Edgar Filing: NAVARRE CORP /MN/

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------

FORM 10-K

(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934

FOR THE FISCAL YEAR ENDED MARCH 31, 2004
OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934

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)

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

Securities registered pursuant to Section 12(b) of the Act:

TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
-------------------------- ------------------------------------------
COMMON STOCK, NO PAR VALUE NASDAQ NATIONAL MARKET

Securities registered pursuant to Section 12(g) of the Act:
NONE

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

Indicate by check mark whether the Registrant is an accelerated filer. Yes [ ]
No [X]

The aggregate market value of the voting stock held by non-affiliates of the
Registrant at September 30, 2003 was $51,806,695 based on the closing sale price
on such date of $2.84 per share.

The Registrant had 26,600,469 shares of Common Stock, no par value, outstanding
at June 18, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K
incorporate certain information by reference from the Registrant's definitive
Proxy Statement to be filed with the Securities and Exchange Commission not
later than 120 days after the conclusion of the registrant's last fiscal year,
which ended March 31, 2004.

NAVARRE CORPORATION
FORM 10-K

TABLE OF CONTENTS

PART I

Page

Item 1. Business..............................................................................................3
Item 2. Properties...........................................................................................15
Item 3. Legal Proceedings....................................................................................16
Item 4. Submission of Matters to a Vote of Security Holders..................................................19

PART II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................19
Item 6. Selected Financial Data..............................................................................21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk...........................................31
Item 8. Financial Statements and Supplementary Data..........................................................32
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................32
Item 9A. Controls and Procedures..............................................................................32

PART III

Item 10. Directors and Executive Officers of the Registrant...................................................32
Item 11. Executive Compensation...............................................................................32
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters.....................................................................32
Item 13. Certain Relationships and Related Transactions.......................................................33
Item 14. Principal Accountant Fees and Services...............................................................33

PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.....................................33

Signatures...........................................................................................38

PART I

ITEM 1. BUSINESS

References in this Form 10-K to "we," "us," "our," "our Company," and "Navarre"
mean Navarre Corporation and our subsidiaries, unless the context otherwise
requires.

GENERAL

Navarre Corporation, a Minnesota corporation formed in 1983, publishes and
distributes a broad range of home entertainment and multimedia products,
including personal computer ("PC") software, audio and video titles and
interactive games. Our business is divided into two business segments --
Distribution and Publishing. Our distribution business is operated through
Navarre Corporation. Our publishing business is operated through our Encore
Software and BCI Eclipse entities. Through these business segments we maintain
and leverage strong relationships throughout the publishing and distribution
chain. Our broad base of customers includes (i) wholesale clubs, (ii) mass
merchandisers, (iii) other third-party distributors, (iv) computer specialty
stores, (v) music specialty stores, (vi) book stores, (vii) office superstores,
and (viii) electronic superstores. Our customer base includes over 500
individual customers with over 18,000 locations, certain of which are
international locations.

Through our Distribution business, we distribute and provide fulfillment
services in connection with a variety of finished goods that are provided by our
vendors, which include a variety of publishers, independent and major music
labels, and movie studios. These vendors provide us with PC software, CD and DVD
audio, DVD and VHS video, video games and accessories. Our Distribution business
focuses on providing retailers and publishers with high-quality services for the
broad, efficient distribution of these products, including vendor-managed
inventory, Electronic Data Interchange services, fulfillment services, cross
docking and assumed receipt, and retailer-oriented marketing services.

Through our Publishing business we are the exclusive licensee or owner of
PC software, CD and DVD audio, DVD and VHS video, and video game titles. Our
Publishing business licenses, packages, markets and sells these products to
third-party distributors, directly to retailers, as well as to our Distribution
business. We expect that our recent agreement to distribute Riverdeep's
educational and interactive products will increase the size of this segment.

During fiscal years 2004, 2003, and 2002, sales for our Distribution
business accounted for 94.5%, 99.0% and 100.0% of net sales, while sales of the
Publishing business accounted for 9.7%, 4.1% and 0.0% of net sales,
respectively. During fiscal 2004 and fiscal 2003, after the elimination of
intercompany sales, our Publishing business accounted for 5.5% of net sales and
1.0% of net sales.

We derive no material revenue from businesses located outside the United
States and Canada.

Our recent acquisitions include the July 2002 acquisition of the primary
assets of Encore Software, Inc. ("Encore") and the November 2003 acquisition of
all the assets of BCI Eclipse, LLC ("BCI Eclipse"). Encore is an interactive
publisher in the video game and PC CD-ROM markets. The assets we purchased
included certain fixed assets, inventory, receivables and contract rights
related to Encore's business. The assets are held by a majority-owned Navarre
subsidiary, which has been named Encore Software, Inc. BCI Eclipse is a provider
of niche DVD and video products. 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 contribute to our
direction of enhancing products and services to our new mass merchandise
customers. 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 Eclipse's business. The assets are held by a
majority-owned Navarre subsidiary, which has been named BCI Eclipse Company,
LLC.

We were incorporated in Minnesota in 1983. Our corporate headquarters is
located at 7400 49th Avenue North, in New Hope, Minnesota, 55428, our telephone
number is (763) 535-8333, our facsimile number is (763) 504-1107 and our
web-site address is www.navarre.com.

SIGNIFICANT SEASONALITY/CUSTOMERS

Traditionally, our third quarter (October 1-December 31) has accounted for
our largest quarterly revenue figures and a substantial portion of our earnings.
Our third quarter accounted for approximately 32.2%, 32.5% and 38.2% of our
revenues for the fiscal years ended March 31, 2004, 2003 and 2002, respectively,
and approximately 40.4%, 69.5% and 120.9% of our net income for the fiscal years
ended March 31, 2004, 2003 and 2002, respectively. As a distributor of products
ultimately sold to retailers, our business is affected by the pattern of
seasonality common to other suppliers of retailers, particularly during the
holiday selling season.

