | 8,750 | ||||||||||||
Home video |
12,087 | | | 12,087 | ||||||||||||
Consolidated |
$ | 144,402 | $ | 8,311 | $ | (5,388 | ) | $ | 147,325 | |||||||
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Nine months ended December 31, 2011 |
||||||||||||||||
Software |
$ | 255,819 | $ | 21,183 | $ | (13,674 | ) | $ | 263,328 | |||||||
Consumer electronics and accessories |
59,682 | | | 59,682 | ||||||||||||
Video games |
21,136 | | | 21,136 | ||||||||||||
Home video |
19,935 | | | 19,935 | ||||||||||||
Consolidated |
$ | 356,572 | $ | 21,183 | $ | (13,674 | ) | $ | 364,081 | |||||||
Distribution | Publishing | Eliminations | Consolidated | |||||||||||||
Nine months ended December 31, 2010 |
||||||||||||||||
Software |
$ | 285,054 | $ | 24,021 | $ | (16,544 | ) | $ | 292,531 | |||||||
Consumer electronics and accessories |
22,565 | | | 22,565 | ||||||||||||
Video games |
20,344 | | | 20,344 | ||||||||||||
Home video |
31,153 | | | 31,153 | ||||||||||||
Consolidated |
$ | 359,116 | $ | 24,021 | $ | (16,544 | ) | $ | 366,593 | |||||||
Geographic Data
The following table provides net sales by geographic region for the three and nine months
ended December 31, 2011 and 2010 and property, plant and equipment, net of accumulated depreciation
by geographic region at December 31, 2011 and March 31, 2011 (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net Sales |
||||||||||||||||
United States |
$ | 127,904 | $ | 132,005 | $ | 319,407 | $ | 333,060 | ||||||||
International |
25,593 | 15,320 | 44,674 | 33,533 | ||||||||||||
Total net sales |
$ | 153,497 | $ | 147,325 | $ | 364,081 | $ | 366,593 | ||||||||
December 31, 2011 | March 31, 2011 | |||||||
Property, Plant and Equipment, Net |
||||||||
United States |
$ | 7,235 | $ | 8,829 | ||||
International |
299 | 470 | ||||||
Total property, plant and equipment, net |
$ | 7,534 | $ | 9,299 | ||||
25
Sales Channel Data
The following table provides net sales by sales channel for the three and nine months ended
December 31, 2011 and 2010 (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Retail |
$ | 126,909 | $ | 127,583 | $ | 311,457 | $ | 329,852 | ||||||||
E-commerce |
26,588 | 19,742 | 52,624 | 36,741 | ||||||||||||
Total net sales |
$ | 153,497 | $ | 147,325 | $ | 364,081 | $ | 366,593 | ||||||||
26
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations. |
Overview
We are a distributor and provider of complete logistics solutions for traditional and
e-commerce retail channels. Our solutions also support both direct-to-consumer (DTC) and
business-to-business (B2B) sales channels. Additionally, we are a publisher of computer
software.
Since our founding in 1983, we have established distribution relationships with major
retailers including Best Buy, Wal-Mart/Sams Club, Costco Wholesale Corporation, Staples, Office
Depot, OfficeMax, Target, Apple, Amazon and RadioShack, and we distribute to nearly 17,000 retail
and distribution center locations throughout the United States and Canada. We believe our
established relationships throughout the supply chain permit us to offer products to our
internet-based and retail customers and to provide our vendors with access to broad retail
channels. In order to participate in the growing revenue streams resulting from e-commerce and
fulfillment services, we are expanding the business services we offer.
Our business operates through two business segments Distribution and Publishing.
Through our distribution business, we distribute computer software, consumer electronics and
accessories, video games and home video, and provide fee-based logistical services. The
distribution business focuses on providing a range of value-added services, electronic and
internet-based ordering and gift card fulfillment. Through our publishing business, we own or
license various computer software brands. Our publishing business packages, brands, markets and
sells directly to consumers, retailers, third-party distributors and our distribution business.
Our publishing business currently consists of Encore Software, Inc. (Encore).
Encore, which we acquired in July 2002, publishes a variety of software products for the PC
and Mac platforms. These products fall mainly into the print, personal productivity, education,
family entertainment, and home and landscape architectural design software categories. In addition
to retail publishing, Encore also sells directly to consumers through its e-commerce websites.
On March 31, 2011, we sold FUNimation Productions, Ltd. (FUNimation), a leading anime
content provider which was previously part of our publishing segment. All results of operations,
assets and liabilities of FUNimation are classified as discontinued operations for all periods
presented, and the consolidated financial statements, including the notes, have been reclassified
to reflect such segregation for all periods presented (see Note 3 to our
Consolidated Financial Statements).
During October 2011, we implemented a series of initiatives, including a reduction in
workforce and simplification of business structures and processes across the Companys operations.
These actions are intended to increase operating efficiencies and provide additional resources to
invest in product lines and service categories in order to execute our long-term growth strategy.
In conjunction with the initiatives described above, the Company reviewed its portfolio of
businesses to identify poor performing activities and areas where continued business
investments would not meet its requirements for financial returns (collectively, Restructuring
Plan). We recognized pre-tax impairment and restructuring charges of approximately $17.1 million
during the third quarter of fiscal 2012. We expect to record additional pre-tax impairment and
restructuring charges of approximately $6.0 million during the fourth quarter of fiscal year 2012.
Executive Summary
Continuing Operations
Consolidated net sales from continuing operations for the third quarter of fiscal 2012
increased 4.2% to $153.5 million compared to $147.3 million for the third quarter of fiscal 2011.
This $6.2 million increase in net sales was due to an increase in net sales of consumer electronics
and accessories and video games, which was driven by the expansion of new products with existing
and new customers, partially offset by reduced demand in software and home video products.
27
Our gross profit from continuing operations decreased to $7.6 million, or 5.0% of net sales,
in the third quarter of fiscal 2012 compared to $17.8 million, or 12.1% of net sales, for the same
period in fiscal 2011. The $10.2 million decrease in gross profit and 57.1% decrease in gross
profit margin was principally due to $8.8 million of inventory, prepaid royalties and software
development write-downs recognized as a result of the Restructuring Plan, which represents 5.7% of
net sales. In addition, the decrease was due to a mix of sales that included a higher amount of
lower gross profit margin security and utilities software products within the distribution segment
and lower gross profit margin value-priced software titles in the publishing segment.
Total operating expenses from continuing operations for the third quarter of fiscal 2012 were
$21.8 million, or 14.2% of net sales, compared to $15.7 million, or 10.7% of net sales, in the same
period for fiscal 2011. The $6.1 million increase was primarily due to the goodwill and intangible
impairment charge of $6.0 million and $2.3 million of Restructuring Plan related charges offset by
reduced overall expenses as a result of our focus to control expenses.
Net loss from continuing operations for the third quarter of fiscal 2012 was $29.1 million or
$0.79 per diluted share compared to net income from continuing operations of $1.1 million or $0.03
per diluted share for the same period last year.
Consolidated net sales from continuing operations for the nine months ended December 31, 2011
were $364.1 million compared to $366.6 million for the first nine months of fiscal 2011, a decrease
of 0.7%. Net sales of consumer electronics and accessories for the nine months ended December 31,
2011 increased by $37.1 million as compared to the prior year, which was driven by the expansion of
new products with existing and new customers. This increase was offset by a decrease of software
net sales in our distribution and publishing segment as well as a decrease of home video products
principally due to reduced demand.
Our gross profit from continuing operations was $34.0 million, or 9.3% of net sales, for the
first nine months of fiscal 2012, compared with $49.6 million, or 13.5% of net sales, for the same
period in fiscal 2011. Both the $15.5 million decrease in gross profit and 31.3% decrease in gross
profit margin were due to $8.8 million, or 2.4% of net sales, of inventory, prepaid royalties and
software development write-downs recognized as a result of the Restructuring Plan. In addition to
the write-downs, the decrease in gross profit was due to a mix of lower gross profit margin
security and utility software products within the distribution segment and lower gross profit
margin value-priced software titles in the publishing segment.
