-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Tzv0IBZiUWTGoAG5OtQYaI4An+uNhJdw8aqG1M3sLmY2/15c2mA8+Z3hw9CdhJyg h3uVKq+3shUe3tMczLhoyg== 0000950134-04-002145.txt : 20040217 0000950134-04-002145.hdr.sgml : 20040216 20040217161405 ACCESSION NUMBER: 0000950134-04-002145 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040217 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NAVARRE CORP /MN/ CENTRAL INDEX KEY: 0000911650 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-COMPUTER & PERIPHERAL EQUIPMENT & SOFTWARE [5045] IRS NUMBER: 411704319 STATE OF INCORPORATION: MN FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22982 FILM NUMBER: 04608861 BUSINESS ADDRESS: STREET 1: 7400 49TH AVE N CITY: NEW HOPE STATE: MN ZIP: 55428 BUSINESS PHONE: 7635358333 MAIL ADDRESS: STREET 1: 7400 49TH AVE NORTH CITY: NEW HOPE STATE: MN ZIP: 55428 10-Q 1 c83002e10vq.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ended December 31, 2003 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _______________ to _______________ Commission File Number 0-22982 NAVARRE CORPORATION (Exact name of registrant as specified in its charter) MINNESOTA 41-1704319 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 7400 49TH AVENUE NORTH, NEW HOPE, MN 55428 (Address of principal executive offices) Registrant's telephone number, including area code (763) 535-8333 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, No Par Value -- 25,633,441 shares as of February 6, 2004 NAVARRE CORPORATION INDEX PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. Consolidated Balance Sheets -- December 31, 2003 and March 31, 2003 Page 3 Consolidated Statements of Income -- Three months and nine months ended December 31, 2003 and 2002 Page 4 Consolidated Statements of Cash Flows -- Nine months ended December 31, 2003 and 2002 Page 5 Notes to Consolidated Financial Statements -- December 31, 2003 Page 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. PAGE 11 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. PAGE 19 ITEM 4. CONTROLS AND PROCEDURES. PAGE 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. PAGE 20 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. PAGE 24 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. PAGE 25 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. PAGE 25 ITEM 5. OTHER INFORMATION. PAGE 25 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. PAGE 25 SIGNATURES PAGE 26
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS. NAVARRE CORPORATION CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, 2003 MARCH 31, 2003 ---------------------------------- (UNAUDITED) (Note) ASSETS Current assets: Cash $ 14,151 $ 10,485 Accounts receivable, less allowance for doubtful accounts and sales returns of $7,840 and $4,833, respectively 81,919 54,787 Inventories 35,579 22,828 Prepaid expenses and other current assets 8,169 4,845 --------------------------- Total current assets 139,818 92,945 Property and equipment, net of accumulated depreciation of $6,182 and $5,633, respectively 4,872 3,585 Other assets: Note receivable, related parties 650 800 Goodwill 9,612 3,109 Other assets 2,362 690 --------------------------- Total assets $ 157,314 $ 101,129 =========================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Note payable $ -- $ 805 Accounts payable 103,745 67,093 Accrued expenses 6,596 4,292 --------------------------- Total current liabilities 110,341 72,190 Note payable, long-term -- 268 --------------------------- Total liabilities 110,341 72,458 Shareholders' equity: Common stock, no par value: Authorized shares -- 100,000,000, issued and outstanding shares--25,523,103 and 21,616,587, respectively 104,085 91,404 Accumulated deficit (57,112) (62,733) --------------------------- Total shareholders' equity 46,973 28,671 --------------------------- Total liabilities and shareholders' equity $ 157,314 $ 101,129 ===========================
Note: The balance sheet at March 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. 3 NAVARRE CORPORATION CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, --------------------------------------------------------------- 2003 2002 2003 2002 --------------------------------------------------------------- Net sales $ 153,039 $ 116,887 $ 332,629 $ 275,735 Cost of sales 135,183 102,846 291,225 242,232 --------------------------------------------------------------- Gross profit 17,856 14,041 41,404 33,503 Operating expenses: Selling and marketing 4,663 3,508 11,821 9,449 Distribution and warehousing 1,852 1,814 4,349 4,244 General and administration 5,706 5,271 16,712 15,001 Depreciation and amortization 578 456 1,374 1,131 Stock-based compensation 536 -- 705 -- --------------------------------------------------------------- 13,335 11,049 34,961 29,825 --------------------------------------------------------------- Income from operations 4,521 2,992 6,443 3,678 Other income (expense): Debt extinguishment (908) -- (908) -- Interest expense (178) (53) (324) (148) Other income 155 66 410 349 --------------------------------------------------------------- Net income $ 3,590 $ 3,005 $ 5,621 $ 3,879 =============================================================== Income per common share: Basic $ 0.16 $ 0.14 $ 0.26 $ 0.18 =============================================================== Diluted $ 0.15 $ 0.14 $ 0.24 $ 0.18 =============================================================== Weighted average common and common equivalent shares outstanding: Basic 22,232 21,616 21,822 21,616 =============================================================== Diluted 24,094 22,009 23,003 21,814 ===============================================================
4 NAVARRE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED DECEMBER 31, ------------------------------ 2003 2002 --------------------------- OPERATING ACTIVITIES Net income $ 5,621 $ 3,879 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 1,374 1,131 Write off of notes receivable 193 193 Warrant expense 372 -- Changes in operating assets and liabilities: Accounts receivable (21,990) (25,881) Inventories (9,680) (8,617) Prepaid expenses and other assets (3,932) (3,217) Accounts payable and accrued expenses 33,264 36,663 --------------------------- Net cash provided by operating activities 5,222 4,151 INVESTING ACTIVITIES Acquisition, net of cash acquired (10,326) (7,046) Note receivable, related parties (43) (755) Purchase of equipment and leasehold improvements (2,423) (878) --------------------------- Net cash used in investing activities (12,792) (8,679) FINANCING ACTIVITIES Proceeds from sale of common stock 11,427 -- Proceeds from exercise of common stock options 882 -- Proceeds from notes payable 134,796 -- Repayment of notes payable (135,869) (267) --------------------------- Net cash provided by (used in) financing activities 11,236 (267) Net increase (decrease) in cash 3,666 (4,795) Cash at beginning of period 10,485 18,966 --------------------------- Cash at end of period $ 14,151 $ 14,171 ===========================