In each of the past several years, we have had one or more customers that
accounted for 10% or more of our net sales. During the fiscal year ended March
31, 2004, sales to three customers, Best Buy, CompUSA and Sam's Clubs,
represented approximately 17%, 12% and 11% of our total sales, respectively.

OUR MARKETS

DISTRIBUTION SEGMENT

PC Software

According to NPD Intelect (formerly P.C. Data), the PC software industry
achieved $3.68 billion in sales in 2003. Categories that experienced an increase
over 2003 were system utilities, business, finance and personal productivity
products. During the past fiscal year, we added several publishers to our
distribution roster. We presently have relationships with PC software publishers
such as Microsoft Corporation, Symantec Corporation, Roxio, Inc., Adobe Systems
Inc., Network Associates, Inc., Dreamcatcher Interactive, Inc., Sony Online
Entertainment, Inc., Delorme and THQ. These relationships are important to our
Distribution business and during the fiscal year ended March 31, 2004 each of
these publishers accounted for more than $5,000,000 in revenues. In the case of
Symantec, sales under this agreement accounted for more than $38 million in net
sales in the fiscal year ended March 31, 2004.

While we have agreements in place with each of these parties, they are
generally short-term agreements lasting one to three years in term, they
generally cover the right to distribute in the United States and Canada, they do
not restrict the publisher from distributing their products through other
distributors or directly to retailers and they do not guarantee product
availability to us for distribution. Our agreements with these publishers
provide us with the ability to purchase the publisher's products at a reduced
wholesale price and for us to provide a variety of distribution and fulfillment
services in connection with the publisher's products. We intend to continue to
seek to add publishers that will increase our market share across all categories
of the PC software industry.

Video Games

We continued to expand our distribution of console-based video games in
fiscal 2004. In 2003, United States sales in the interactive entertainment
industry decreased 2.7% to $10 billion from $10.3 billion in 2002. According to
industry researcher UBS Warburg, the industry is estimated to reach $31 billion
in worldwide sales by 2005. Relationships with vendors such as Square Enix USA,
Inc. are important to our growth.

Major Label Music

According to the Recording Industry Association of America ("RIAA"), audio
and music video product shipped to domestic markets was $11 billion in calendar
2003. Industry sources indicate that approximately 83% of the unit shipments are
derived from major recording labels controlled by five major companies. Those
companies are Warner-Elektra-Atlantic Corp., Sony Music Entertainment Inc., EMI
Music Marketing, Bertelsmann Music Group, and Universal Music & Video
Distribution Corp. Generally, these companies control distribution of their
products through major music retail chains and other channels. We distribute
major label music to wholesale clubs and mass merchant retailers on a
non-exclusive basis through our Distribution business.

Independent Music

The independent segment of the music industry currently represents
approximately 17% of total music product. We are one of a limited number of
large independent distribution companies that represent independent

labels exclusively on a regional or national basis. These companies provide
products and services to the nation's leading music specialty stores and
wholesalers. They provide unique services to their labels and artists including
financing, manufacturing, marketing, promotion and access to North American
retailers.

We continue to seek to increase our market share of the independent
distribution business by continuing to seek higher quality music labels and to
provide greater service to our customers, in addition to providing content
ownership and licensing opportunities. Relationships with independent music
labels such as CMH Records, Inc., Studio Distribution, Inc. and Cleopatra
Records, Inc. are also important to our Distribution business. We have exclusive
distributions agreements in place with certain of these labels that allow us to
retain a percentage of amounts received in connection with the sale of the
products provided by these labels. Among other customary provisions, these
agreements provide us with full returnability of the products, the right for us
to retain a reserve against potential returns of products, and requirements that
the label provide discounts, rebates and price protections.

Major Studio DVD

According to Video Business, the home video industry totaled $22 billion
in sales in 2003. DVD sales accounted for $12 billion, an increase of 46% from
2002. Relationships with Universal Distribution Corp., Twentieth Century Fox
Home Entertainment and Buena Vista Home Video are important to our growth of our
Distribution business.

PUBLISHING

In July 2002 and November 2003, we acquired the Encore and the BCI Eclipse
businesses. Encore is a publisher of entertainment and education PC products and
BCI Eclipse is a provider of niche DVD/video products. Both of these businesses
exclusively own or license and produce their PC/DVD/video products. In April of
2004, we entered into an exclusive co-publishing agreement with Riverdeep Inc.
for the sales and marketing of Riverdeep's interactive products in the
educational and productivity markets, which includes products published under
the Broderbund and The Learning Company labels.

E-COMMERCE

During fiscal year 2004, we continued to expand the number of electronic
commerce ("e-commerce") customers for whom we perform fulfillment and
distribution. These services include sales of PC software, prerecorded music and
DVD/VHS videos and video games. Our business-to-business web-site
www.navarre.com integrates on-line ordering and deployment of text and visual
product information, and has been enhanced to allow for easier user navigation
and ordering.

RECENT DEVELOPMENTS

RECENT CHANGE IN BUSINESS STRUCTURE

Prior to our purchase of BCI Eclipse, we had two segments - Home
Entertainment Products and Encore. Following our purchase of BCI Eclipse, we
treated the BCI Eclipse business as a third segment. Shortly after filing
financial information for our third quarter ended December 31, 2003, we decided
to combine the Encore and BCI Eclipse segments and relabel our segments. Thus,
we relabeled the Home Entertainment Products segment as "Distribution" and the
combined BCI Eclipse and Encore segments into a segment called "Publishing." We
believe that the new labels and combined segments more closely align the
Company's divisions based on their actual functions.

SECURITIES OFFERING

In December 2003, we completed a private placement to institutional and
other accredited investors of 2,631,547 shares of common stock and 657,887
shares of common stock issuable upon exercise of warrants. We sold the
securities for $4.75 per share for total proceeds of approximately $12,500,000
and net proceeds of approximately $11,735,000. The per share price of $4.75
represented a discount of approximately 15% of the closing price of our common
stock on the date the purchase was completed. The net proceeds were used to

discharge our approximate $6.6 million debt to Hilco Capital, LP incurred in
connection with the BCI Eclipse acquisition and the remainder was made available
for, among other things, general working capital needs.