Total operating expenses from continuing operations for the nine months ended December 31,
2011 were $50.4 million, or 13.8% of net sales, compared to $43.2 million, or 11.8% of net sales,
in the same period for fiscal 2011. The increase in operating
expenses of $7.2 million was
primarily due to the goodwill and intangible impairment charge of $6.0 million and other
restructuring charges of $4.1 million offset by reduced personnel costs as a result of the
Restructuring Plan that commenced during the third quarter of fiscal 2012.
Net loss from continuing operations for the nine months ended December 31, 2011 was $31.0
million or $0.84 per diluted share compared to net income from continuing operations of $2.7
million, or $0.07 per diluted share for the same period last year.
Impairments and Other Charges
During October 2011, we implemented the Restructuring Plan in order to transition away from
facilities, business processes and other assets that were in place to sustain now divested non-core
businesses. These changes are designed to support high-growth opportunities in the distribution of
consumer electronics and accessories, to enhance our e-commerce fulfillment business and to
increase our market expansion in Canada. The Restructuring Plan is expected to generate annualized
pre-tax cost savings of $5.5 $6.5 million when fully implemented in fiscal year 2013, which
savings of $2.0 million is expected to be achieved during fiscal year 2012.
We expect substantially all restructuring activities to be completed by March 31, 2012. The
Restructuring Plan includes:
| The elimination of approximately 90 positions across all areas, |
| Abandoning inventory and other investments that we determined would not meet our
requirements for financial returns, |
| The relocation of Encore operations from Los Angeles, California to the corporate
headquarters in Minneapolis, Minnesota, and |
| Vacating a leased property in Minneapolis, Minnesota, that was utilized for warehouse
and manufacturing assembly space. |
Net assets impacted included inventory, prepaid royalties, goodwill and software development
costs.
Inventory. The total inventory charges related to the distribution segment were $441,000 during
the three and nine months ended December 31, 2011. The total inventory charges related to the
publishing segment were $1.3 million during the three and nine months ended December 31, 2011. We
determined the estimated realizable value by evaluating the nature and quantity of inventory on
hand as compared to expected future sales volumes in addition to corroboration of estimated sales
values with market participants.
Prepaid Royalties. Based on our review of business activities and the identification of
investments that would not meet requirements for financial returns, we recorded an impairment
charge related to the publishing segment for amounts that will not be recouped of $5.8 million
during the three and nine month periods ended December 31, 2011, which is included in cost of sales
within the Consolidated Statements of Operations.
Software Development. Based on the expected cash flows related to the publishing segment
software development, we recorded an impairment charge of $1.2 million during the three and nine
month periods ended December 31, 2011, which is included in cost of sales within the Consolidated
Statements of Operations.
28
Severance and other related costs. We completed a Company-wide reduction in force during the
three months ended December 31, 2011. In addition, we incurred expenses related to the CEO
transition which commenced during the first quarter of fiscal 2012. For the three months ended
December 31, 2011, the total severance and related costs were $2.3 million, of which $1.6 million
were associated with the distribution business and $614,000 with the publishing business. For the
nine months ended December 31, 2011, the total severance and related costs were $4.1 million, of
which $3.3 million were associated with the distribution business and $809,000 with the publishing
business.
Goodwill and intangibles. We performed goodwill and intangible impairment assessments due to
the Restructuring Plan and the underperformance of the Punch! product lines relative to historical
or projected future operating results. We determined fair value using widely accepted valuation
techniques, including discounted cash flow and market multiple analysis. We recognized a goodwill
impairment charge for the publishing segment was $5.7 million during the three and nine months
ended December 31, 2011.
The fair value of the indefinite lived intangible assets is determined for the impairment test
using the relief from royalty valuation technique, which is a variation of the income approach. We
determined that the Punch! trademark was impaired as of December 31, 2011. The intangible
impairment charge for the publishing segment was $306,000 during the three and nine months ended
December 31, 2011.
The following table summarizes the impairment and other charges included in our Consolidated
Statement of Operations for the three months ended December 31, 2011 (in thousands):
Software | Goodwill | |||||||||||||||||||||||||||||||
Development | Prepaid | and | Severance | Severance | ||||||||||||||||||||||||||||
Costs - | Royalties - | intangible- | Inventory- | and other- | Inventory- | and other- | ||||||||||||||||||||||||||
Publishing | Publishing | Publishing | Publishing | Publishing | Distribution | Distribution | Total | |||||||||||||||||||||||||
Cost of sales |
$ | 1,238 | $ | 5,826 | $ | | $ | 1,287 | $ | 2 | $ | 441 | $ | | $ | 8,794 | ||||||||||||||||
Selling and marketing |
| | | | 86 | | 213 | 299 | ||||||||||||||||||||||||
Distribution and
warehousing |
| | | | | | 146 | 146 | ||||||||||||||||||||||||
General and
administrative |
| | | | 526 | | 1,290 | 1,816 | ||||||||||||||||||||||||
Goodwill and
intangible
impairment |
| | 5,996 | | | | | 5,996 | ||||||||||||||||||||||||
Total |
$ | 1,238 | $ | 5,826 | $ | 5,996 | $ | 1,287 | $ | 614 | $ | 441 | $ | 1,649 | $ | 17,051 | ||||||||||||||||
The following table summarizes the impairment and other charges included in our Consolidated
Statement of Operations for the nine months ended December 31, 2011 (in thousands):
Software | Goodwill | |||||||||||||||||||||||||||||||
Development | Prepaid | and | Severance | Severance | ||||||||||||||||||||||||||||
Costs - | Royalties - | intangible - | Inventory- | and other- | Inventory- | and other- | ||||||||||||||||||||||||||
Publishing | Publishing | Publishing | Publishing | Publishing | Distribution | Distribution | Total | |||||||||||||||||||||||||
Cost of sales |
$ | 1,238 | $ | 5,826 | $ | | $ | 1,287 | $ | 2 | $ | 441 | $ | | $ | 8,794 | ||||||||||||||||
Selling and marketing |
| | | | 86 | | 213 | 299 | ||||||||||||||||||||||||
Distribution and
warehousing |
| | | | | | 146 | 146 | ||||||||||||||||||||||||
General and
administrative |
| | | | 721 | | 2,952 | 3,673 | ||||||||||||||||||||||||
Goodwill and
intangible
impairment |
| | 5,996 | | | | | 5,996 | ||||||||||||||||||||||||
Total |
$ | 1,238 | $ | 5,826 | $ | 5,996 | $ | 1,287 | $ | 809 | $ | 441 | $ | 3,311 | $ | 18,908 | ||||||||||||||||
The accrued expense activity related to impairments and other charges was as follows (in
thousands):
Royalty and | ||||||||||||||||
Severance | Software | Severance | ||||||||||||||
and other- | Development- | and other- | ||||||||||||||
Publishing | Publishing | Distribution | Total | |||||||||||||
Accrued expense balance at March 31, 2011 |
$ | | $ | | $ | | $ | | ||||||||
Provision |
809 | 1,092 | 3,081 | 4,982 | ||||||||||||
Cash payments |
379 | | 2,571 | 2,950 | ||||||||||||
Accrued expense balance at December 31, 2011 |
$ | 430 | $ | 1,092 | $ | 510 | $ | 2,032 | ||||||||
We expect to incur additional restructuring costs of approximately $6.0 million during the
three months ended March 31, 2012 by segment as follows: Distribution $5.0 million and Publishing
$1.0 million. Of the expected additional restructuring costs, $1.6 million relates to employee
severance costs, $4.0 million relates to facility termination costs and approximately $400,000
relates to other charges.
Of the aggregate total expected impairment and restructuring costs of $25.0 million,
approximately $2.6 million was cash expenditures during the three months ended December 31, 2011
and we expect $8.2 million will be cash expenditures which is
expected to occur no later than the three months ended June 30, 2012.
Discontinued Operations
On March 31, 2011, we sold our wholly-owned subsidiary, FUNimation. Accordingly, all results
of operations, assets and liabilities of FUNimation for all periods presented are classified as
discontinued operations, and our consolidated financial statements, including the notes, have been
reclassified to reflect such segregation for all periods presented.