5 NAVARRE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) DECEMBER 31, 2003 NOTE A - BASIS OF PRESENTATION The accompanying unaudited financial statements of Navarre Corporation have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. All intercompany accounts and transactions have been eliminated. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Because of the seasonal nature of our business, the operating results for the nine month period ended December 31, 2003 are not necessarily indicative of the results that may be expected for the year ending March 31, 2004. For further information, refer to the financial statements and footnotes thereto included in Navarre Corporation's Annual Report on Form 10-K for the year ended March 31, 2003. Certain 2003 amounts have been reclassified to conform to the 2004 presentation. NOTE B - NEW ACCOUNTING PRONOUNCEMENTS In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). FIN 46 requires the consolidation of variable interest entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. The provisions of FIN 46 are effective for fiscal year 2004. We do not expect that our adoption of FIN 46 will have a material impact on our consolidated results of operations, financial position or cash flows. In May 2003, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for issuer classification and measurement of certain financial instruments with characteristics of both liabilities and equity. In accordance with this standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and is otherwise effective at the beginning of the first interim period that begins after June 15, 2003. Our adoption of SFAS No. 150 did not have a material impact on our consolidated results of operations, financial position or cash flows. NOTE C -- ACQUISITIONS On November 3, 2003, we acquired the assets of BCI Eclipse, LLC. Under the terms of the acquisition, a newly-formed subsidiary of Navarre acquired all assets of BCI Eclipse for approximately $7.9 million in cash, $2.4 million in debt and $5.2 million for the value of the one million shares of common stock. The assets purchased by us included certain fixed assets, intellectual property, inventory, receivables and contract rights related to BCI Eclipse's business. The acquisition of BCI Eclipse is part of our strategy for growth with expanded content ownership and gross margin enhancement. BCI Eclipse's proprietary audio products will contribute to our direction of enhancing products and services to our new mass 6 merchandise customers. BCI Eclipse is recognized as a significant provider of niche DVD/Video products. BCI Eclipse's DVD/Video and audio collection represents exclusively licensed titles and in-house produced CDs and DVDs. BCI is headquartered in Newbury Park, California. The acquisition will be accounted for using the purchase method in accordance with SFAS No. 141. Accordingly, the net assets were recorded at their estimated fair values and operating results were included in our financial statements from the date of acquisition. The purchase price was allocated on a preliminary basis using information currently available. The allocation of the purchase price to the assets acquired will be finalized in fiscal 2004. We will adjust the allocation of the purchase price after obtaining more information regarding asset and liability valuations. The preliminary allocations resulted in goodwill of $6.5 million. Under SFAS No.142, goodwill is not amortized. The preliminary purchase price allocation was as follows: (in thousands) Accounts receivable, net of allowances $ 5,142 Inventories 3,071 Prepaid expenses and other current assets 1,272 Property and equipment 30 Value of 1,000,000 shares 5,370 Goodwill 11,873 Current liabilities (5,692) ------------ $10,326 ============
In connection with the above acquisition, on November 5, 2003, we entered into a new agreement with Hilco Capital, L.P. for a four-year $6 million credit facility. Our obligations under the credit agreement were collateralized by a security interest in our receivables and inventories. In association with that agreement, we paid certain facility and agent fees. Under that agreement we were required to meet certain covenants. In connection the Hilco loan, we granted Hilco a five (5)-year warrant to purchase 320,000 shares of our common stock exercisable at $2.88 per share, the market price of our common stock on the date of the Hilco commitment. Also in connection with the Hilco loan, we were required to grant to Hilco a second five (5)-year warrant to purchase an additional 55,000 shares of our common stock if our common stock should trade at less than ninety-five percent (95%) of the closing stock price on the date of the BCI Eclipse closing for a specified period of time. As our common stock did trade at less than ninety-five percent (95%) of the closing stock price on the date of the BCI Eclipse closing for the specified period of time, on November 17, 2003, we granted Hilco a second warrant to purchase 55,000 shares of our common stock exercisable at $5.67 per share, the market price of our common stock on the date of the closing of the Hilco loan. Each of these warrants contains customary anti-dilution and cashless exercise provisions. Each of these warrants also contains customary registration rights that become effective on November 3, 2004, which is the first anniversary date of the BCI Eclipse closing. On December 16, 2003, we paid off this credit facility in full and in doing so recorded a special charge for a debt retirement expense of $908,000 consisting of debt acquisition fees of $536,000 and the fair value of the warrants issued to the lender of $372,000. 7 NOTE D -- BUSINESS SEGMENTS Financial information by reportable business segment is included in the following summary:
THREE MONTHS ENDED NINE MONTHS ENDED (In thousands) DECEMBER 31, DECEMBER 31, --------------------------------------------------------------- 2003 2002 2003 2002 --------------------------------------------------------------- NET SALES Home Entertainment Products $ 146,305 $ 116,116 $ 321,887 $ 273,606 Encore 10,194 4,755 24,069 8,512 BCI 2,098 -- 2,098 -- Intercompany elimination (5,558) (3,984) (15,425) (6,383) --------------------------------------------------------------- CONSOLIDATED 153,039 116,887 332,629 275,735 =============================================================== OPERATING INCOME (LOSS) Home Entertainment Products 4,641 2,865 6,499 3,740 Encore (614) 127 (550) (62) BCI 494 -- 494 -- --------------------------------------------------------------- CONSOLIDATED INCOME FROM OPERATIONS 4,521 2,992 6,443 3,678 =============================================================== Debt retirement expense (908) -- (908) -- Interest expense (178) (53) (324) (148) Other income (expense) 155 66 410 349 --------------------------------------------------------------- NET INCOME $ 3,590 $ 3,005 $ 5,621 $ 3,879 ===============================================================
NOTE E - NET EARNINGS (LOSS) PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
(In thousands, except per share data) THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, ------------------------------------------------------ 2003 2002 2003 2002 ------------------------------------------------------ Numerator: Net income $ 3,590 $ 3,005 $ 5,621 $ 3,879 Denominator: Denominator for basic earnings per share--weighted-average shares 22,232 21,616 21,822 21,616 Dilutive securities: Employee stock options 1,862 393 1,181 198 ---------------------------------------------------- Denominator for diluted earnings per share -adjusted weighted-average shares 24,094 22,009 23,003 21,814 ==================================================== Basic income per share $ 0.16 $ 0.14 $ 0.26 $ 0.18 ==================================================== Dilutive income per share $ 0.15 $ 0.14 $ 0.24 $ 0.18 ====================================================
NOTE F - STOCK-BASED COMPENSATION In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure. SFAS No. 148 amends SFAS No. 123, 8 Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value-based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 requires expanded and more prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results. We have stock-based employee compensation plans comprised primarily of fixed stock option plans. We have not adopted a method of transition to the fair value-based method of accounting for stock-based employee compensation provided under SFAS No. 148, but continue to apply Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for these plans. Accordingly, no compensation expense has been recognized for stock option plans as the exercise price equals the stock price on the date of grant. The tables below illustrate the effect on net income (loss) and income (loss) per share as if we had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation for the last three quarters. The tables for the two previous quarters ended June 30, 2003 and September 30, 2003 have been restated.