The warrants issued to the placement investors are five-year warrants
exercisable at any time after the sixth month anniversary of the date of
issuance at $7.00 per share. The warrants contain customary anti-dilution
provisions and a cashless exercise provision that is applicable only if a
registration statement permitting sale of the underlying shares is not then
available. In addition, we have the right after the first anniversary date of
the warrant to require cash exercise of the warrant if, among other things, the
volume weighted average price of our common stock exceeds $12.00 per share for
each of 30 consecutive trading days. Furthermore, each warrant includes a
provision that limits the number of shares obtainable upon exercise to ensure
that the holder does not exceed 4.99% and 9.99% of our issued and outstanding
shares of common stock.

We issued to our agent in the private placement, Craig-Hallum Capital
Group, LLC, a warrant to purchase 131,577 shares. The warrant expires on
December 14, 2005 and is exercisable at $7.00 per share. The warrant contains
customary anti-dilution and piggyback registration rights, although, if the
shares underlying the warrant are included in any registration statement filed
pursuant to the placement purchasers registration rights agreement, then those
registration rights and obligations apply to the agent's warrant. The warrant
does not contain a cashless exercise provision and includes a mandatory exercise
provision that allows us to require exercise in full of the warrant within ten
days of notice that the average closing price of our common stock is equal to or
greater than $10.50 per share for any 30 consecutive trading days. We exercised
the mandatory exercise provision on June 9, 2004 and the warrant was exercised
on June 10, 2004.

On April 28, 2004, we registered for resale by the selling shareholders
the shares of common stock and the shares of common stock issuable upon exercise
of the warrants issued in the private placement under a registration statement
on Form S-3. This registration statement also covered the registration of
131,577 shares issuable upon the exercise of the agent's warrant as well as
320,000 shares issuable upon the exercise of a warrant issued to Hilco Capital,
LP, which provided financing in connection with our November 2003 acquisition of
the assets of BCI Eclipse and 1,000,000 shares issued in connection with the BCI
Eclipse acquisition.

RECENT SENIOR MANAGEMENT PROMOTIONS AND NEW DIRECTORS

We recently made several promotions amongst our senior management team. In
February 2004, Brian Burke, the Senior Vice President/General Manager of Navarre
Distribution, was promoted to Chief Operating Officer - Distribution; Cary
Deacon, our Corporate Relations Officer, assumed the newly-created position of
Chief Operating Officer - Publishing; and Jim Gilbertson, our Vice President and
Chief Financial Officer, was appointed to our Board of Directors to serve until
our next annual shareholder meeting. In addition, on April 22, 2004, Alfred Teo
resigned from our Board of Directors and on May 20, 2004, the Board of Directors
appointed Timothy R. Gentz to serve as a director until our next annual
shareholder meeting. Mr. Gentz was also appointed to serve on the Governance and
Audit Committees of the Board.

COMPETITION

All aspects of our business are highly competitive. Our competitors
include other national and regional distributors, as well as some suppliers that
sell directly to retailers. Some of these competitors have substantially greater
financial and other resources than we do. Our ability to effectively compete in
the future depends upon a number of factors, including our ability to: (i)
obtain exclusive national distribution contracts and licenses with independent
labels, studios, content owners, artists and manufacturers; (ii) maintain our
margins and volume; (iii) expand our sales through a varied range of products
and personalized services; (iv) anticipate changes in the marketplace including
technological developments and successfully continue our ability to distribute
products in light of these developments; (v) continue to provide our varied
retail customers with specialized services; and (vi) maintain operating expenses
at an appropriate level.

In the personal computer software industry, we face competition from a
number of distributors including Ingram Micro, Inc., Tech Data Corporation and
Atari, Inc. as well as from manufacturers and publishers that sell directly to
retailers. In the prerecorded music industry, we face competition from the five
major label distribution companies, as well as other national independent
distributors, such as Koch Entertainment, RED Music Distribution,

Alternative Distribution Alliance ("ADA"), Ryko Distribution, and Caroline
Distribution, as well as from other entities that sell directly to retailers.

We believe that the distribution of PC software, prerecorded music, DVD
Video and video games will remain highly competitive and the keys to growth and
profitability will be: (i) customer service, (ii) continued focus on
improvements and operating efficiencies, (iii) the ability to develop
proprietary products, and (iv) the ability to attract higher quality artists and
software publishers. We also believe that over the next several years, both the
personal computer software distribution industry and prerecorded music
distribution industry, particularly on the independent side, will continue to
further consolidate.

The market for Internet content providers is highly competitive and
rapidly changing. We expect that competition between suppliers to Web retailers
will continue to intensify. We support numerous Internet retailers, including
traditional music retail chains, record labels and independents with web sites
on the Internet.

OUR STRATEGY

Our goal is to expand our distribution and publishing of products on an
international basis, including music, software, video games and DVDs. We intend
to achieve this goal by: (i) increasing the number and quality of national
distribution arrangements with vendors supplying home entertainment product;
(ii) developing further PC software and DVD licensing arrangements to expand our
high margin publishing business; (iii) expanding our business through strategic
acquisitions in areas or in businesses that complement our existing businesses;
(iv) continuing to deliver high levels of service to our retail customers; (v)
continuing to improve our efficiencies and technologies at our state-of-the-art
distribution center; and (vi) utilizing the Internet to expand the appeal of our
products to a broader customer base.

Our strategy also includes growth through the acquisition of complementary
businesses. At present, we have no plans, proposals or arrangements to acquire
any complementary business and we may not be able to identify suitable
acquisition candidates.

EMPLOYEES

As of June 1, 2004, we had 441 employees, including 145 in administration,
finance and merchandising, 75 in sales and marketing and 221 in distribution.

BACKLOG

Because our products are shipped in response to orders, we do not maintain
any significant backlog.