There were no net sales from discontinued operations for the nine months ended December 31,
2011. Net sales from discontinued operations for the three and nine months ended December 31, 2010
were $8.9 million and $25.6 million, respectively.
Net income from discontinued operations for the three and nine month ended December 31, 2010
was $1.8 million or $0.05 per diluted share and $4.4 million or $0.12 per diluted share,
respectively.
29
Working Capital and Debt
Our business is working capital intensive and requires significant levels of working capital
primarily to finance accounts receivable and inventories. We finance our operations through cash
and cash equivalents, funds generated through operations, accounts payable and our revolving credit
facility. The timing of cash collections and payments to vendors may require usage of our revolving credit facility in order to
fund our working capital needs.
Checks written in excess of cash balances may occur from time to time, including period ends, and
represent payments made to vendors that have not yet been presented by the vendor to our bank, and
therefore a corresponding advance on our revolving line of credit has not yet occurred. On a terms
basis, we extend varying levels of credit to our customers and receive varying levels of credit
from our vendors. During the last twelve months, we have not had any significant changes in the
terms extended to customers or provided by vendors which would have a material impact to the
reported financial statements.
On November 12, 2009, we entered into a three year, $65.0 million revolving credit facility
(the Credit Facility) with Wells Fargo Foothill, LLC as agent and lender, and Capital One
Leverage Financing Corp. as a participating lender. On December 29, 2011, we entered into a
five-year extension of our Credit Facility that eliminated the participating lender. The $50
million Credit Facility now provides for reduced interest rates on borrowings and includes an
accordion feature allowing us to increase borrowing availability up to $70 million in certain circumstances. Proceeds from
the Credit Facility are available for general working capital purposes and also includes a $5
million permitted for acquisitions. The Credit Facility is secured by a first priority security
interest in all of our assets, as well as the capital stock of our companies. Additionally, the
Credit Facility, as amended, calls for monthly interest payments at the banks base rate (as
defined in the Credit Facility) plus 1.25%, or LIBOR plus 2.25%, at our discretion.
At both December 31, 2011 and March 31, 2011 we had zero outstanding on the Credit
Facility.
Amounts available under the Credit Facility are subject to a borrowing base formula. Changes in the
assets within the borrowing base formula can impact the amount of availability. Based on the
facilitys borrowing base and other requirements at such dates, we had excess availability of $43.5
million and $33.3 million at December 31, 2011 and March 31, 2011, respectively. At December 31,
2011, we were in compliance with all covenants under the Credit Facility and we currently believe that we
will be in compliance with all covenants within the next twelve months.
In association with, and per the terms of the Credit Facility, we also pay and have paid
certain facility and agent fees. Weighted-average interest on the Credit Facility was 4.25% and
7.5% at December 31, 2011 and March 31, 2011, respectively. Such interest amounts have been, and
continue to be, payable monthly.
Forward-Looking Statements / 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 managements 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 21E 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 SEC, including
this Quarterly 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. 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 statement 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.
30
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: our
revenues being derived from a small group of customers; our dependence on significant vendors and
manufacturers and the popularity of their products; technological developments, particularly
software as a service application, electronic transfer and downloading could adversely impact
sales, margins and results of operations; inability to adapt to evolving technological standards;
some revenues are dependent on consumer preferences and demand; a deterioration in businesses of
significant customers could harm our business; the seasonality and variability in our business and
decreased sales could adversely affect our results of operations; growth of non-U.S. sales and
operations could increasingly subject us to additional risks that could harm our business; pending
litigation could subject us to significant costs and could divert managements attention; the
extent to which our insurance does not mitigate the risks facing our business or our insurers are
unable to meet their obligations, our operating results may be negatively impacted; increased
counterfeiting or piracy may negatively affect demand for our home entertainment products; we may
not be able to protect our intellectual property rights; the failure to diversify our business
could harm us; the loss of key personnel could affect the depth, quality and effectiveness of the
management team; our ability to meet our significant working capital requirements or if working
capital requirements change significantly; product returns or inventory obsolescence could reduce
sales and profitability or negatively impact our liquidity; the potential for inventory values to
decline; impairment in the carrying value of our assets could negatively affect consolidated
results of operations; our credit exposure or negative product demand trends or other factors could
cause credit loss; our ability to adequately and timely adjust cost structure for decreased demand;
our ability to compete effectively in distribution and publishing, which are highly competitive
industries; our dependence on third-party shipping and fulfillment for the delivery of our product;
our reliance on third-party subcontractors for certain of our business services; developing
software is complex, costly and uncertain and operational errors or defects in such products could
result in liabilities and/or impair such products marketability; our dependence on information
systems; future acquisitions or divestitures could disrupt business; future acquisitions could
result in potentially unsuccessful integration of acquired companies; our restructuring efforts may
have unpredictable outcomes, including the possibility of us incurring additional restructuring
charges; interruption of our business or catastrophic loss at any of our facilities could curtail
or shutdown our business; future terrorist or military activities could disrupt our operations or
harm assets; we may be subject to one or more jurisdictions asserting that we should collect or
should have collected sales or other taxes; our ability to use net operating loss carryforwards to
reduce future tax payments may be limited; we may be unable to refinance our debt facility prior to December 2016; our
debt agreement limits operating and financial flexibility; we may incur additional debt, fluctuations in stock price could
adversely affect our ability to raise capital or make our securities undesirable; the exercise of
outstanding options could adversely affect our stock price; our anti-takeover provisions, our
ability to issue preferred stock and our staggered board may discourage takeover attempts
beneficial to shareholders; we do not intend to pay dividends on common stock, thus shareholders
should not expect a return on investment through dividend payments; and our directors may not be
personally liable for certain actions which may discourage shareholder suits against them.
A detailed statement of risks and uncertainties is contained in our reports to the SEC,
including, in particular, our Annual Report on Form 10-K for the year ended March 31, 2011 and
other public filings and disclosures. Investors and shareholders are urged to read these documents
carefully.
Critical Accounting Policies
We consider our critical accounting policies to be those related to revenue recognition,
allowance for doubtful accounts, goodwill and intangible assets, impairment of long-lived assets,
inventory valuation, share-based compensation, income taxes, restructuring charges, and
contingencies and litigation. Other than the addition of the accounting policy related to
restructuring charges below, there have been no material changes to these critical accounting
policies as discussed in greater detail under this heading in Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the
year ended March 31, 2011.
31
Restructuring charges. We monitor and regularly evaluate our organizational structure and
associated operating expenses. Depending on events and circumstances, we may decide to take
additional actions to reduce future operating costs as our business requirements evolve. In
determining restructuring charges, we analyze our future operating requirements, including the
required headcount by business functions and facility space requirements. Our restructuring costs
and any resulting accruals involve significant estimates made by management using the best
information available at the time the estimates are made. In recording employee separation
accruals, we record a liability when all of the following conditions have been met: employees
rights to receive compensation for future absences is attributable to employees services already
rendered; the obligation relates to rights that vest or accumulate; payment of the compensation is
probable; and the amount can be reasonably estimated. In recording facilities lease loss accruals, we make various assumptions, including the time period over which the facilities are
expected to be vacant, expected sublease terms, expected sublease rates, expected future operating
costs, and expected future use of the facilities. Our estimates involve a number of risks and
uncertainties, some of which are beyond our control, including future real estate market conditions
and our ability to successfully enter into subleases or lease termination agreements with terms as
favorable as those assumed when arriving at our estimates. We regularly evaluate a number of
factors to determine the appropriateness and reasonableness of our restructuring reserves,
including the various assumptions noted above. If actual results differ significantly from our
estimates, we may be required to adjust our restructuring reserves in the future.
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 of sales that are not prepared in
accordance with generally accepted accounting principles (GAAP) in the United States. Management
believes these non-GAAP measures are useful because they provide supplemental information that
facilitates comparisons to prior periods and for the evaluation of financial results. Management
uses these non-GAAP measures to evaluate its financial results, develop budgets and manage
expenditures. The method we use to produce non-GAAP results is not computed according to GAAP, is
likely to differ from the methods used by other companies and should not be regarded as a
replacement for corresponding GAAP measures. Net sales before inter-company eliminations has
limitations as a supplemental measure, and you should not consider it in isolation or as a
substitute for analysis of our results as reported under GAAP.