(In thousands, except per share data) THREE MONTHS ENDED JUNE 30, --------------------------- 2003 2002 -------------------- Net income, as reported $ 308 $ 198 Add: Stock-based employee compensation expense 28 -- Deduct: Stock-based compensation expense determined under fair (200) (207) value method for all awards -------------------- Net income , pro forma $ 136 $ (9) ==================== Income per share: Basic -- as reported $0.01 $ 0.01 ==================== Basic -- pro forma $0.01 $ 0.00 ==================== Diluted -- as reported $0.01 $ 0.01 ==================== Diluted -- pro forma $0.01 $ 0.00 ====================
(In thousands, except per share data) THREE MONTHS ENDED SIX MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ----------------------------------------------------- 2003 2002 2003 2002 ----------------------------------------------------- Net income, as reported $ 1,723 $ 676 $2,031 $ 874 Add: Stock-based employee compensation expense 141 -- 169 -- Deduct: Stock-based compensation expense determined under fair value method for all awards (211) (211) (411) (417) ---------------------------------------------------- Net income , pro forma 1,653 465 1,789 457 ==================================================== Income per share: Basic -- as reported $ 0.08 $0.03 $ 0.09 $ 0.04 ==================================================== Basic -- pro forma $ 0.08 $0.02 $ 0.08 $ 0.02 ==================================================== Diluted -- as reported $ 0.08 $0.03 $ 0.09 $ 0.04 ==================================================== Diluted -- pro forma $ 0.07 $0.02 $ 0.08 $ 0.02 ====================================================
9
(In thousands, except per share data) THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, ------------------------ --------------------------- 2003 2002 2003 2002 ------------ ----------- ------------- ------------- Net income, as reported $3,590 $3,005 $5,621 $3,879 Add: Stock-based employee compensation expense 536 ---- 705 Deduct: Stock-based compensation expense determined under fair value method for all awards (209) (68) (621) (485) ------------ ----------- ------------- ------------- Net income , pro forma $3,917 $2,937 $5,705 $3,394 ============ =========== ============= ============= Income per share: Basic -- as reported $0.16 $0.14 $0.26 $0.18 ============ =========== ============= ============= Basic -- pro forma $0.18 $0.14 $0.26 $0.16 ============ =========== ============= ============= Diluted -- as reported $0.15 $0.14 $0.24 $0.18 ============ =========== ============= ============= Diluted -- pro forma $0.16 $0.13 $0.25 $0.16 ============ =========== ============= =============
NOTE G - BANK FINANCING AND DEBT On June 24, 2003, we amended our credit agreement with General Electric Capital Corporation. The credit facility increased from $30 million to $40 million and the term was extended to 2007. As of December 31, 2003, we had no borrowings under our credit facility. Under this agreement we are required to meet certain covenants. We were in compliance with these covenants as of December 31, 2003. NOTE H -- INCOME TAX Due to the accumulated net operating losses from prior years, we have not recorded any provision for income taxes. We had net operating loss carryforwards of $22.9 million at March 31, 2003, which begin to expire in 2014. We have not recorded any income tax expense for the three and nine months ended December 31, 2003 and 2002, respectively, as we have been able to utilize existing net operating loss carryforwards. The deferred tax assets associated with these net operating loss carryforwards have been fully reserved, resulting in no tax expense in periods where such carryforwards are utilized. NOTE I -- CONTINGENCIES In the normal course of our business, we are involved in a number of routine litigation matters that are incidental to the operation of our business. These matters generally include collection matters with regard to products distributed by us and accounts receivable owed to us. We currently believe that the resolution of any of these pending matters will not have a material adverse effect on our financial position or liquidity, but an adverse decision in more than one of the matters could be material to our consolidated results of operations. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL Navarre Corporation, a Minnesota corporation formed in 1983, is a provider of distribution, fulfillment and marketing services for a broad range of home entertainment and multimedia products, including personal computer ("PC") software, audio and video titles, and interactive games. We maintain and leverage strong relationships on both ends of the content distribution chain, including relationships with leading national retailers, wholesalers and rackjobbers, as well as major publishers, music labels and movie studios. We are recognized as an industry leader in the distribution of consumer PC software, interactive video games, DVD videos and independent music labels and artists. Our product line contains a broad assortment of compact discs, PC software, video games and DVD/VHS videos sold to over 500 customers through over 18,000 locations internationally. Our broad base of customers includes (i) wholesale clubs, (ii) mass merchandisers, (iii) computer specialty stores, (iv) music specialty stores, (v) book stores, (vi) office superstores, and (vii) electronic superstores. We operate in three business segments: Home Entertainment Products, Encore Software, Inc. ("Encore") and BCI Eclipse ("BCI"). Home Entertainment Products consists of two divisions: Navarre Distribution Services ("NDS") and Navarre Entertainment Media ("NEM"). Our Encore subsidiary engages in interactive publishing, and BCI is a significant provider of niche DVD/Video products. Through NDS, we distribute non-proprietary or non-exclusive entertainment products, including PC software, major label music, DVD video, video games and accessories. We focus on providing retailers and publishers a wide array of high-quality services, including vendor-managed inventory, full EDI protocol, packaging, manufacturing, fulfillment, and marketing, for the broad, efficient distribution of non-proprietary home entertainment products. We will pursue substantial growth of NDS in several ways, including by (i) extending the number of software categories we serve, such as the productivity category; (ii) expanding the presence in distribution of home entertainment content formats, such as DVD and interactive games; and (iii) leveraging our unique mix of operational capabilities to deepen relationships with existing retailers and publisher clients. Through NEM, we distribute prerecorded music of primarily independent labels and their artists, CD and DVD audio, and video in DVD and VHS format, that is exclusively licensed to us, to national and regional music retailers, rackjobbers, and one-stops throughout the United States and Canada. We offer independent content creators, such as labels, studios and artists, the resources and exposure to generate high visibility with valuable distribution in a broad array of major outlets throughout North America. We seek to significantly enhance our competitive position in independent music label distribution in several ways, including: (i) possible acquisitions of competing independent distribution companies; (ii) continuing to seek new proprietary distribution opportunities; (iii) increased ownership of content that broadens our reach across all musical genres; and (iv) exclusive licenses and outright strategic acquisition. We acquired the primary assets of Encore Software, Inc. on July 31, 2002. Encore is an interactive publisher in the video game and PC CD-ROM markets. Encore had been a leading publisher in the software market for nearly a decade. They had built a solid expertise in product development, sales distribution, marketing and public relations. The assets purchased by us included certain fixed assets, intellectual property, inventory, receivables, and contract rights related to Encore's business. The assets are held by our majority-owned subsidiary, Encore Software, Inc. 11 On November 3, 2003, we acquired the assets of BCI Eclipse, LLC. The acquisition of BCI Eclipse is part of Navarre's strategy for growth with expanded content ownership and gross margin enhancement. BCI Eclipse's proprietary audio products will contribute to our direction of enhancing products and services to our new mass merchandise customers. BCI Eclipse is recognized as a significant provider of niche DVD/Video products. BCI Eclipse's DVD/Video and audio collection represents exclusively licensed titles and in-house produced CDs and DVDs. The assets purchased by us included certain fixed assets, intellectual property, inventory, receivables, and contract rights related to BCI's business. The assets are held by our wholly-owned subsidiary, BCI. FORWARD LOOKING STATEMENTS The forward-looking statements contained herein are subject to risks and uncertainties, and the actual results that the Company achieves may differ materially from these forward-looking statements due to such risks and uncertainties including, but not limited to, the Company's dependence upon a limited number of large customers that account for a significant part of its business; developments in the retail and consumer markets for prerecorded music products and computer software products; the Company's ability to successfully increase its sales of video and DVD products; retail consumer buying patterns; the ability of the Company and the music industry generally to maintain or increase sales in light of the wide-spread Internet-based music swapping and file sharing by consumers; new and different competition in the Company's traditional and new markets; seasonality in its business and the fact that a large portion of the Company's revenues have traditionally been related to the holiday selling season; the Company's ability to successfully act as distributor to on-line retailers; the Company's ability to manage its inventory; the Company's dependence upon recording labels and artists; the Company's dependence upon obtaining and maintaining license agreements with software publishers; the Company's ability to react to changes in the distribution of software and prerecorded music; the Company's dependence upon a key employee, namely, Eric H. Paulson, Chairman of the Board, President and Chief