ENVIRONMENTAL MATTERS

We do not anticipate any material effect on our capital expenditures,
earnings or competitive position due to compliance with government regulations
involving environmental matters.

FORWARD-LOOKING STATEMENTS / IMPORTANT RISK FACTORS

We make written and oral statements from time to time regarding our
business and prospects, such as projections of future performance, statements of
management's plans and objectives, forecasts of market trends, and other matters
that are forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21F of the Securities Exchange Act of 1934.
Statements containing the words or phrases "will likely result," "are expected
to," "will continue," "is anticipated," "estimates," "projects," "believes,"
"expects," "anticipates," "intends," "target," "goal," "plans," "objective,"
"should" or similar expressions identify forward-looking statements, which may
appear in documents, reports, filings with the Securities and Exchange
Commission, including this Annual Report on Form 10-K, news releases, written or
oral presentations made by officers or other representatives made by us to
analysts, shareholders, investors, news organizations and others and discussions
with management and other representatives of us. For such statements, we claim
the protection of the safe harbor for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995.

Our future results, including results related to forward-looking
statements, involve a number of risks and uncertainties. No assurance can be
given that the results reflected in any forward-looking statements will be
achieved. Any forward-looking statement made by or on behalf of us speaks only
as of the date on which such statement is made. Our forward-looking statements
are based on assumptions that are sometimes based upon estimates, data,
communications and other information from suppliers, government agencies and
other sources that may be subject to revision. Except as required by law, we do
not undertake any obligation to update or keep current either (i) any
forward-looking statement to reflect events or circumstances arising after the
date of such statement, or (ii) the important factors that could cause our
future results to differ materially from historical results or trends, results
anticipated or planned by us, or which are reflected from time to time in any
forward-looking statement which may be made by or on behalf of us.

In addition to other matters identified or described by us from time to
time in filings with the SEC, there are several important factors that could
cause our future results to differ materially from historical results or trends,
results anticipated or planned by us, or results that are reflected from time to
time in any forward-looking statement that may be made by or on behalf of us.
Some of these important factors, but not necessarily all important factors,
include the following:

OUR FOUNDER SIGNIFICANTLY INFLUENCES OUR BUSINESS OPERATIONS. THE LOSS OF OUR
FOUNDER COULD AFFECT THE DEPTH, QUALITY AND EFFECTIVENESS OF OUR MANAGEMENT. IN
ADDITION, IF WE FAIL TO ATTRACT AND RETAIN QUALIFIED PERSONNEL, THE DEPTH,
QUALITY AND EFFECTIVENESS OF OUR MANAGEMENT TEAM AND EMPLOYEES COULD BE
NEGATIVELY AFFECTED.

Eric H. Paulson, our President, Chief Executive Officer and founder, has
been with us since our inception in 1983. Although we have invested a
substantial amount of time and effort in developing our total management team
and Mr. Paulson's employment agreement extends through March 31, 2007, the loss
of Mr. Paulson, by death or disability, could affect management's ability to
continue to effectively operate our business.

Our ability to enhance and develop markets for our current products and to
introduce new products to the marketplace also depends on our ability to attract
and retain qualified management personnel. We compete for such personnel with
other companies and organizations, many of which have substantially greater
capital resources and name recognition than us. We may not be successful in
recruiting or retaining such personnel, which could have a material adverse
effect on our business.

SALES TO THREE OF OUR CUSTOMERS ACCOUNTED FOR APPROXIMATELY 40% OF OUR TOTAL
REVENUE FOR THE FISCAL YEAR ENDED MARCH 31, 2004 AND APPROXIMATELY 48% OF TOTAL
REVENUE FOR FISCAL 2003. A REDUCTION IN SALES TO ANY OF THESE THREE CUSTOMERS
COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR SALES AND PROFITABILITY.

In each of the past several years, we have had one or more customers that
accounted for 10% or more of our net sales. During the fiscal year ended March
31, 2003, sales to three customers, Best Buy, CompUSA and Sam's Clubs,
represented approximately 19%, 15% and 14% of our total sales, respectively. For
the fiscal year ended March 31, 2004, these three customers accounted for
approximately 17%, 12% and 11% of our total sales, respectively.

We are a non-exclusive supplier to each of our customers and there can be
no assurance that we will continue to recognize a significant amount of revenue
from sales to any specific customer. If we are unable to continue to sell our
products to all or any of these three customers or are unable to maintain our
sales to these customers at current levels, and are unable to find other
customers to replace these sales, there would be an adverse impact on our
revenues and profitability.

A POOR HOLIDAY SELLING SEASON COULD ADVERSELY AFFECT OUR SALES AND
PROFITABILITY.

THE LOSS OF A SIGNIFICANT VENDOR COULD ADVERSELY EFFECT THE PRODUCTS WE HAVE
AVAILABLE TO DISTRIBUTE, AND CORRESPONDINGLY, COULD NEGATIVELY AFFECT OUR SALES.

Relationships with PC software publishers such as Microsoft Corporation,
Symantec Corporation, Roxio, Inc., Adobe Systems Inc., Network Associates, Inc.,
Dreamcatcher Interactive, Inc. Sony Online Entertainment, Inc., Delorme, and THQ
are important to our Distribution business, and during the fiscal years ended
March 31, 2004 and 2003, each of these publishers accounted for more than $5.0
million in net sales. In the case of Symantec, sales under our agreement with
Symantec accounted for more than $38.0 million in net sales in the fiscal year
ended March 31, 2004. While we have agreements in place with each of these
parties, they are generally short-term agreements lasting one to three years in
term, they generally cover the right to distribute in the United States and
Canada, they do not restrict the publisher from distributing their products
through other distributors, or directly to retailers and they do not guarantee
product availability to us for distribution. These agreements provide the
Company with the ability to purchase the publisher's products at a reduced
wholesale price and for the Company to provide a variety of distribution and
fulfillment services in connection with the publisher's products. If we were to
lose our right to distribute products of our PC software publisher, our revenues
and profitability could be adversely impacted.