32
The following table represents a reconciliation of GAAP net sales to net sales before
inter-company eliminations:
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net sales: |
||||||||||||||||
Distribution |
$ | 150,801 | $ | 144,402 | $ | 356,572 | $ | 359,116 | ||||||||
Publishing |
7,661 | 8,311 | 21,183 | 24,021 | ||||||||||||
Net sales before inter-company eliminations |
158,462 | 152,713 | 377,755 | 383,137 | ||||||||||||
Inter-company sales |
(4,965 | ) | (5,388 | ) | (13,674 | ) | (16,544 | ) | ||||||||
Net sales as reported |
$ | 153,497 | $ | 147,325 | $ | 364,081 | $ | 366,593 | ||||||||
Results of Operations
The following table sets forth for the periods indicated the percentage of net sales
represented by certain items included in our Consolidated Statements of Operations.
Three Months Ended | Nine Months Ended | |||||||||||||||
December 31, | December 31, | |||||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Net sales: |
||||||||||||||||
Distribution |
98.2 | % | 98.0 | % | 97.9 | % | 98.0 | % | ||||||||
Publishing |
5.0 | 5.7 | 5.8 | 6.5 | ||||||||||||
Inter-company sales |
(3.2 | ) | (3.7 | ) | (3.7 | ) | (4.5 | ) | ||||||||
Total net sales |
100.0 | 100.0 | 100.0 | 100.0 | ||||||||||||
Cost of sales, exclusive of depreciation |
95.0 | 87.9 | 90.7 | 86.5 | ||||||||||||
Gross profit |
5.0 | 12.1 | 9.3 | 13.5 | ||||||||||||
Operating expenses |
||||||||||||||||
Selling and marketing |
3.7 | 4.0 | 4.3 | 4.4 | ||||||||||||
Distribution and warehousing |
1.7 | 2.0 | 2.1 | 2.1 | ||||||||||||
General and administrative |
4.3 | 4.0 | 5.0 | 4.5 | ||||||||||||
Depreciation and amortization |
0.6 | 0.7 | 0.8 | 0.8 | ||||||||||||
Goodwill and intangible impairment |
3.9 | | 1.6 | | ||||||||||||
Total operating expenses |
14.2 | 10.7 | 13.8 | 11.8 | ||||||||||||
Income (loss) from operations |
(9.2 | ) | 1.4 | (4.5 | ) | 1.7 | ||||||||||
Interest income (expense), net |
(0.2 | ) | (0.3 | ) | (0.2 | ) | (0.4 | ) | ||||||||
Other income (expense), net |
(0.1 | ) | (0.1 | ) | (0.1 | ) | (0.1 | ) | ||||||||
Income (loss)from continuing operations before taxes |
(9.5 | ) | 1.0 | (4.8 | ) | 1.2 | ||||||||||
Income tax expense |
(9.4 | ) | (0.3 | ) | (3.6 | ) | (0.5 | ) | ||||||||
Net income (loss) from continuing operations |
(18.9 | ) | 0.7 | (8.4 | ) | 0.7 | ||||||||||
Discontinued operations: |
||||||||||||||||
Income from discontinued operations, net of tax |
| 1.3 | | 1.2 | ||||||||||||
Net income (loss) |
(18.9 | )% | 2.0 | % | (8.4 | )% | 1.9 | % | ||||||||
33
Distribution Segment
The distribution segment distributes computer software, consumer electronics and accessories,
video games and home video and provides fee-based distribution logistics services.
Fiscal 2012 Third Quarter Results from Continuing Operations Compared To Fiscal 2011 Third Quarter
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the distribution segment increased $6.4
million, or 4.4%, to $150.8 million for the third quarter of fiscal 2012 compared to $144.4 million
for the third quarter of fiscal 2011. Consumer electronics and accessories net sales increased
$21.3 million to $32.6 million during the third quarter of fiscal 2012 from $11.3 million for the
same period last year due to the distribution of new products to existing and new customers. The
increase in consumer electronics and accessories net sales more than offset the net sales decline in
software, video game and home video products. Net sales decreased $8.4 million in the
software product group to $103.9 million during the third quarter of fiscal 2012 from $112.2
million for the same period last year due to reduced demand for our software products. Video games
net sales increased $2.0 million to $10.8 million in the third quarter of fiscal 2012 from $8.8
million for the same period last year, due to new video game releases. Home video net sales
decreased $8.5 million to $3.5 million in the third quarter of fiscal 2012 from $12.1 million in
third quarter of fiscal 2011, primarily due to two large customers no longer selling our home video
products and our transition out of home video exclusive content. We believe future net sales will be dependent upon our ability to continue to add new,
appealing content and upon the strength of the retail environment and overall economic conditions.
Gross Profit
Gross profit for the distribution segment was $12.6 million, or 8.3% of net sales, for the
third quarter of fiscal 2012 compared to $13.4 million, or 9.3% of net sales, for the third quarter of
fiscal 2011. The $871,000 decrease in gross profit and the 6.5% decrease in gross profit margin
percent were primarily due to inventory write-downs as a result of the Restructuring Plan of
$441,000, or 0.3% of net sales. In addition, the gross profit margin was due to a mix of lower
gross profit margin security and utility software products.
We expect
gross profit rates to fluctuate depending principally upon the make-up of products sold, however, we anticipate
expenencing similar margin blends going forward.
Operating Expenses
Total operating expenses for the distribution segment were $12.6 million, or 8.4% of net
sales, for the third quarter of fiscal 2012 compared to $12.6 million, or 8.7% of net sales, for
the third quarter of fiscal 2011. Overall expenses increased by $1.6 million in Restructuring Plan
related costs, or 1.1% of net sales, which were offset by reduced personnel costs as a result of
the Restructuring Plan.
Selling and marketing expenses for the distribution segment decreased $64,000 to $4.1 million,
or 2.7% of net sales, for the third quarter of fiscal 2012 compared to $4.2 million, or 2.9% of net
sales, for the third quarter of fiscal 2011. This decrease was primarily due to $213,000 of
Restructuring Plan related costs which was offset by a reduction in personnel and related costs
partially due to the Restructuring Plan.
Distribution and warehousing expenses for the distribution segment was $2.7 million, or 1.8%
of net sales, for the third quarter of fiscal 2012 compared to $2.9 million, or 2.0% of net sales,
for the third quarter of fiscal 2011. The $237,000 decrease was primarily a result of decreased
personnel costs partially due to the Restructuring Plan.
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 $5.1 million, or 3.4%
of net sales, for the third quarter of fiscal 2012 compared to $4.7 million, or 3.3% of net sales,
for the third quarter of fiscal 2011. The $421,000 increase in the third quarter of fiscal 2012 was
primarily a result of Restructuring Plan related costs of $1.3 million recognized in the third
quarter fiscal 2011 offset by decreased compensation expense
partially due to the Restructuring Plan,
as well as a decrease of $216,000 in
bad debt expense as a result of a decrease in higher risk accounts receivable balances.
Depreciation and amortization expense for the distribution segment was $698,000 for the third
quarter of fiscal 2012 compared to $820,000 for the third quarter of fiscal 2011. The $122,000
decrease was primarily due to certain assets becoming fully depreciated.
34
Operating Income (Loss)
Net operating loss from continuing operations for the distribution segment was $67,000 for the
third quarter of fiscal 2012 compared to net operating income of $802,000 for the third quarter of
fiscal 2011.
