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

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)

Registrant’s telephone number, including area code (763) 535-8333

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 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 issuer’s 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
PART I. FINANCIAL INFORMATION			3
Item 1. Consolidated Financial Statements			3
Consolidated Balance Sheets — December 31, 2011 and March 31, 2011			3
Consolidated Statements of Operations — Three and Nine Months ended December 31, 2011 and 2010			4
Consolidated Statements of Cash Flows — Nine Months ended December 31, 2011 and 2010			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			27
Item 3. Quantitative and Qualitative Disclosures About Market Risk			43
Item 4. Controls and Procedures			43
PART II. OTHER INFORMATION			44
Item 1. Legal Proceedings			44
Item 1A. Risk Factors			45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			45
Item 3. Defaults Upon Senior Securities			45
Item 4. Mine Safety Disclosures			45
Item 5. Other Information			45
Item 6. Exhibits			45
SIGNATURES			47

PART I. FINANCIAL INFORMATION

Item 1.		Consolidated Financial Statements.

NAVARRE CORPORATION

		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.

NAVARRE CORPORATION

		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.

NAVARRE CORPORATION

		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.

NAVARRE CORPORATION

Notes to Consolidated Financial Statements
(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 Company’s 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 Corporation’s 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 Company’s current financial assets and liabilities, because of their short-term nature, approximates fair value.

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 Company’s 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 Company’s distribution customers, at times, qualify for certain price protection benefits from the Company’s 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 Company’s 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 stockholder’s 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 stockholder’s 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.

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 Company’s 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 Company’s 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 Company’s 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.

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 Company’s 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 Company’s 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

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 Company’s Consolidated Balance Sheets at March 31, 2011. In connection with the sale, the Company entered into an agreement to act as FUNimation’s exclusive distributor in the United States on a continuing basis, and act as FUNimation’s 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 Company’s 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

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 Company’s 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 Company’s 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 Company’s 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

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.

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 Company’s 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 Company’s 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 management’s 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.

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 Company’s 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 Company’s 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

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 employee’s contributions up to the first 4% of their base pay, annually. The Company’s 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 Company’s matching contributions vest over three years.

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.

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 Company’s 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 Company’s financial position or liquidity, but an adverse decision in more than one of these matters could be material to the Company’s 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 Company’s 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 Company’s restatements of previously-issued financial statements, certain write-offs, reserve methodologies and revenue recognition practices. The Company cooperated fully with the SEC’s 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 Company’s assets, as well as the capital stock of its subsidiary companies. Additionally, the Credit Facility, as amended, calls for monthly interest payments at the bank’s base rate (as defined in the Credit Facility) plus 1.25%, or LIBOR plus 2.25%, at the Company’s discretion.

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 Facility’s 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 Company’s 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 Company’s 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 Company’s 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 Company’s Annual Report filed on Form 10-K for the fiscal year ended March 31, 2011.

Stock Options

A summary of the Company’s 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 Company’s 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 Company’s common stock.

A summary of the Company’s 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 stock’s 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.

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 share—weighted-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 share—adjusted 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 Company’s 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 Company’s 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 Company’s 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 Company’s 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.

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 Company’s 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 (“UTB’s”) 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 UTB’s 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 UTB’s 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 UTB’s, net of deferred federal and state income tax benefits that would impact the effective tax rate if recognized, were $490,000.

The Company’s 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. Deacon’s employment.

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 Company’s evaluation it was determined that FUNimation was a VIE. Consolidating any VIEs within the Company’s 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 Company’s 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 Company’s corporate office maintains a majority of the Company’s 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 Company’s 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).

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

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