Executive Officer, who has been with the Company since its inception in 1983; the ability of the Company's majority-owned subsidiary, Encore Software, Inc, a videogame and CD-ROM publisher, to successfully develop and distribute new and existing products; the ability of the Company to integrate the business of BCI Eclipse; and the ability of BCI Eclipse to develop and distribute DVD/Video products. A detailed statement of risks and uncertainties is contained in the Company's reports to the Securities and Exchange Commission, including in particular the Company's Annual Report on Form 10-K for the year ended March 31, 2003. Investors and shareholders are urged to read this document carefully. The Company undertakes no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this Quarterly Report on Form 10-Q. 12 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, ---------------------------------------------------- 2003 2002 2003 2002 ---------------------------------------------------- NET SALES: Home Entertainment Products: Distribution Services 86.4% 85.5% 83.8% 82.9% Entertainment Media 9.2 13.8 13.0 16.3 -------------------------------------------------- Home Entertainment Products net sales 95.6 99.3 96.8 99.2 Encore 6.6 4.1 7.2 3.1 BCI 1.4 -- 0.6 -- Inter company elimination (3.6) (3.4) (4.6) (2.3) -------------------------------------------------- Total net sales 100.0 100.0 100.0 100.0 Cost of sales 88.3 88.0 87.6 87.8 -------------------------------------------------- Gross profit 11.7 12.0 12.4 12.2 Selling and promotion 3.0 3.0 3.6 3.4 Distribution and warehousing 1.2 1.5 1.3 1.5 General and administration 3.7 4.5 5.0 5.4 Depreciation and amortization 0.4 0.3 0.4 0.4 Stock-based compensation 0.4 -- 0.2 -- -------------------------------------------------- Income from operations 3.0 2.6 1.9 1.3 Debt retirement expense (0.6) -- (0.3) -- Interest expense (0.1) (0.0) (0.1) (0.0) Other income and expense 0.1 0.0 0.1 0.1 -------------------------------------------------- NET INCOME 2.3% 2.6% 1.7% 1.4% ==================================================
HOME ENTERTAINMENT PRODUCTS FOR THE THIRD QUARTER ENDED DECEMBER 31, 2003 NET SALES Net sales for the third quarter ended December 31, 2003 increased 26.0% to $146.3 million from $116.1 million in the same period in fiscal 2003. The increase in net sales was due to increased sales for NDS. Net sales for NDS increased 32.2% to $132.3 million for the third quarter ended December 31, 2003 from $100.1 million for the same period in fiscal 2003. The increase was due to the division continuing to grow its foothold in the productivity software space, an expansion of its customer roster of major label music and major studio DVD video and growth in video game distribution of $15 million, an increase of 870% over last year. Net sales for NEM decreased 12.5% to $14.0 million for the third quarter ended December 31, 2003 from $16.0 million for the same period in fiscal 2003. The NEM product is subject to the quality of offerings from the labels throughout the year. As the label offering may vary on a quarter by quarter basis, we do not believe the drop in revenue signifies a trend toward future lower sales. 13 GROSS PROFIT Gross profit for the third quarter ended December 31, 2003 increased 18.1% to $15.0 million from $12.7 million for the same period in fiscal 2003. As a percent of net sales, gross profit decreased to 10.3% from 10.9%. The decrease in gross profit as a percent of net sales was due principally to lower margins from the growth of our video game distribution business. The sales of the video game distribution business, with margins of 6% to 9%, represent only 5.2% of Home Entertainment Products sales for the quarter. It should be noted that the video game business is highly skewed to the holiday season. As such, the sales of video games as a percent of sales on a rolling twelve months basis would be much lower. Additionally, video games are sold on a one-way basis with no returns by the customer allowed; therefore, the lower handling costs of the product offset some of the lower margins as it relates to profitability. Depending upon the overall mix of products sold by Home Entertainment Products, further expansion of video game distribution could cause margins to decrease slightly. Gross profit from NDS net sales for the third quarter ended December 31, 2003 was $12.5 million or 9.4% as a percent of net sales compared with $10.2 million or 10.2% as a percent of net sales in the same period in fiscal 2003. The decrease in gross profit as a percent of net sales for NDS was due to changes in the mix of products as described above. Additional software categories such as business and productivity generally have lower gross margins; however, these product categories tend to sell at higher dollar price points. We expect gross profit to fluctuate slightly depending upon the make-up of product sales each quarter as the Company continues to expand its market share in business and productivity software and video games. Gross profit from NEM net sales for the third quarter ended December 31, 2003 was $2.5 million or 17.9% as a percent of net sales compared with $2.5 million or 15.6% as a percent of net sales in the same period in fiscal 2003. The increase in gross profit and as a percent of net sales for NEM was a result of the division's continuing efforts to sign new labels at higher distribution rates. OPERATING EXPENSES Total operating expenses for the third quarter ended December 31, 2003 increased to $10.3 million from $9.8 million in the same period in fiscal 2003. As a percent of net sales, total operating expenses for the third quarter ended December 31, 2003 decreased to 7.1% from 8.4% in the same period in fiscal 2003. Selling and marketing expenses for the third quarter ended December 31, 2003 decreased to $2.9 million or 2.0% as a percent of sales compared to $3.2 million or 2.8% as a percent of sales for the same period in fiscal 2003. The decrease is related to an expense of $325,000 incurred in the prior year from the write-off of racks that were purchased with an attempt to expand our DVD business. Distribution and warehousing expenses for the third quarter ended December 31, 2003 increased to $1.9 million from $1.8 million for the same period in fiscal 2003. As a percent of net sales, distribution and warehousing expense decreased to 1.3% from 1.6%. The decrease in distribution and warehousing expense as a percent of net sales was due to the overall improved efficiency of warehousing expenses of approximately $370,000 reflecting, in part, the efficiencies associated with a higher level of sales. General and administration expenses for the third quarter ended December 31, 2003 increased to $4.6 million from $4.4 million for the same period in fiscal 2003. As a percent of net sales, general and administration expenses decreased to 3.1% from 3.8%. Although general and administration expenses increased in dollar amount because of an increase in IT cost of $157,000 and an increase in overall insurance of $75,000, overall we experienced a decrease in general and administration expenses as a 14 percent of net sales. Certain expenses, such as IT expense, are directly attributable to increased sales due to handling costs. We also added personnel in our investor relations payroll and legal staff, although their costs were offset by a decrease in our overall actual legal expenses. Depreciation and amortization was $380,000 for the third quarter ended December 31, 2003 compared to $333,000 for the same period in fiscal 2003. During the third quarter ended December 31, 2003, we recorded a non-cash charge of $536,000 for stock-based compensation relating to the vesting of option shares exercisable under option agreements for the key employees. Operating income for Home Entertainment Products was $4.7 million for the third quarter ended December 31, 2003 compared to $2.9 million for the same period in fiscal 2003. HOME ENTERTAINMENT PRODUCTS FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 2003 Net sales for the nine-month period ended December 31, 2003 increased 17.7% to $321.9 million from $273.6 million in the same period in fiscal 2003. Net sales for NDS for the nine-month period ended December 31, 2003 increased 21.9% to $278.6 million from $228.6 million in the same period in fiscal 2003. The increase was due to the division continuing to grow its foothold in the productivity software space, an expansion of its customer roster of major label music and major studio DVD video and growth in video game distribution of $15 million, an increase of 870% over last year. Net sales for NEM for the nine-month period ended December 31, 2003 decreased 3.8% to $43.3 million from $45.0 million in the same period in fiscal 2003. The NEM product is subject to the quality of offerings from the labels throughout the year. We do not believe at this time for this to be a trend of future lower sales. Gross profit for the nine-month period ended December 31, 2003 increased 11.9% to $34.0 million from $30.4 million for the same period in fiscal 2003. As a percent of net sales, gross profit for the nine-month period ended December 31, 2003 decreased to 10.6% from 11.1% for the same period in fiscal 2003. The decrease in gross profit as a percent of net sales was due principally to lower margins from the growth of its video game distribution business. It should be noted that the video game business is highly skewed to the holiday season. As such, the sales of video games as a percent of sales on a rolling twelve months basis would be much lower. Additional, video games are sold on a one-way basis with no returns by the customer allowed. Therefore, the lower handling costs of the product offset some of the lower margins as it relates to profitability. Depending upon the overall mix of products sold by Home Entertainment Products, further expansion of video game distribution could cause margins to decrease slightly. Gross profit from NDS net sales for the nine-month period ended December 31, 2003 was $26.9 million or 9.7% as a percent of net sales compared with $23.6 million or 10.3% as a percent of net sales in the same period in fiscal 2003. Software categories such as business and productivity generally have lower gross margins; however, these product categories tend to sell at higher dollar price points. We expect gross profit to fluctuate slightly depending upon the make-up of product sales each quarter as the Company continues to expand its market share in business and productivity software and video games. Gross profit from NEM net sales for the nine-month period ended December 31, 2003 was $7.1 million or 16.4% as a percent of net sales compared with $6.9 million or 15.3% as a percent of net sales in the same period in fiscal 2003. The increase in gross profit and as a percent of net sales for NEM was a result of the division's continuing efforts to sign new labels at higher distribution rates. 