Relationships with independent music labels, such as CMH Records, Inc.,
Studio Distribution, Inc. and Cleopatra Records, Inc., are also important to our
Distribution business. We have exclusive distribution agreements in place with
these labels that allow us to retain a percentage of amounts received in
connection with the sale of the products provided by these labels. Among other
customary provisions, these agreements provide us with full returnability of the
products, the right for us to retain a reserve against potential returns of
products, and requirements that the label provide discounts, rebates and price
protections.

If we are unable to continue to sell products to one, or more, of our
publishers of independent music labels, there could be an adverse impact on our
revenues and profitability.

THE FAILURE TO FINANCE OUR SIGNIFICANT WORKING CAPITAL NEEDS COULD ADVERSELY
EFFECT A NUMBER OF ASPECTS RELATED TO OUR BUSINESS SUCH AS OUR ABILITY TO OBTAIN
PRODUCTS TO SELL OR FINANCE ACCOUNTS RECEIVABLES. IT COULD ALSO NEGATIVELY
AFFECT OUR ABILITY TO REMAIN CURRENT ON AMOUNTS DUE TO OUR VENDORS.

As a distributor and publisher of prerecorded music and personal computer
software products, we purchase products directly from manufacturers for resale
to retailers. As a result, we have significant working capital requirements,
principally to finance inventory and accounts receivable. These working capital
needs will expand as inventory and accounts receivable increase in response to
our growth. Although we believe we have obtained financing sufficient to meet
our working capital requirements to date, the failure to finance our working
capital needs or the failure to obtain additional financing upon favorable terms
when required in the future could adversely affect our business as the cost of
replacement financing may be very expensive or not available which could curtail
our distribution or publishing activities.

In the past, we have periodically relied upon bank borrowings to finance
our expansion, primarily for inventory and accounts receivable. Although on
March 31, 2004, 2003 and 2002, we had no debt, we have a credit facility in the
amount of $40.0 million in place with General Electric Credit Corporation (GECC)
and, at times, borrow to finance working capital requirements during the year.
Under the terms of our credit facility with GECC, borrowings are dependent upon
the eligibility of accounts receivable and inventory, and certain other
covenants in the discretion of the lender. We believe that it may be necessary
for us to acquire additional financing in the future depending upon the growth
of our business and the possible financing of acquisitions. If we were unable to
borrow under the credit facility and were unable to secure additional financing,
our future growth and profitability would be adversely affected.

THE LOSS OF A SOFTWARE DEVELOPER OR MANUFACTURER COULD NEGATIVELY CHANGE OUR
PRODUCT OFFERING AND ACCORDINGLY REDUCE OUR REVENUES.

We distribute interactive software under distribution agreements with
software developers and manufacturers. Our continued growth and success depends
partly upon our ability to procure and renew these agreements and to sell the
underlying software. There can be no assurance that we will enter into new
distribution agreements with developers and/or manufacturers or that we will be
able to sell software under existing distribution

agreements. Further, current distribution agreements may be terminated and not
replaced. The loss of a software developer or manufacturer could negatively
affect our product offering and accordingly our sales.

THE CONTINUED GROWTH AND BREADTH OF OUR EXCLUSIVE DISTRIBUTION BUSINESS COULD BE
NEGATIVELY AFFECTED IF WE FAILED TO SECURE NEW DISTRIBUTION AGREEMENTS WITH
RECORDING ARTISTS.

Our Distribution division makes a portion of its sales as a result of
exclusive distribution agreements with recording artists. Our continued growth
and success depend partly upon our ability to procure and renew these agreements
and to sell the underlying recordings. In addition, we depend upon artists and
labels to generate additional quality recordings. In order to procure future
distribution agreements, we regularly review artists and labels. There is no
assurance that we will sign such artists and labels to distribution agreements
or that we will be able to sell recordings under existing distribution
agreements. Further, there can be no assurance that any current distribution
agreements will be renewed or that current agreements will not be terminated.

A DECREASE IN THE POPULARITY OF PC SOFTWARE COULD NEGATIVELY AFFECT OUR
REVENUES.

A large portion of our recent sales increase has been due to increased
sales of PC software. A decrease in the need or desirability of customer
purchase of such software could negatively affect our sales.

EXCESSIVE PRODUCT RETURNS OR INVENTORY OBSOLESCENCE COULD SIGNIFICANTLY REDUCE
OUR SALES OR PROFITABILITY.

We maintain a significant investment in product inventory. Like other
companies operating in our industry, our product returns are significant when
expressed as a percentage of revenues. Our agreements with suppliers generally
permit us to return products that are in the suppliers' current product listing.
Adverse financial or other developments with respect to a particular supplier
could cause a significant decline in the value and marketability of our
products, and could make it difficult for us to return products to a supplier
and recover our initial product acquisition costs. Such an event could have a
material adverse effect upon our business and financial results. We maintain a
sales return reserve based on our trailing twelve month sales returns by product
line. We have historically experienced an actual return rate ranging from 14% to
20%, depending upon the product, which we believe is in line with industry
practice. In the past, these levels have been adequate to cover potential
returns, but there can be no assurance that our reserves will be adequate in the
future.

OUR ACQUISITION STRATEGY COULD RESULT IN DISRUPTIONS TO OUR BUSINESS BY, AMONG
OTHER THINGS, DISTRACTING MANAGEMENT TIME AND DIVERTING FINANCIAL RESOURCES.

One of our growth strategies is the acquisition of complementary
businesses. At present, we have no plans, proposals or arrangements to acquire
any complementary business and we may not be able to identify suitable
acquisition candidates, or if we do, we may not be able to make such
acquisitions on commercially acceptable terms or at all. If we make
acquisitions, a significant amount of management time and financial resources
may be required to complete the acquisition and integrate the acquired business
into our existing operations. Even with this investment of management time and
financial resources, an acquisition may not produce the revenue, earnings or
business synergies that we anticipated. Acquisitions involve numerous other
risks including: assumption of unanticipated operating problems or legal
liabilities, problems integrating the purchased operations, technologies or
products, diversion of management's attention from our core businesses, adverse
effects on existing business relationships with suppliers and customers,
incorrect estimates made in the accounting for acquisitions and amortization of
acquired intangible assets which would reduce future reported earnings, and
potential loss of customers or key employees of acquired businesses.