Fiscal 2012 Nine Months Results from Continuing Operations Compared With Fiscal 2011 Nine Months
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the distribution segment decreased $2.5
million, or 0.7%, to $356.6 million for the first nine months of fiscal 2012 compared to $359.1
million for the first nine months of fiscal 2011. Net sales decreased $29.2 million in the software
product group to $255.8 million for the first nine months of fiscal 2012 from $285.0 million for
the same period last year primarily due to decreased demand for our software products. Consumer
electronics and accessories net sales increased $37.1 million to $59.7 million during the first
nine months of fiscal 2012 from $22.6 million for the same period last year due to the distribution
of new products to existing customers and obtaining new customers. Video games net sales increased
$792,000 to $21.1 million for the first nine months of fiscal 2012 from $20.3 million for
the same period last year, due to new video game releases. Home video net sales decreased $11.2
million to $19.9 million for the first nine months of fiscal 2012 from $31.1 million for the first
nine months of fiscal 2011, primarily due to two large customers no longer selling our home video products and our transition out of home video exclusive content. We believe future net sales will be dependent upon our ability to continue to add new,
appealing content and upon the strength of the retail environment and overall economic conditions.
Gross Profit
Gross profit for the distribution segment was $32.3 million, or 9.1% of net sales, for the
first nine months of fiscal 2012 compared to $36.4 million, or 10.1% of net sales, for the first
nine months of fiscal 2011. The $4.1 million decrease in gross profit and the 11.2% decrease in
gross profit margin were both primarily due to inventory write-downs as a result of the
Restructuring Plan of $441,000, or 0.1% of net sales. In addition, the gross profit margin
decreased due to a higher mix of lower gross profit margin security and utility software products. We
expect gross profit rates to fluctuate depending principally upon the make-up of products sold.
Operating Expenses
Total operating expenses for the distribution segment were $36.3 million, or 10.2% of net
sales, for the first nine months of fiscal 2012 compared to $33.9 million, or 9.4% of net sales,
for the same period of fiscal 2011. Overall expenses increased by $3.3 million of Restructuring
Plan related costs, or 0.9%, which were offset by reduced personnel costs resulting from the
Restructuring Plan.
Selling and marketing expenses for the distribution segment increased $528,000 to $11.5
million, or 3.2% of net sales, for the first nine months of fiscal 2012 compared to $10.9 million,
or 3.0% of net sales, for the first nine months of fiscal 2011. This increase was primarily due to
$213,000 of Restructuring Plan related costs in addition to an increase in marketing and
advertising costs.
Distribution and warehousing expenses for the distribution segment were $7.6 million, or 2.1%
of net sales, for the first nine months of fiscal 2012 compared to $8.1 million, or 2.2% of net
sales, for the same period of fiscal 2011. The $457,000 decrease was primarily due to decreased
personnel and related costs resulting from the Restructuring Plan.
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 $14.9 million, or 4.1%
of net sales, for the first nine months of fiscal 2012 compared to $12.4 million, or 3.4% of net
sales, for the first nine months of fiscal 2011. The $2.5 million increase was primarily due to
$3.0 million of Restructuring Plan related costs which were offset by decreased personnel and
related costs resulting from the Restructuring Plan.
Depreciation and amortization for the distribution segment was $2.3 million for the first nine
months of fiscal 2012 compared to $2.5 million for the first nine months of fiscal 2011.
35
Operating Income (Loss)
Net operating loss from continuing operations for the distribution segment was $4.0 million
for the first nine months of fiscal 2012 compared to net operating income of $2.5 million for the
same period of fiscal 2011.
Publishing Segment
The publishing segment owns or licenses various widely-known computer software brands through
Encore. In addition to sales to retailers, Encore also sells directly to consumers through its
websites.
We also published anime content through FUNimation prior to its sale on March 31, 2011. The
results of operations, assets and liabilities of FUNimation for all periods presented are
classified as discontinued operations (see Note 3 to our Consolidated
Financial Statements).
Fiscal 2012 Third Quarter Results from Continuing Operations Compared To Fiscal 2011 Third Quarter
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the publishing segment were $7.7 million for
the third quarter of fiscal 2012 compared to $8.3 million for the third quarter of fiscal 2011. The
$650,000, or 7.8% decrease in net sales, was primarily due to a decline in retail sales resulting
from reduced demand and loss of shelf space. We believe sales results in the future will be
dependent upon our ability to continue to add new, appealing content, to develop digitally
downloadable products and to access a variety of sales channels.
Gross Profit
Gross profit for the publishing segment was negative $4.9 million, or negative 64.2% of net
sales, for the third quarter of fiscal 2012 compared to $4.4 million, or 52.7% of net sales, for
the third quarter of fiscal 2011. The $9.3 million decrease in
gross profit was primarily a result
of inventory, prepaid royalties and software development write-downs totaling $8.4 million, or
109.0% of net sales, related to the Restructuring Plan. In addition, gross profit decreased as a
result of decreased sales volume and the mix of sales that included a significant amount of lower
gross profit margin value-priced software titles. We expect gross profit rates to fluctuate
depending principally upon the make-up of product sales.
Operating Expenses
Total
operating expenses increased $6.1 million for the publishing
segment to $9.2 million, or
119.7% of net sales, for the third quarter of fiscal 2012, from $3.1 million, or 37.4% of net
sales, for the third quarter of fiscal 2011. Overall expenses
increased due to goodwill and intangible impairment of $6.0 million
and $612,000 of Restructuring Plan related costs.
Selling and marketing expenses for the publishing segment were $1.6 million, or 20.8% of net
sales, for the third quarter of fiscal 2012 compared to $1.7 million, or 20.9% of net sales, for
the third quarter of fiscal 2011. The $145,000 decrease was primarily due to personnel and related
expense reductions associated with decreased personnel and related
costs resulting from the Restructuring Plan offset by Restructuring Plan related charges
of $86,000.
General and administrative expenses for the publishing segment consist principally of
executive, accounting and administrative personnel and related expenses, including professional
fees. General and administrative expenses for the publishing segment were $1.4 million, or 18.2% of
net sales, for the third quarter of fiscal 2012 compared to $1.2 million, or 14.5% of net sales,
for the third quarter of fiscal 2011. The $187,000 increase was primarily due to $526,000 of
Restructuring Plan related costs offset by a reduction in personnel
and related costs resulting from the Restructuring Plan.
36
Depreciation and amortization expense for the publishing segment remained flat at $185,000 for
the third quarter of fiscal 2012 compared to $163,000 for the third quarter of fiscal 2011.
Goodwill and intangible impairment for the publishing segment was $6.0 million for the third
quarter of fiscal 2012 compared to zero for the prior period. During the third quarter of fiscal
2012, we concluded that indicators of potential impairment were present due to the Restructuring
Plan announced in October 2011 which included a review of the portfolio of businesses for where
continued business investments would not meet our requirements for financial returns. We conducted
impairment tests during the third quarter of fiscal 2012 based on present facts and circumstances
and our business strategy in light of existing industry and economic conditions, as well as taking
into consideration future expectations. Accordingly, goodwill impairment of $5.7 million and
intangible impairment of $306,000 was recorded during the third quarter of fiscal 2012.
Operating Income
The
publishing segment had a net operating loss of $14.1 million for the third quarter of fiscal
2012 compared to net operating income of $1.3 million for the third quarter of fiscal 2011.
Fiscal 2012 Nine Months Results from Continuing Operations Compared With Fiscal 2011 Nine Months
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the publishing segment were $21.2 million for
the first nine months of fiscal 2012 compared to $24.0 million for the same period of fiscal 2011.
The $2.8 million, or 11.8% decrease in net sales, over the prior year nine months was primarily due
to a decline in retail sales of print productivity and gaming products, partially offset by an
increase in licensing revenue. We believe sales results in the future will be dependent upon
our ability to continue to add new, appealing content, to develop digitally downloadable products
and to access a variety of sales channels.
Gross Profit
Gross profit for the publishing segment was $1.7 million, or 8.1% of net sales, for the first
nine months of fiscal 2012 compared to $13.2 million, or 54.9% of net sales, for the first nine
months of fiscal 2011. The $11.5 million decrease in gross profit and 86.9% decrease in gross
profit margin percent were both primarily a result of inventory, prepaid royalties and software
development write-downs totaling $8.4 million, or 39.4% of net sales, related to the Restructuring
Plan. In addition, gross profit decreased as a result of decreased sales volume and the mix of
sales included lower gross profit margin value-priced software titles. We expect gross profit rates
to fluctuate depending principally upon the make-up of product sales.