15 Total operating expenses for the nine-month period ended December 31, 2003 increased to $27.5 million from $26.6 million in the same period in fiscal 2003. As a percent of net sales, total operating expenses for the nine-month period ended December 31, 2003 decreased to 8.5% from 9.7% in the same period in fiscal 2003. Selling and marketing expenses for the nine-month period ended December 31, 2003 decreased to $7.4 million from $7.9 million for the same period in fiscal 2003. Selling and marketing expenses as a percent of net sales decreased to 2.3% for the nine-month period ended December 31, 2003 from 2.9% for the same period in fiscal 2003. The decrease is related to an expense of $325,000 incurred in the prior year from the write-off of racks that were purchased with an attempt to expand our DVD business. Distribution and warehousing expenses for the nine-month period ended December 31, 2003 increased to $4.4 million from $4.2 million for the same period in fiscal 2003. As a percent of net sales, distribution and warehousing expense for the nine-month period ended December 31, 2003 decreased to 1.4% from 1.5% for the same period in fiscal 2003. The decrease in distribution and warehousing expense as a percent of net sales was due to the overall improved efficiency of warehousing expenses of approximately $540,000 reflecting, in part, the efficiencies associated with a higher level of sales. General and administration expenses for the nine-month period ended December 31, 2003 increased to $14.1 million from $13.6 million for the same period in fiscal 2003. As a percent of net sales, general and administration expenses for the nine-month period ended December 31, 2003 decreased to 4.4% from 4.9% for the same period in fiscal 2003. Although general and administration expense increased in dollar amount from an increase in IT cost of $277,000 and an increase in overall insurance of $184,000, overall we experienced a decrease in general and administration expense as a percent of net sales. Certain expenses, such as IT expenses, are directly attributable to increased sales due to handling costs. We also added personnel in our investor relations payroll and legal staff, although their costs were offset by a decrease in our overall actual legal expenses. For the nine-month period ended December 31, 2003, depreciation and amortization was $898,000 compared to $934,000 for the same period in fiscal 2003. For the nine-month period ended December 31, 2003, stock-based compensation expense was $705,000. For the nine-month period ended December 31, 2003, operating income for Home Entertainment Products was $6.5 million compared to $3.7 million for the same period in fiscal 2003. ENCORE SOFTWARE, INC. FOR THE THIRD QUARTER ENDED DECEMBER 31, 2003 Encore had net sales of $10.2 million less $5.6 million of inter-company net sales sold to Home Entertainment Products for the third quarter ended December 31, 2003 compared to $4.7 million less $4.0 million of inter-company net sales sold to Home Entertainment Products for the same period in fiscal 2003. The increase in net sales resulted from an expansion of third party distribution of a vendor into a mass merchant customer, which began in late August 2003. The increase in net sales of approximately $1.0 million was attributable to the robust sales of Marine Aquarium products. Gross profit from Encore's net sales for the third quarter ended December 31, 2003 was $1.9 million or 18.6% as a percent of net sales compared with $1.4 million or 29.2% as a percent of net sales in the same period in fiscal 2003. The decrease in gross profit as a percent of net sales was due to an expansion of third party distribution of a vendor into a mass merchant customer, which began in late August 2003. The sales and margin for this business for the third quarter was $4.8 million or 15%. This business was 16 initiated at Encore due to Encore's previously established relationship with the mass merchant. It is expected that this ongoing business will move to Home Entertainment Products beginning in fiscal 2005 as the relationship has shifted to Home Entertainment Products due to its distribution skills. Margins were also affected by a $1.0 million charge to cost of goods based upon an impairment test concerning Encore's lone video game development project. This project was acquired with the purchase of Encore. Selling and promotion expense for the third quarter ended December 31, 2003 was $1.6 million or 15.7% as a percent of net sales compared to $264,000 or 5.5% as a percent of net sales for the same period in fiscal 2003. The increase was related to the advertising expense of approximately $200,000 to set up the release of several products of a vendor that are expected to sell in the fiscal fourth quarter. General and administration expense for the third quarter ended December 31, 2003 was $755,000 or 7.4% of net sales compared to $857,000 or 17.9% as a percent of net sales for the same period in fiscal 2003. The decrease in general and administration expenses and as a percent of net sales was due to the overall improved efficiencies. Depreciation expense was $141,000 for the third quarter ended December 31, 2003 compared to $123,000 for the same period in fiscal 2003. Encore had an operating loss of $614,000 for the third quarter ended December 31, 2003 compared to operating income of $127,000 for the same period in fiscal 2003. Due to the fact that Home Entertainment purchases from Encore, $5.6 million of inter-company net sales were eliminated in the third quarter ended December 31, 2003 compared to $4.0 million for the same period in fiscal 2003. ENCORE SOFTWARE, INC. FOR THE NINE-MONTH PERIOD ENDED DECEMBER 31, 2003 For the nine-month period ended December 31, 2003, Encore had net sales of $24.1 million less $15.4 million of inter-company net sales sold to Home Entertainment Products compared to $8.5 million less $6.4 million of inter-company net sales sold to Home Entertainment Products for the five-month period in fiscal 2003. Gross profit from Encore's net sales for the nine-month period ended December 31, 2003 was $6.4 million or 26.6% as a percent of net sales compared with $3.1 million or 36.5% as a percent of net sales in the five-month period in fiscal 2003. For the nine-month period ended December 31, 2003, selling and promotion expense was $4.3 million or 17.8% as a percent of net sales compared to $1.5 million or 17.6% as a percent of net sales for the five-month period in fiscal 2003. For the nine-month period ended December 31, 2003, general and administration expense was $2.3 million or 9.6% as a percent of net sales compared to $1.4 million or 17.0% as a percent of net sales for the five-month period in fiscal 2003. For the nine-month period ended December 31, 2003, depreciation was $418,000 compared to $197,000 for the five-month period in fiscal 2003. For the nine-month period ended December 31, 2003, Encore had an operating loss of $550,000 compared to an operating loss of $62,000 for the five-month period in fiscal 2003. BCI FOR THE TWO-MONTH PERIOD ENDED DECEMBER 31, 2003 BCI had net sales of $2.1 million, gross profit of $1.0 million, selling and promotion expense of $161,000, general and administration expense of $307,000, depreciation expense of $58,000 and operating income of $494,000 for the two-month period ended December 31, 2003. 17 CONSOLIDATED OTHER INCOME/EXPENSE Interest expense for the third quarter ended December 31, 2003 was $178,000 compared to $53,000 for the same period in fiscal 2003. For the nine-month period ended December 31, 2003, interest expense was $324,000 compared to $148,000 for the same period in fiscal 2003. The increase for the third quarter and nine-month period ended December 31, 2003 resulted from our use of our line of credit and the Hilco Loan in connection with the acquisition of BCI Eclipse. For the third quarter ended December 31, 2003, we recorded a non-recurring charge incurred in connection with the complete discharge of the Hilco financing used for the BCI acquisition of deferred debt acquisition costs of $908,000, consisting of debt acquisition fees of $536,000 and the fair value of the warrants issued to the lender of $372,000. Other income, which consists principally of interest income, was $156,000 for the third quarter ended December 31, 2003 compared to $66,000 for the same period in fiscal 2003. For the nine-month period ended December 31, 2003, other income was $411,000 compared to $349,000 for the same period in fiscal 2003. Due to the accumulated net operating losses from prior years, we have not recorded any provision for income taxes. We had net operating loss carryforwards of $22.9 million at March 31, 2003, which begin to expire in 2014. We have not recorded any income tax expense for the three and nine months ended December 31, 2003 and 2002, respectively, as we have been able to utilize existing net operating loss carryforwards. The deferred tax assets associated with these net operating loss carryforwards have been fully reserved, resulting in no tax expense in periods where such carryforwards are utilized. We had net income for the third quarter ended December 31, 2003 of $3.6 million compared to $3.0 million for the same period in fiscal 2003. For the nine-month period ended December 31, 2003, our net income was $5.6 million compared to $3.9 million for the same period in fiscal 2003. MARKET RISK Although we are subject to some interest rate risk,because we currently have limited borrowings under our bank credit facility, we believe a 10% increase or reduction in interest rates would not have a material effect on future earnings, fair values or cash flows. It is our policy not to enter into derivative financial instrument transactions. LIQUIDITY AND CAPITAL RESOURCES We have historically financed our working capital needs through bank borrowings, sale of equity securities and management of the various components of our working capital, including accounts receivable, inventory and accounts payable. The level of borrowings has historically fluctuated significantly during the year. At December 31, 2003, we had net accounts receivable of $81.9 million, inventory of $35.6 million, prepaid expenses of $8.2 million, accounts payable of $103.7 million, accrued expenses of $6.6 million and no bank borrowings under our $40 million credit facility. Net cash provided by operating activities was $5.2 million for the nine months ended December 31, 2003. During that period, accounts receivable increased by $22.0 million, inventories increased by $9.7 million and accounts payable and accrued expense increased by $33.3 million. Accounts receivable, inventory and accounts payable typically fluctuate during the first three quarters of our fiscal year and decrease after the holiday season. 