WE OPERATE IN A HIGHLY COMPETITIVE INDUSTRY AND COMPETE WITH LARGE NATIONAL
FIRMS. FURTHER COMPETITION COULD, AMONG OTHER THINGS, REDUCE OUR SALES VOLUME OR
MARGINS OR BOTH.

The Distribution segment, comprised of the prerecorded music and the PC
software industries, is highly competitive. Our competitors include other
national and regional distributors as well as suppliers that sell directly to
retailers. These competitors include the distribution affiliates of Time-Warner,
Sony Corporation, Thorn/EMI, Bertelsmann A.G., Ingram Micro and Tech Data
Corporation. Many of these competitors have substantially greater financial and
other resources than we have. Our ability to effectively compete in the future
depends upon a number of factors, including our ability to:

- obtain exclusive national distribution contracts and licenses with
independent labels and manufacturers;

- maintain our margins and volume;

- expand our sales through a varied range of products and personalized
services;

- anticipate changes in the marketplace including technological
developments; and

- maintain operating expenses at an appropriate level.

Our failure to adequately perform one or more of these tasks may materially harm
our business.

In addition, competition in the prerecorded music and PC software
distribution industries is intense and is often based on price. Distributors,
such as us, generally experience low gross and operating margins. Consequently,
our profitability is highly dependent upon achieving expected sales levels as
well as effective cost and management controls. Any erosion in our gross profit
margins could harm our financial results.

TECHNOLOGY DEVELOPMENTS, PARTICULARLY IN THE ELECTRONIC DOWNLOADING ARENA, MAY
ADVERSELY AFFECT OUR SALES, MARGINS, LIQUIDITY AND RESULTS OF OPERATIONS.

Prerecorded music and PC software have traditionally been marketed and
delivered on a physical delivery basis. Traditionally, all our revenues have
been generated from sales to retail and wholesale channels. If, in the future,
these products are increasingly marketed and delivered through technology
transfers, such as "electronic downloading" through the Internet or another
delivery mechanism, then our retail and wholesale distribution business could be
negatively impacted as we presently do not do business in this distribution
channel. As physical and electronic distribution grows through Internet
resellers, competition between suppliers to electronic retailers in traditional
ways will intensify and likely negatively impact our sales and margins.
Furthermore, we may be required to spend significant capital to enter or
participate in this delivery channel. If we are unable to develop necessary
supplier relationships with electronic retailers or are unable to develop
relationships to facilitate electronic distribution of software and music, our
business may be materially harmed.

INCREASED COUNTERFEITING AND FREE OR LOW COST MUSIC DOWNLOADS MAY NEGATIVELY
AFFECT THE DEMAND FOR OUR PRODUCTS AND SERVICES.

The recorded music industry continues to be adversely affected by
counterfeiting of both audiocassettes and CDs, piracy and parallel imports, and
also by websites and technologies that allow consumers to electronically
download and access music from these sources. Increased proliferation of these
alternative access methods to these products could impair our ability to
generate revenues and could cause our business to suffer.

OUR BUSINESS PRESENTLY IS DEPENDENT ON TRADITIONAL METHODS OF MUSIC, CD AND DVD
PRODUCT DISTRIBUTION AND ANY SIGNIFICANT CHANGE IN TRADITIONAL DISTRIBUTION
METHODS COULD NEGATIVELY AFFECT CONSUMER DEMAND FOR THE PRODUCTS WE DISTRIBUTE.

Our current sales strategy will continue to be successful only if our
wholesale and retail customers continue to purchase products through us rather
than directly from manufacturers, through other distributors or through other
means of distribution. Customers and retailers are constantly searching for ways
to lower costs in an attempt to maintain competitive prices and meet the pricing
demands of consumers. Our business could be adversely affected if our customers
decide to purchase directly from manufacturers, other distributors or other
distribution channels rather than from us.

WE CANNOT OFFER ANY ASSURANCE THAT SIGNIFICANT GROWTH WILL OCCUR IN OUR
PUBLISHING SEGMENT.

We have grown our Publishing segment substantially over the past two years
through acquisitions and a recent agreement. Accordingly, this segment's
historical financial performance may not be indicative of future performance and
this segment may experience a large variability in results.

We have grown our Publishing segment significantly over the past two years
with the acquisitions of Encore (July 2002) and BCI Eclipse (November 2003) and
the recent exclusive, five-year co-publishing agreement with Riverdeep (April
2004). Our discussions of changes in financial position and results of
operations of this segment may not be indicative of future performance and this
segment's financial results may vary in future quarters as we integrate these
new lines of business. Furthermore, as these new lines of business represent new
opportunities and challenges, we may encounter difficulties in the operation of
this segment that could negatively affect this segment's financial condition and
results of operation. Investors should not place undue reliance on the past
performance of our Publishing segment or rely on statements of expected growth
in this segment.

WE MAY NOT BE ABLE TO ADEQUATELY ADJUST OUR COST STRUCTURE IN A TIMELY FASHION
IN RESPONSE TO A DECREASE IN DEMAND, WHICH MAY CAUSE OUR PROFITABILITY TO
SUFFER.

We seek to continually institute more effective operational and expense
controls to reduce selling, general and administrative, or SG&A, expenses as a
percentage of net sales. However, a significant portion of our SG&A expense is
comprised of personnel, facilities and costs of invested capital. Historically,
we have monitored and controlled the growth in operating costs in relation to
overall net sales growth and continue to pursue and implement process and
organizational changes to provide sustainable operating efficiencies. However,
in the event of a significant downturn in net sales, we may not be able to exit
facilities, reduce personnel, or improve business processes, or make other
significant changes to our cost structure without significant disruption to our
operations or without significant termination and exit costs. Additionally,
management may not be able to implement such actions, if at all, in a timely
manner to offset a shortfall in net sales and gross profit. As a result, our
profitability may suffer.