Operating Expenses
Total
operating expenses increased
$4.8 million for the publishing segment to $14.1 million
for the first nine months of fiscal 2012 from $9.3 million for the first nine months of fiscal
2011. Overall expenses increased due to goodwill and intangible
impairment of $6.0 million, or 28.3% of net sales, and $808,000, or 3.8% of net sales, of Restructuring Plan related costs
offset by a reduction in personnel costs resulting from the
Restructuring Plan.
Selling and marketing expenses for the publishing segment were $4.3 million, or 20.2% of net
sales, for the first nine months of fiscal 2012 compared to $5.1 million, or 21.4% of net sales,
for the first nine months of fiscal 2011. The $850,000 decrease was principally due to personnel
and related expense reductions resulting from the
Restructuring Plan.
General and administrative expenses for the publishing segment consist principally of
executive, accounting and administrative personnel and related expenses, including professional
fees. General and administrative expenses for the publishing segment decreased to $3.3 million, or
15.6% of net sales, for the first nine months of fiscal 2012 compared to $3.8 million, or 15.8% of
net sales, for the first nine months of fiscal 2011. The $468,000 decrease was primarily due to
the reversal of the $526,000 first anniversary Punch! contingent liability accrual during the first
nine months of fiscal 2012 as well as a reduction in personnel costs resulting from the
Restructuring Plan. These decreases were partially offset by an increase in legal fees and Restructuring
Plan related costs of $721,000.
37
Depreciation and amortization for the publishing segment was $514,000 for the first nine
months of fiscal 2012 compared to $408,000 for the first nine months of fiscal 2011. The $106,000
increase was associated with the amortization of the Punch! acquisition-related intangibles for a
full nine months in fiscal 2012.
Goodwill and intangible impairment for the publishing segment was $6.0 million for the first
nine months of fiscal 2012 compared to zero for the prior period. During the third quarter of
fiscal 2012, we concluded that indicators of potential impairment were present due to the
Restructuring Plan announced in October 2011 which included a review of the portfolio of businesses for
where continued business investments would not meet our requirements for financial returns. We
conducted impairment tests during the third quarter of fiscal 2012 based on present facts and
circumstances and our business strategy in light of existing industry and economic conditions, as
well as taking into consideration future expectations. Accordingly, goodwill impairment of $5.7
million and intangible impairment of $306,000 was recorded during the first nine months of fiscal
2012.
Operating Income
The publishing segment had a net operating loss of $12.4 million for the first nine months of
fiscal 2012 compared to net operating income of $3.9 million for the first nine months of fiscal
2011.
38
Consolidated Other Income and Expense
Interest income (expense), net was expense of $292,000 for the third quarter of fiscal 2012
compared to expense of $506,000 for the third quarter of fiscal 2011. Interest income (expense),
net was expense of $873,000 for the first nine months of fiscal 2012
compared to expense of $1.4 million
for the same period of fiscal 2011. The decrease in interest expense for both the third quarter
and first nine months of fiscal 2012 was a result of a reduction in borrowings as compared to the
same period in fiscal 2011.
Other income (expense), net, which consists of foreign exchange loss, for the three and nine
months ended December 31, 2011 was expense of $171,000 and $501,000, respectively. Other income
(expense), net, for the three and nine months ended December 31, 2010 was expense of $108,000 and
$539,000, respectively.
Consolidated Income Tax Expense from Continuing Operations
We
recorded income tax expense from continuing operations of $14.5 million for the third
quarter of fiscal 2012 or an effective tax rate of negative 98.9% compared to income tax expense of
$393,000 or an effective tax rate of 26.9% for the third quarter of fiscal 2011. We recorded income
tax expense from continuing operations for the first nine months of fiscal 2012 of $13.2 million or
an effective tax rate of negative 74.8% compared to income tax expense of $1.8 million or an
effective tax rate of 39.3% for the first nine months of fiscal 2011. The change in our effective
tax rate for the three and nine months ended December 31, 2011 is principally attributable to the
fact that the Company recorded a valuation allowance against its deferred tax assets of $18.9
million during the three months ended December 31, 2011.
Deferred tax assets are evaluated by considering historical levels of income, estimates of
future taxable income streams and the impact of tax planning strategies. A valuation allowance is
recorded to reduce deferred tax assets when it is determined that it is more likely than not, based
on the weight of available evidence, we would not be able to realize all or part of our deferred
tax assets. An assessment is required of all available evidence, both positive and negative, to
determine the amount of any required valuation allowance.
As a result of the current market conditions and their impact on our future outlook,
management has reviewed its deferred tax assets and concluded that the uncertainties related to the
realization of some of its assets, have become unfavorable. As of December 31, 2011, we had a net
deferred tax asset position before valuation allowance of $36.2 million which is composed of
temporary differences, primarily related to net operating loss carryforwards, which will begin to
expire in fiscal 2029. The Company also has a foreign tax credit carryforwards at December 31, 2011
which will begin to expire in 2016. We have considered the positive and negative evidence for the
potential utilization of the net deferred tax asset and have concluded that it is more likely than
not that we will not realize the full amount of net deferred tax assets. Accordingly, a valuation
allowance of $18.9 million has been recorded
as of December 31, 2011,
which is included in income tax expense for the three and nine months ended December 31, 2011. We
had no valuation allowance against these deferred tax assets at March 31, 2011.
We recognize interest accrued related to unrecognized income tax benefits (UTBs) in the
provision for income taxes. At March 31, 2011, interest accrued was approximately $168,000, which
was net of federal and state tax benefits, and total UTBs net of federal and state income tax
benefits that would impact the effective tax rate if recognized, were $612,000. During the nine
months ended December 31, 2011, $122,000 of UTBs were reversed, which was net of $123,000 of
deferred federal and state income tax benefits. At December 31, 2011, interest accrued was $177,000
and total UTBs, net of deferred federal and state income tax benefits that would impact the
effective tax rate if recognized, were $490,000.
Consolidated Net Income (Loss) from Continuing Operations
We recorded net loss from continuing operations of $29.1 million for the third quarter of
fiscal 2012 compared to net income from continuing operations of $1.1 million for the third quarter
of fiscal 2011. For the first nine months of fiscal 2012, we recorded net loss from continuing
operations of $31.0 million, compared to net income from continuing operations of $2.7 million for
the same period last year.
39
Discontinued Operations
On March 31, 2011, we sold our wholly-owned subsidiary, FUNimation. Accordingly, all results
of operations and assets and liabilities of FUNimation for all periods presented are classified as
discontinued operations and our consolidated financial statements, including the notes, have been
reclassified to reflect such segregation for all periods presented.
There were no net sales from discontinued operations for the nine months ended December 31,
2011. We recorded net income from discontinued operations of $1.8 million, net of tax, for the
third quarter of fiscal 2011 and net income from discontinued operations of $4.4 million, net of
tax, for the first nine months of fiscal 2011.
Consolidated Net Income (Loss)
For the third quarter of fiscal 2012, we recorded a net loss of $29.1 million compared to net
income of $2.9 million for the same period last year. For the first nine months of fiscal 2012, we
recorded a net loss of $31.0 million, compared to net income of $7.2 million for the same period last
year.
Market Risk
At December 31, 2011, we had no outstanding indebtedness subject to interest rate
fluctuations. As such, a 100-basis point change in the current LIBOR rate would have no impact on
our annual interest expense.
Our sales to customers in Canada are increasing. The majority of the sales and purchasing
activity related to these customers results in receivables and accounts payables denominated in
Canadian dollars. When these transactions are translated into U.S. dollars at the exchange rate in
effect at the time of each transaction, gain or loss is recognized. These gains and/or losses are
reported as a separate component within other income and expense. During the three and nine months
ended December 31, 2011 we had foreign exchange transaction loss of $171,000 and $501,000,
respectively and foreign exchange transaction loss of $84,000 and $515,000, respectively, for the
three and nine months ended December 31, 2010.
Additionally, our balance sheet pertaining to these foreign operations is translated into U.S.
dollars at the exchange rate in effect on the last day of each month. The net unrealized balance
sheet translation gains and/or losses are excluded from income and are reported as accumulated
other comprehensive income or loss. At December 31, 2011 we had accumulated other comprehensive
gain related to foreign translation of $33,000 compared to $155,000 at March 31, 2011.