18 During the nine months ended December 31, 2003, investing activities used $12.8 million of net cash primarily for the acquisition of BCI of $10.3 million and the purchase of furniture, equipment and leasehold improvements. Financing activities provided $11.2 million of net cash during the nine months ended December 31, 2003, primarily from a private placement to institutional and other accredited investors of approximately 2.6 million shares of common stock and approximately 650,000 five-year warrants to purchase common stock exercisable at $7.00 per share. The placement raised approximately $12.5 million, resulting in net proceeds of approximately $11.4 million after deducting offering costs and placement agent fees. Proceeds from the private placement were used for repayment of approximately $6.6 million of debt owed to Hilco Capital, LP incurred in connection with the recent acquisition of BCI Eclipse and for working capital and general corporate purposes, including potential acquisitions. In connection with the repayment of the debt owed to Hilco, we recorded a non-recurring charge to write off deferred debt acquisition costs of $908,000, consisting of debt acquisition fees of $536,000 and the fair value of the warrants issued to the lender of $372,000. Cash decreased by $3.7 million during the nine months ended December 31, 2003. Although we believe we have sufficient cash and working capital to meet our short-term liquidity and capital requirements, we anticipate we could utilize our credit facility during the next twelve months to meet seasonal working capital needs. We currently have a $40 million line of credit with General Electric Capital Corporation. The facility requires a $10 million excess capacity limit which allows us to use up to $30 million based on accounts receivable and inventory criteria. Although we have not needed to use our full capacity under the credit facility, future acquisitions could require other funding as the line is to be used primarily for working capital needs and not as acquisition capital. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information with respect to disclosures about market risk is contained in the section of this Quarterly Report on Form 10-Q entitled "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk." ITEM 4. CONTROLS AND PROCEDURES As required by Rule 13a-15 under the Securities Exchange Act of 1934 ("Exchange Act"), we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and 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 upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. In connection with the rules, we currently are in the process of further reviewing and documenting our disclosure controls and procedures, including our internal controls over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business. For the quarter ended December 31, 2003, there were no changes in our internal controls. 19 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In the normal course of our business, we are involved in a number of routine litigation matters that are incidental to the operation of our business. We currently believe that the resolution of any of these pending matters will not have a material adverse effect on our financial position or liquidity, but an adverse decision in more than one of the matters could be material to our consolidated results of operations. ALDRIN V. NAVARRE CORPORATION, ET AL. Plaintiff, Dr. Buzz Aldrin, commenced this action in the Los Angeles Superior Court, Central District, Los Angeles, California, Case No. BC 305356, by filing a Complaint on October 31, 2003, and serving the Complaint on the Company on November 7, 2003. Plaintiff alleges claims against the Company, Encore Software, Inc., a subsidiary of the Company, and others. On February 4, 2004, the Company executed and delivered to counsel for Encore a settlement agreement previously agreed to by all parties. Neither the Company nor its subsidiary are required to make a monetary contribution to the settlement, but both will obtain a complete release of claims related to the matter. The settlement agreement is being circulated for execution by all parties and requires the parties to stipulate to dismissal of the lawsuit. BOB GRADY AND WILSON MEADOWS V. NAVARRE CORPORATION, ET. AL On or about January 29, 2001, Bob Grady Music and Wilson Meadows (collectively,"Plaintiffs") filed this action in the United States District Court for the Northern District of Georgia, Case No. 01-CV-0252, alleging, among other things, copyright infringement against the Company and seeking damages in excess of $150,000 in connection with the Company's distribution of musical albums pursuant to a written distribution agreement with Fortune Entertainment, Inc. ("Fortune"). On March 13, 2001, the Company answered the Complaint, denying liability and asserting affirmative defenses. On March 13, 2001, the Company filed a Third-Party Complaint against co-defendant Fortune and its owner Bruce Dugan seeking indemnity and contribution on the claims made by Bob Grady and Wilson Meadows. Neither Fortune nor Bruce Dugan has responded to the Third Party Complaint. Discovery is completed, and the parties filed cross-motions for summary judgment. On March 31, 2003, the District Court granted the Company's motion for summary judgment, denied Plaintiffs' motion for summary judgment, and entered judgment dismissing all of Plaintiffs' claims against the Company. The Company moved for an award of its attorneys' fees on April 14, 2003, and Plaintiffs responded, opposing the motion. The District Court has not decided the motion. By Order dated January 26, 2004, the District Court granted in part and denied in part the Company's motion for an award of attorneys' fees and ordered the Company to submit an itemized attorneys' fees statement for purposes of entry of the award. The Company submitted the attorneys' fees and expenses statement to the Court on February 6, 2004, requesting $70,512.82. Plaintiffs have filed a Notice of Appeal with the Eleventh Circuit Court of Appeals. After requesting briefs on whether it had jurisdiction to hear the appeal, the Court ruled that it had jurisdiction. However, Plaintiffs/Appellants did not timely file their papers as required by appellate rules of procedure, and the appeal was administratively dismissed on August 25, 2003. Plaintiffs/Appellants moved to re-open the appeal, the Company opposed the motion, but on September 22, 2003, the Court granted the request and 20 accepted the late filed brief. The Company filed its responsive appeal brief on October 22, 2003. Oral argument on the appeal has been set for March 11, 2004. The Company intends to vigorously defend against Plaintiffs' claims on appeal to pursue the recovery of its attorneys' fees and costs incurred in the matter, and to pursue indemnity and contribution from Fortune and Dugan. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. BRIDGEPORT MUSIC, INC., ET AL. V. 11C MUSIC, INC., ET AL. On or about May 17, 2001, the Company received notice of the commencement and filing of action in the Federal District Court for the Middle District of Tennessee, Court File No. 3:01-0412, brought by Plaintiffs against a "record number" of defendants alleging, among other things, copyright infringement claims. Among the defendants identified is an entity named as "Breakaway Navarre." Through counsel, the Company has notified Plaintiffs' counsel that there is no such entity as "Breakaway Navarre," and that, therefore, the Company is not in a position to waive service of process in connection with the matter. Pursuant to certain court orders, all summons to be served on defendants were to be issued by the court at the request of the plaintiffs by mid-May 2001. Service was to be completed thereafter within the federal rules requirements. It does not appear that service of process against the Company has been accomplished, and plaintiffs' counsel has agreed to dismiss their claims against "Breakaway Navarre." By Order dated May 29, 2003, Plaintiffs' claims against "Breakaway Navarre" were dismissed with prejudice and on the merits. The Company has not yet been made a party to this lawsuit and, based on the comments from plaintiffs' counsel, it is unlikely that plaintiffs will attempt to include the Company as a party defendant in the future. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. NAVARRE CORPORATION V. BROOKLYN MUSIC LTD., ET AL. The Company commenced this action against Brooklyn Music Limited, Frank Babar, and Joe Natoli. The Complaint was filed with the Hennepin County District Court for the District of Minnesota on July 26, 2002, Brooklyn Music Ltd. was served with the Company's Complaint on July 31, 2002, Frank Babar was served with the Company's Complaint on July 31, 2002, and Joe Natoli was served with the Company's Complaint on October 9, 2002. The Company alleges, among other things, that the Defendants breached distribution and loan contracts with the Company, and the Company seeks damages of at least $295,000. As of November 15, 2002, all Defendants had answered the Company's Complaint and asserted counterclaims. Defendants allege eleven separate counterclaims based on breach of contract, gross negligence, willful misconduct, and intentional bad faith, and seek damages which are difficult to decipher but appear be at least $3,000,000, as well as nullification of the personal guaranties of the individual defendants. The parties have completed discovery. The Court issued an Amended Scheduling Order setting the case for trial during the calendar trial block of January 5, 2004, but that date was 21 continued indefinitely because of a Court scheduling conflict. Mediation was completed, but no settlement agreement was reached. Both sides moved for summary judgment, and the motions were heard on September 11, 2003. By Order dated October 7, 2003, the court granted in part, and denied in part, the Company's motion, and denied entirely defendants' motion for summary judgment. Among other things, the Court granted the Company's motion against the individual defendants/guarantors for the entire debt claimed by the Company (in excess of $442,000), plus the Company's attorneys' fees and costs. The Court also dismissed Counts 7, 8, and 9 of the individual defendants' counterclaims. Prior to the continuance of the January 5, 2004, trial date, the Company filed various pretrial motions with the Court, including a motion for sanctions against defendants for failure to comply with the Court's pretrial order. The Court has denied the motion for sanctions, but has reserved the pretrial motions including motions to exclude certain portions of defendants' evidence, and has ordered a settlement/pretrial conference for March 10, 2004. The Company intends to vigorously pursue its claims against Defendants and to vigorously defend against the remaining claims asserted by Defendants. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. CLOUD TEN PICTURES, INC. V. NAVARRE CORPORATION. On or about April 2, 2003, Cloud Ten Pictures, Inc. ("Plaintiff") commenced this action in Hennepin County District Court for the State of Minnesota, by serving the Company with a Summons and Complaint, which Plaintiff has now amended. Plaintiff has not yet served the Amended Complaint. Plaintiff alleges, among other things, accounting, breach of contract, misrepresentation and negligent misrepresentation and seeks unspecified damages. Plaintiff's claims are based upon Navarre's distribution of two of Plaintiff's films. While discovery is on-going and the factual basis for all of Plaintiff's claims has not yet been fully articulated by Plaintiff, it appears that Plaintiff is claiming that, among other things, the Company took credits on the account to which it was not entitled, failed to pay for allegedly shipped product for which no invoice has been issued, and failed to properly describe certain retail placement programs to Plaintiff. The Company answered Plaintiff's Complaint on May 2, 2003, denying liability to Plaintiff and asserting various affirmative defenses. In addition, the Company asserted its counterclaim against Plaintiff for breach of contract and account stated and seeking damages in an amount of at least $663,826.54. The Court heard the Company's motion for summary judgment on January 30, 2004, but has not yet issued a ruling on that motion. The parties are in the process of scheduling depositions. The Company intends to vigorously defend against Plaintiff's claims and pursue its counterclaim. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. 22 NAVARRE CORPORATION V. PROGRAM POWER ENTERTAINMENT On or about August 1, 2003, the Company commenced an action against Defendant Program Power Entertainment in Hennepin County District Court for the State of Minnesota. The Company seeks damages in excess of $50,000 against Program Power Entertainment, arising from Defendant's alleged breach of financing agreements and a letter agreement intended to resolve disputes surrounding a distribution agreement. On October 16, 2003, Defendant answered the Complaint, denying liability to the Company and asserting a counterclaim for breach of contract related to the distribution agreement. The Defendant seeks damages in excess of $50,000. On November 5, 2003, the Company replied to the Counterclaim and denied the material allegations thereof. The Company also asserted certain affirmative defenses including, and without limitation, that the alleged contractual breaches claimed by Defendant were settled by way of the letter agreement. This case is in the very early stages of litigation, and the parties have not yet begun the discovery process. The Company intends to vigorously pursue its claims against the Defendant and to vigorously defend against the counterclaims asserted by the Defendant. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. BLACK MARKET RECORDS, INC. Black Market Records, Inc., is a debtor in a Chapter 7 bankruptcy proceeding pending in the Eastern District of California, Sacramento Division (Case No. 02-22348-B-7). On or about October 13, 2003, Black Market filed pleadings in its bankruptcy case, identifying various claims against the Company, including potential claims for infringement in connection with the Company's distribution of certain musical recordings in which Black Market claims an interest. Black Market seeks damages of "at least $100,000" in connection with its claims against the Company. The Company and Black Market are in the process of negotiating a settlement of the claims. The Company has denied liability and, if a settlement is not finalized, intends to vigorously defend against the claims or any action commenced by Black Market or the trustee in the bankruptcy case of Black Market. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. AMERICAN GRAMAPHONE LLC MATTERS 1. ACCOUNTING RECONCILIATION CLAIM. The Company distributed American Gramaphone, LLC products pursuant to a written distribution agreement which has terminated. Since termination, the Company and American Gramaphone, LLC have been attempting to reconcile the various account balances between the parties. American 23 Gramaphone, LLC has notified the Company that it believes sums in excess of $250,000 are owed to it. The Company disputes these claims, and the parties continue to attempt to resolve this dispute. American Gramaphone, LLC has indicated that if the dispute cannot be resolved, it intends to commence an arbitration pursuant to the written agreements between it and the Company. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. 2. AMERICAN GRAMAPHONE, ET AL. V. CLEOPATRA RECORDS AND NAVARRE Plaintiffs, American Gramaphone, LLC, Dots and Lines Ink, and Louis F. Davis, Jr. commenced this action by filing a Summons and Complaint with the United States District Court, Central District of California, on December 8, 2003, Court File No. CV03-8913 JSL, against the Company and Cleopatra Records, Inc. Plaintiffs allege trademark infringement, false designation of origin, dilution, copyright infringement, California Statutory Unfair Competition, California Common Law Unfair Competition, Accounting, and Constructive Trust, in connection with the Company's distribution of "tribute albums" pursuant to its distribution contract with Cleopatra Records. Plaintiffs seek injunctive relief and statutory and related damages in an amount to be proven. Plaintiffs moved for a temporary restraining order on December 8, 2003, and by Order dated December 10, 2003, the Court granted the temporary restraining order. Pursuant to the terms of the temporary restraining order, the Company has, among other things, placed a "stop sell" on the subject albums and issued a recall notice to retailers with respect to the tribute albums distributed by the Company for its label, Cleopatra Records, Inc. Based upon an agreement between all parties, the hearing on the order to show cause why a temporary injunction should not be entered has been reset for March 8, 2004. The Company is in the process of attempting to negotiate a compromise settlement of the matter. The Company is looking to the label, Cleopatra Records, to cover the monetary costs of any such settlement. On January 21, 2004, the Company served and filed its Answer to Plaintiff's Complaint, denying liability and asserting applicable affirmative defenses available under the law. If necessary, the Company will vigorously defend itself against the claims asserted by Plaintiffs and, if necessary will seek indemnity and contribution from the co-defendant. The ultimate outcome of this proceeding cannot be predicted at this time, and the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On December 15, 2003, we completed a $12.5 million private placement to institutional and other accredited investors. The securities sold to the investors included approximately 2.6 million shares of common stock of the Company and approximately 650,000 shares of common stock subject to five-year warrants immediately exercisable at $7.00 per share. Net proceeds were used for, among other things, discharging the company's debt to Hilco Capital, LP and general working capital needs. Craig-Hallum Capital Group LLC ("Craig-Hallum") acted as the placement agent for the Company in the transaction. In return for its services, Craig-Hallum received a cash fee equal to five percent (5%) of the total selling price of the securities sold in the placement (excluding the exercise price of the warrants sold), for a total cash fee of $625,000. In addition, the Company issued to Craig-Hallum a two-year warrant to purchase a number of shares equal to five percent (5%) of the total number of shares sold in the placement (equal to approximately 130,000 shares), excluding the shares subject to the warrants sold. The exercise price of the warrant is $7.00 per share. The warrant must be exercised if the average closing price of the Company's common stock as quoted on Nasdaq (or any exchange where the Company's common stock is then traded) for thirty (30) consecutive trading days is greater than or equal to one hundred fifty percent (150%) of the exercise price of the warrant. In offering and selling the securities in the placement, the Company relied upon the exemptions from registration provided by Rule 506 under the Securities Act of 1933 ("Securities Act") and Section 4(2) of the Securities Act. 24 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) The following exhibits are included herein: 10.1.1 Amendment to Employment Agreement between us and Eric H. Paulson. 31 (a) Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act). 31 (b) Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act). 32 (a) Certifications of the Chief Executive Officer pursuant Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350). 32 (b) Certifications of the Chief Financial Officer pursuant Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350).