WE ARE DEPENDENT ON A VARIETY OF INFORMATION SYSTEMS AND A FAILURE OF THESE
SYSTEMS COULD DISRUPT OUR BUSINESS AND HARM OUR REPUTATION AND NET SALES.

We depend on a variety of information systems for our operations. These
systems support a number of our operational functions, including:

- inventory management;

- order processing;

- shipping;

- receiving; and

- accounting.

Although we have not in the past experienced material system-wide failures
or downtime of any of our information systems, failures or significant downtime
could prevent us from taking customer orders, printing product pick-lists,
and/or shipping product. It could also prevent customers from accessing our
price and product availability information. From time to time we may acquire
other businesses having information systems and records, which may be converted
and integrated into our information systems. This can be a lengthy and expensive
process that results in a material diversion of resources from other operations.
In addition, because our information system is comprised of a number of legacy,
internally developed applications, it can be harder to upgrade, and may not be
adaptable to commercially available software. Particularly as our needs or
technology in general evolve, we may experience greater than acceptable
difficulty or cost in upgrading our information system, or we may be required to
replace it entirely.

We also rely on the Internet for a percentage of our orders and
information exchanges with our customers. The Internet and individual websites
can experience disruptions and slowdowns. In addition, some websites have
experienced security breakdowns. To date, our website has not experienced any
material breakdowns, disruptions or breaches in security; however, we cannot
assure that this will not occur in the future. If we were to experience a
security breakdown, disruption or breach that compromised sensitive information,
this could harm our relationship with our customers or suppliers. Disruption of
our website or the Internet in general could impair our order

processing or more generally prevent our customers and suppliers from accessing
information. This could cause us to lose business.

We believe that customer information systems and product ordering and
delivery systems, including Internet-based systems, are becoming increasingly
important in the distribution of technology products and services. As a result,
we are continually enhancing our customer information systems by adding new
features, including on-line ordering through the Internet. However, we offer no
assurance that competitors will not develop superior customer information
systems or that we will be able to meet evolving market requirements by
upgrading our current systems at a reasonable cost, or at all. Our inability to
develop competitive customer information systems or upgrade our current systems
could cause our business and market share to suffer.

WE HAVE SIGNIFICANT CREDIT EXPOSURE TO OUR RESELLER CUSTOMERS AND NEGATIVE
TRENDS IN THEIR BUSINESSES COULD CAUSE US SIGNIFICANT CREDIT LOSS.

As is customary in many industries, we extend credit to our reseller
customers for a significant portion of our net sales. Resellers have a period of
time, generally 30 to 60 days after date of invoice, to make payment. We are
subject to the risk that our reseller customers will not pay for the products
they have purchased. The risk that we may be unable to collect on receivables
may increase if our reseller customers experience decreases in demand for their
products and services or otherwise become less stable, due to adverse economic
conditions. If there is a substantial deterioration in the collectibility of our
receivables or if we cannot obtain credit insurance at reasonable rates or are
unable to collect under existing credit insurance policies, our earnings, cash
flows and our ability to utilize receivable-based financing could deteriorate.

WE ARE SUBJECT TO THE RISK THAT OUR INVENTORY VALUES MAY DECLINE AND PROTECTIVE
TERMS UNDER SUPPLIER AGREEMENTS MAY NOT ADEQUATELY COVER THE DECLINE IN VALUES.

Our business is subject to rapid technological change, new and enhanced
product specification requirements, and evolving industry standards. These
changes may cause inventory in stock to decline substantially in value or to
become obsolete. It is the policy of many suppliers to offer distributors like
us, who purchase directly from them, limited protection from the loss in value
of inventory due to technological change or such suppliers' price reductions.
For example, we can receive a credit from some suppliers for products, based
upon the terms and conditions with those suppliers, in the event of a supplier
price reduction. In addition, we have a limited right to return to some
suppliers a certain percentage of purchases. These policies are often not
embodied in written agreements and are subject to the discretion of the
suppliers. As a result, these policies do not protect us in all cases from
declines in inventory value. We offer no assurance that our price protection
will continue, that unforeseen new product developments will not materially
adversely affect us, or that we will successfully manage our existing and future
inventories.

During an economic downturn, it is possible that prices will decline due
to an oversupply of product, and therefore, there may be greater risk of
declines in inventory value. If major suppliers decrease the availability of
price protection to us, such a change in policy could lower our gross margins on
products we sell or cause us to record inventory write-downs. We expect the
restrictive supplier terms and conditions to continue for the foreseeable
future. We are also exposed to inventory risk to the extent that supplier
protections are not available on all products or quantities and are subject to
time restrictions. In addition, suppliers may become insolvent and unable to
fulfill their protection obligations to us.

FUTURE TERRORIST OR MILITARY ACTIONS COULD RESULT IN DISRUPTION TO OUR
OPERATIONS OR LOSS OF ASSETS, IN CERTAIN MARKETS OR GLOBALLY.

Future terrorist or military actions, in the U.S. or abroad, could result
in destruction or seizure of assets or suspension or disruption of our
operations. Additionally, such actions could affect the operations of our
suppliers or customers, resulting in loss of access to products, potential
losses on supplier programs, loss of business, higher losses on receivables or
inventory, and/or other disruptions in our business, which could negatively
affect our operating results. We do not carry broad insurance covering such
terrorist or military actions, and even if we were to seek such coverage, the
cost would likely be prohibitive.

FAILURE TO ATTRACT NEW SOURCES OF BUSINESS FROM EXPANSION OF PRODUCTS OR
SERVICES OR ENTRY INTO NEW MARKETS COULD NEGATIVELY IMPACT OUR FUTURE OPERATING
RESULTS.