Though changes in the exchange rate are out of our control, we periodically monitor our
Canadian activities and can reduce exposure from exchange rate fluctuations by limiting these
activities or taking other actions, such as exchange rate hedging. At this time, we do not engage
in any hedging transactions to mitigate foreign currency effects, but we continually monitor our
activities and evaluate such opportunities periodically.
Seasonality and Inflation
Quarterly operating results are affected by the seasonality of our business. Specifically, our
third quarter (October 1-December 31) typically accounts for our largest quarterly revenue figures
and a substantial portion of our earnings. As a supplier of products ultimately sold to retailers,
our business is affected by the pattern of seasonality common to other suppliers of retailers,
particularly during the holiday selling season. Poor economic or weather conditions during this
period could negatively affect our operating results. Inflation is not expected to have a
significant impact on our business, financial condition or results of operations since we can
generally offset the impact of inflation through a combination of productivity gains and price
increases.
40
Liquidity and Capital Resources
Cash Flow Analysis
Operating Activities
Cash used in operating activities for the first nine months of fiscal 2012 was $9.3 million
compared to $3.7 million for the same period last year.
The net cash used in operating activities for the first nine months of fiscal 2012 mainly
reflected our net loss, combined with various non-cash charges, including the reversal of the first
anniversary Punch! contingent payment accrual of $526,000 which was unearned, depreciation and
amortization of $2.8 million, amortization of debt acquisition costs of $448,000, amortization of
software development costs of $1.9 million, share-based compensation of $933,000, goodwill and
intangibles impairment of $6.0 million, a decrease in deferred income taxes of $13.4 million,
offset by our working capital demands. The following are changes in the operating assets and
liabilities during the first nine months of fiscal 2012: accounts receivable increased $34.4
million, resulting from the timing of sales, net of decreased sales during the quarter; inventories
increased $8.0 million, primarily reflecting additional inventory related to our growing consumer
electronics and accessories product line; prepaid expenses decreased $5.9 million, primarily
resulting from the write-down of prepaid expenses and recoupments of prepaid royalties; income taxes
receivable increased $20,000, primarily due to the timing of required tax payments and tax refunds;
accounts payable increased $33.8 million, primarily as a result of timing of payments and
purchases; income taxes payable decreased $37,000 primarily due to the timing of required tax
payments and tax refunds; and accrued expenses decreased $661,000, net of various accrual payments
and a decrease in accrued wages due to timing of pay periods.
The net cash used in operating activities for the first nine months of fiscal 2011 mainly
reflected our net income, combined with various non-cash charges, including depreciation and
amortization of $2.9 million, amortization of debt acquisition costs of $447,000, amortization of
software development costs of $360,000, share-based compensation of $786,000, a decrease in
deferred income taxes of $4.2 million, offset by our working capital demands. The following are
changes in the operating assets and liabilities during the first nine months of fiscal 2011:
accounts receivable increased $16.2 million, as a result of increased sales; inventories increased
$6.4 million, primarily reflecting additional inventory related to the opening of our Canadian
distribution facility and the timing of other inventory purchases; prepaid expenses increased
$402,000, primarily resulting from prepaid royalty advances; income taxes receivable decreased
$94,000 and income taxes payable increased $12,000, primarily due to the timing of required tax
payments and tax refunds; accounts payable increased $12.2 million, primarily as a result of timing
of payments and purchases; and accrued expenses decreased $4.6 million, primarily due to the
payment of the fiscal 2010 performance-based cash compensation accrual.
Investing Activities
Cash flows provided by investing activities totaled $20.0 million for the first nine months of
fiscal 2012 and cash flows used in investing activities totaled $9.3 million for the same period
last year.
Proceeds from the sale of discontinued operations totaled $22.5 million and payment of the
note payable acquisition totaled $1.0 million, both in the first nine months of fiscal 2012.
The cash paid for the acquisition of Punch! totaled $8.1 million in the first nine months of
fiscal 2011.
The investment in software development totaled $905,000 and $693,000 for the first nine months
of fiscal 2012 and 2011, respectively.
The purchases of property and equipment totaled $593,000 and $483,000 in the first nine months
of fiscal 2012 and 2011, respectively. Purchases of property and equipment in fiscal 2012 consisted
primarily of a back-up generator and computer equipment. Purchases of property and equipment in
fiscal 2011 consisted primarily of computer equipment and assets related to our Canadian
distribution facility.
Financing Activities
Cash flows used in financing activities totaled $8.8 million for the first nine months of
fiscal 2012 and cash flows provided by financing activities totaled $7.3 million for the first nine
months of fiscal 2011.
For the first nine months of fiscal 2012, we had proceeds from and repayments of the revolving
line of credit of $34.9 million and a decrease in checks written in excess of cash balances of $8.8
million.
41
For the first nine months of fiscal 2011, we had proceeds from the revolving line of credit of
$156.9 million, repayments of the revolving line of credit of $151.0 million, a payment of deferred
compensation of $1.3 million and an increase in checks written in excess of cash balances of $2.8
million.
Capital Resources
On November 12, 2009, we entered into a three year, $65.0 million revolving credit facility
(the Credit Facility) with Wells Fargo Foothill, LLC as agent and lender, and Capital One
Leverage Financing Corp. as a participating lender. On December 29, 2011, the Credit Facility was
amended to eliminate the participating lender, reduce the Credit Facility limit to $50.0 million,
provide for an additional $20.0 million of available credit under the Credit Facility under certain circumstances and
extend the maturity date to December 29, 2016. The Credit Facility is secured by a first priority
security interest in all of our assets, as well as the capital stock of our companies.
Additionally, the Credit Facility, as amended, calls for monthly interest payments at the banks
base rate (as defined in the Credit Facility) plus 1.25%, or LIBOR plus 2.25%, at our discretion.
Amounts available under the Credit Facility are subject to a borrowing base formula. Changes
in the assets within the borrowing base formula can impact the amount of availability. At December
31, 2011 we had zero outstanding on the Credit Facility and based on the facilitys borrowing base
and other requirements, we had excess availability of $43.5 million.
In association with, and per the terms of the Credit Facility, we also pay and have paid
certain facility and agent fees. Weighted-average interest on the Credit Facility was 4.25% and
7.5% at December 31, 2011 and March 31, 2011, respectively. Such interest amounts have been and
continue to be payable monthly.
Under the Credit Facility 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 our overall financial stability and include limitations on our capital expenditures, a
minimum ratio of adjusted EBITDA to fixed charges, limitations on
prepaid royalties and a minimum borrowing
base availability requirement. At December 31, 2011, we were in compliance with all covenants under
the Credit Facility. We currently believe we will be in compliance with the Credit Facility
covenants over the next twelve months.
Liquidity
We finance our operations through cash and cash equivalents, funds generated through
operations, accounts payable and our revolving credit facility. The timing of cash collections and
payments to vendors can require the usage of our revolving credit facility in order to fund our working
capital needs. Checks written in excess of cash balances may
occur from time to time, including period ends, and represent payments made to vendors that have
not yet been presented by the vendor to our bank, and therefore a corresponding advance on our
revolving line of credit has not yet occurred. On a terms basis, we extend varying levels of credit
to our customers and receive varying levels of credit from our vendors. During the last twelve
months, we have not had any significant changes in the terms extended to customers or provided by
vendors which would have a material impact on the reported financial statements.
We continually monitor our actual and forecasted cash flows, our liquidity and our capital
resources. We plan for potential fluctuations in accounts receivable, inventory and payment of
obligations to creditors and unbudgeted business activities that may arise during the year as a
result of changing business conditions or new opportunities. In addition to working capital needs
for the general and administrative costs of our ongoing operations, we have cash requirements for
among other things: (1) investments in inventory related to consumer electronics and accessories
and other growth product lines; (2) investments to license content and develop software for
established products; (3) legal disputes and contingencies (4) payments related to restructuring
activities (5) investments to sign exclusive distribution agreements; (6) equipment needs for our
operations; and (7) asset or company acquisitions. During the first nine months of fiscal 2012, we
invested approximately $4.8 million, before recoveries, in connection with the acquisition of
licensed and exclusively distributed product in our publishing and distribution segments.