(b) Reports on Form 8-K On November 5, 2003, we filed a Current Report on Form 8-K with the Securities and Exchange Commission announcing the acquisition of the operating assets of BCI Eclipse Company, LLC. On December 16, 2003, we filed a Current Report on Form 8-K with the Securities and Exchange Commission announcing our $12.5 million private placement to institutional and other accredited investors. On January 21, 2004, we filed a Current Report on Form 8-K with the Securities and Exchange Commission reporting our earnings for the third quarter ended December 31, 2003. 25 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 13, 2004 /s/ Eric H. Paulson ------------------------------ Eric H. Paulson Chairman of the Board, President and Chief Executive Officer Date: February 13, 2004 /s/ James Gilbertson ------------------------------ James Gilbertson Vice President and Chief Financial Officer 26 EX-10.1.1 3 c83002exv10w1w1.txt AMENDMENT TO EMPLOYMENT AGREEMENT - ERIC H PAULSON EXHIBIT 10.1.1 AMENDMENT TO EMPLOYMENT AGREEMENT THIS AMENDMENT TO EMPLOYMENT AGREEMENT (this "Amendment") is made effective December 4, 2003, by and between NAVARRE CORPORATION, a Minnesota corporation, (hereafter the "Company"), and ERIC H. PAULSON, a resident of the State of Minnesota (hereafter "Executive"). W I T N E S S E T H: WHEREAS, the Company and Executive are parties to an existing Employment Agreement dated November 1, 2001 (hereafter "Employment Agreement"); and WHEREAS, the Company and Executive mutually desire to amend the Employment Agreement upon the terms and conditions set forth in this Amendment. NOW, THEREFORE, in consideration of the foregoing premises and the mutual promises and covenants hereinafter contained, the receipt and sufficiency of which is hereby acknowledged, each of the parties to this Amendment agree that the Employment Agreement is hereby amended as follows: 1. Section 4(d) of the Employment Agreement is amended adding the following immediately subsequent to the current Section 4(d)(v): (vi) EXECUTIVE'S COMPLIANCE WITH SECTION 8(c) OF THIS AGREEMENT. Notwithstanding anything herein to the contrary, Executive's receipt of any IDCP award payment pursuant to this Section 4 is conditioned upon Executive's compliance with Section 8(c) of this Agreement. In the event that Executive has materially breached the terms and conditions set forth in Section 8(c) of this Agreement prior to the time that any IDCP award would otherwise be due to Executive, the Company's obligation to make any such IDCP award payment(s) to Executive shall cease immediately as of the date of the breach, and any future IDCP award payment obligations otherwise due to Executive by the Company shall cease for all time, irregardless of Executive's later cure of the breach. 2. This Amendment shall be attached to and be a part of the Employment Agreement between the Company and Executive, and the parties hereto expressly acknowledge and agree that except as amended hereby, the Employment Agreement remains in full force and effect in accordance with its original terms and conditions and is not subject to any defenses, counterclaims or rights to setoff. 3. This Amendment and the Employment Agreement reflect the entire agreement of the parties hereto and no other action or statement of either Executive or the Company, or any of its officers, directors, agents, employees, legal counsel or other representatives shall amend, or be deemed an addendum of, the Employment Agreement. 4. This Amendment may be executed in counterparts, each of which will be deemed an original but all of which will constitute one and the same instrument. 27 IN WITNESS WHEREOF, in consideration of the mutual covenants contained herein, the parties have executed this Amendment effective as of the date and year above written. THE COMPANY: EXECUTIVE: Navarre Corporation, a Minnesota Corporation By: James G. Gilbertson, Eric H. Paulson Chief Financial Officer 28 EX-31.(A) 4 c83002exv31wxay.txt CERTIFICATION OF CEO PURSUANT TO SECTION 302 EXHIBIT 31 (a) CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Eric H. Paulson, certify that: 1. I have reviewed this Form 10-Q of Navarre Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2004 /s/ Eric H. Paulson ------------------------------------- Eric H. Paulson Chairman of the Board, President and Chief Executive Officer 29 EX-31.(B) 5 c83002exv31wxby.txt CERTIFICATION OF CFO PURSUANT TO SECTION 302 EXHIBIT 31 (b) CERTIFICATION OF CHIEF FINANCIAL OFFICER I, James Gilbertson, certify that: 1. I have reviewed this Form 10-Q of Navarre Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2004 /s/ James Gilbertson ------------------------------------------ James Gilbertson Vice President and Chief Financial Officer 30 EX-32.(A) 6 c83002exv32wxay.txt CERTIFICATION OF CEO PURSUANT TO SECTION 906 EXHIBIT 32 (a) CERTIFICATION OF CHIEF EXECUTIVE OFFICER The undersigned certifies pursuant to 18 U.S.C. Section 1350, that: (1) The accompanying Quarterly Report on Form 10-Q for the period ended December 31 2003, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the accompanying Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: February 13, 2004 /s/ Eric H. Paulson ------------------------------ Eric H. Paulson Chairman of the Board, President and Chief Executive Officer 31 EX-32.(B) 7 c83002exv32wxby.txt CERTIFICATION OF CFO PURSUANT TO SECTION 906 EXHIBIT 32 (b) CERTIFICATION OF CHIEF FINANCIAL OFFICER The undersigned certifies pursuant to 18 U.S.C. Section 1350, that: (1) The accompanying Quarterly Report on Form 10-Q for the period ended December 31, 2003, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the accompanying Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: February 13, 2004 /s/ James Gilbertson ------------------------------- James Gilbertson Vice President and Chief Financial Officer 32 -----END PRIVACY-ENHANCED MESSAGE-----