Of
the aggregate total expected impairment and restructuring costs, $2.6
million was cash expenditures during the three months ended December
30, 2011, and we expect $8.2 million will be cash
expenditures which is expected to occur no later than the three months ended
June 30, 2012.
Net cash flows provided by discontinued operations were $5.7 million for the first nine months
of fiscal 2011.
42
At December 31, 2011, we had zero outstanding on our $50.0 million Credit Facility. Our
Credit Facility includes an accordion feature allowing the Company to increase borrowing
availability up to $70 million under certain circumstances. Our Credit Facility is available for working capital and general
corporate needs and amounts available are subject to a borrowing base formula. Changes in the
assets within the borrowing base formula can impact the amount of availability. At December 31,
2011, based on the facilitys borrowing base and other requirements at such dates, we had excess
availability of $43.5 million. At December 31, 2011, we were in compliance with all covenants under
the Credit Facility and currently believe we will be in compliance with all covenants throughout
the next twelve months.
We currently believe cash and cash equivalents, funds generated from the expected results of
operations, funds available under our Credit Facility and vendor terms will be sufficient to
satisfy our working capital requirements, other cash needs, costs of restructuring and to finance
expansion plans and strategic initiatives for at least the next twelve months, absent significant
acquisitions. Additionally, with respect to long-term liquidity, we have an effective shelf
registration statement covering the offer and sale of up to $20.0 million of common and/or
preferred shares. Any growth through acquisitions would likely require the use of additional equity
or debt capital, some combination thereof, or other financing.
Contractual Obligations
The following table presents information regarding contractual obligations that existed as of
December 31, 2011 (in thousands):
Less | More | |||||||||||||||||||
than 1 | 13 | 35 | than 5 | |||||||||||||||||
Total | Year | Years | Years | Years | ||||||||||||||||
Operating leases (1) |
$ | 14,319 | $ | 2,499 | $ | 4,406 | $ | 3,662 | $ | 3,752 | ||||||||||
Capital leases (2) |
108 | 78 | 30 | | | |||||||||||||||
Contingent payment acquisition (3) |
422 | 422 | | | | |||||||||||||||
License and distribution agreements |
2,910 | 1,324 | 1,426 | 160 | | |||||||||||||||
Total |
$ | 17,759 | $ | 4,323 | $ | 5,826 | $ | 3,822 | $ | 3,752 | ||||||||||
(1) | See further disclosure in Note 13 to our consolidated financial statements. |
|
(2) | See further disclosure in Note 14 to our consolidated financial statements. |
|
(3) | See further disclosure in Note 4 to our consolidated financial statements. |
We have excluded liabilities resulting from uncertain tax positions of $723,000 from the table
above because we are unable to make a reasonable estimate of the period of cash settlement with the
respective taxing authorities. Additionally, interest payments related to the Credit Facility have
been excluded as the balance at December 31, 2011 is zero and future interest rates are uncertain.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Information with respect to disclosures about market risk is contained in the section entitled
Managements Discussion and Analysis of Financial Condition and Results of Operations Market
Risk in this Form 10-Q.
Item 4. | Controls and Procedures |
(a) Controls and Procedures
We maintain disclosure controls and procedures (Disclosure Controls), as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that
information required to be disclosed in our Exchange Act reports, was recorded, processed,
summarized and reported within the time periods specified in the SECs rules and forms, and that
such information is accumulated and communicated to our management, including our Chief Executive
Officer and Interim Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
43
As required by Rule 13a-15(b) and 15d-15(b) under the Exchange Act, we carried out an
evaluation, under the supervision and with the participation of our management, including our Chief
Executive Officer and our Interim Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, the Chief Executive Officer and Interim Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of the date of such
evaluation.
(b) Change in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting during the most
recently completed quarter that have materially affected or are reasonably likely to materially
affect our internal control over financial reporting, as defined in Rule 13a-15(f) under the
Exchange Act.
Part II. OTHER INFORMATION
Item 1. | Legal Proceedings |
See Litigation and Proceedings disclosed in Note 13 to our consolidated financial statements
included herein.
44
Item 1A. | Risk Factors |
Information regarding risk factors appears in Managements Discussion and Analysis of
Financial Condition and Results of Operations Forward-Looking Statements / Risk Factors in Part
1 Item 2 of this Form 10-Q and in Part 1 Item 1A of our Annual Report on Form 10-K for the
fiscal year ended March 31, 2011. The risk factor disclosed in our Annual Report on Form 10-K for
the fiscal year ended March 31, 2011 related to the SEC investigation is no longer applicable due
to the SEC investigation concluding during the third quarter of fiscal 2012. Other than the
inapplicability of the SEC investigation risk factor and the addition of the risk factor below, the risk
factors associated with our Company have not materially changed, as compared to the risk factors
disclosed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.
We
have recently restructured our operations, which may result in additional or
unanticipated restructuring charges, and we may not be able to
achieve the cost savings expected from these
restructuring efforts. In addition, we may incur restructuring charges that exceed our
expectations.
To improve our profitability, we implemented a series of restructuring initiatives during
fiscal 2012. As part of our restructuring initiatives, we expect to
incur an additional $6.0 million of
restructuring and other charges during the three months ended
March 31, 2012. These changes are being made to transition
away from facilities, business processes and other assets that were in place to sustain now
divested and non-core businesses. These changes are also designed to support high-growth opportunities
in the distribution of consumer electronics and accessories, to enhance e-commerce fulfillment
business and to increase our market expansion in Canada. The
Restructuring Plan is expected to generate
annualized, pre-tax cost savings of $5.5-$6.5 million when fully implemented in fiscal year 2013,
with savings of $2.0 million expected to be achieved in fiscal year 2012.
However, we may not be able to achieve the level of benefits that we expect to realize from
these or any future restructuring activities, within expected timeframes, or at all. Furthermore,
upon the closure of any facilities in connection with our restructuring efforts, we may not be able
to divest such facilities at a fair price or in a timely manner. Changes in the amount, timing and
character of charges related to our current or future restructurings
and the failure to complete,
or a substantial delay in completing, our current and any future restructuring plan could have a
material adverse effect on our results of operations.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | Mine Safety Disclosures. |
Not applicable.
Item 5. | Other Information |
None.
Item 6. | Exhibits |
(a) | The following exhibits are included herein: |
31.1 | 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) |
|||
31.2 | Certification of the Interim Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(Rules 13a-14 and 15d-14 of the Exchange Act) |
|||
32.1 | Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.
Section 1350) |
45
32.2 | Certification of the Interim Chief Financial Officer
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(18 U.S.C. Section 1350) |
|||
101* | The following financial information from our Quarterly
Report on Form 10-Q for the third quarter of fiscal 2012,
filed with the SEC on February 3, 2012, is formatted in
eXtensible Business Reporting Language (XBRL): (i) the
Consolidated Balance Sheets at December 31, 2011 and March
31, 2011; (ii) the Consolidated Statements of Operations
for the three and nine months ended December 31, 2011 and
2010; (iii) the Consolidated Statements of Cash Flows for
the nine months ended December 31, 2011 and 2010; and (iv)
the Notes to Consolidated Financial Statements (Unaudited) |
* | The XBRL related information in Exhibit
101 to this Quarterly Report on Form 10-Q
shall not be deemed filed or part of a
registration statement or prospectus for
purposes of Sections 11 or 12 of the
Securities Act of 1933, as amended,
additionally the data shall not be deemed
filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as
amended, or otherwise subject to liability
under these sections. |
46
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Navarre Corporation (Registrant) |
||||
Date: February 3, 2012 | /s/ Richard S Willis | |||
Richard S Willis | ||||
President and Chief Executive Officer (Principal Executive Officer) |
||||
Date: February 3, 2012 | /s/ Diane Lapp | |||
Diane Lapp | ||||
Interim Chief Financial Officer (Principal Financial and Accounting Officer) |
47