Our business is subject to rapid technological change, new and enhanced
product specification requirements, and evolving industry standards. We continue
to look for new markets for products and services to keep up with changes in
demand and to respond to competition and other changes in the distribution
industry. Failure to successfully attract new sources of business could result
in loss of revenue in the future and negatively impact our operating results.

WE ARE DEPENDENT ON THIRD-PARTY SHIPPING COMPANIES FOR THE DELIVERY OF OUR
PRODUCTS.

We rely almost entirely on arrangements with third-party shipping
companies for the delivery of our products. The termination of our arrangements
with one or more of these third-party shipping companies, or the failure or
inability of one or more of these third-party shipping companies to deliver
products from suppliers to us or products from us to our reseller customers or
their end-user customers, could disrupt our business and harm our reputation and
net sales.

OUR STOCK PRICE HAS EXPERIENCED SIGNIFICANT VOLATILITY AND CONTINUED FLUCTUATION
COULD IMPAIR OUR ABILITY TO RAISE CAPITAL AND MAKE AN INVESTMENT IN OUR
SECURITIES UNDESIRABLE.

The stock markets have experienced price and volume fluctuations,
resulting in changes in the market prices of the stock of many companies, which
may not have been directly related to the operating performance of those
companies. In addition, the market price of our common stock has historically
fluctuated significantly. We believe factors such as indications of the market's
acceptance of our products and the performance of our business relative to
market expectations, as well as general volatility in the securities markets,
could cause the market price of our common stock to fluctuate substantially. Our
stock price has experienced significant volatility, and continued fluctuation
could impair our ability to raise capital and make an investment in our
securities undesirable.

THE EXERCISE OF OUTSTANDING WARRANTS AND OPTIONS MAY ADVERSELY AFFECT OUR STOCK
PRICE.

Our stock option plan authorizes the issuance of options to purchase
5,224,000 shares of our common stock. As of March 31, 2004, options and warrants
to purchase 4,091,664 shares of our common stock were outstanding. Many of these
options and warrants are currently exercisable. These options and warrants are
likely to be exercised at a time when the market price for our common stock is
higher than the exercise prices of the options and warrants. If holders of these
outstanding options and warrants sell the common stock received upon exercise,
it may have a negative effect on the market price of our common stock.

OUR ANTI-TAKEOVER PROVISIONS, RIGHT TO ISSUE PREFERRED STOCK AND OUR STAGGERED
BOARD MAY DISCOURAGE TAKEOVER ATTEMPTS THAT COULD BE BENEFICIAL FOR OUR
SHAREHOLDERS.

We are subject to Sections 302A.671 and 302A.673 of the Minnesota Business
Corporation Act, which may have the effect of limiting third parties from
acquiring significant amounts of our common stock without our approval. These
laws, among others, may have the effect of delaying, deferring or preventing a
third party from acquiring us or may serve as a barrier to shareholders seeking
to amend our Articles of Incorporation or Bylaws. Our Articles of Incorporation
also grant us the right to issue preferred stock which could allow us to delay
or block a third party from acquiring us. These shares of preferred stock could
also possess voting and conversion rights that could adversely affect the voting
power of the holders of the common stock. Finally, our Articles of Incorporation
and Bylaws divide our board of directors into three classes that serve staggered
three-year terms. Each of these factors could make it difficult for a third
party to effect a change in control of us. As a result, our shareholders may
lose opportunities to dispose of their shares at the higher prices typically
available in takeover attempts or that may be available under a merger proposal.
In addition, these measures may have the effect of permitting our current
directors to retain their positions and place them in a better position to
resist changes that our shareholders may wish to make if they are dissatisfied
with the conduct of our business.

* * * * * * * * * *

We operate a large business in a continually changing environment that
involves numerous risks and uncertainties. It is not reasonable for us to
itemize all of the factors that could affect us and/or the products and services
distribution industry as a whole. Future events that may not have been
anticipated or discussed here could adversely affect our business, financial
condition, results of operations or cash flows.

ITEM 2. PROPERTIES

On March 12, 1998, we entered into an operating lease agreement of
approximately 86,500 square feet of office and warehouse space for our principal
facilities in suburban Minneapolis. The lease agreement, as amended, expires in
June 2019 and provides for monthly payments of $40,712 over the lease term, with
a 2.5% increase every 30 months. In addition, we are responsible for taxes and
all operating costs associated with the building.

On April 22, 1999, we entered into an operating lease agreement of
approximately 74,000 square feet of office and warehouse space for a second
facility in suburban Minneapolis. The lease expires in September 2004 and
provides for a monthly rental of $35,473 over the lease term. In addition, we
are responsible for taxes and all operating costs associated with the building.

On March 30, 2000, we entered into an operating lease agreement of
approximately 40,000 square feet of warehouse space for a third facility in
suburban Minneapolis. The lease, which expires in March 2006, provides for a
monthly rental of $13,333 over the lease term. In addition, we are responsible
for taxes and all operating costs associated with the building.

On August 2, 2002, with the acquisition of Encore Software, Inc., we
acquired their operating lease of approximately 73,245 square feet of office and
warehouse space for their principal facilities in Gardena, California. The lease
expires in February 2005 and provides for a monthly rental of $40,438 over the
term of the lease. In addition, we are responsible for taxes and all operating
costs associated with the building.

On November 3, 2003, with the acquisition of BCI Eclipse Company LLC, we
acquired their operating lease of approximately 6,534 square feet of office
space for their principal facilities in Newbury Park, California. The lease
expires in March 2005 and provides for a monthly rental of $7,089 over the term
of the lease.

On May 27, 2004, we entered into an operating lease agreement of
approximately 115,286 square feet of office and warehouse space as an addition
to our principal facilities in suburban Minneapolis. The lease expires in June
2019 and provides for monthly payments of $57,939 over the lease term, with a
2.75% increase annually. In addition, we are responsible for taxes and all
operating costs associated with the building.

We believe that our facilities are adequate for our present operations for
the foreseeable future. We continually explore alternatives to certain of these
facilities that could expand our capacities and enhance efficiencies, but no
definitive agreements have been entered into in this regard.

ITEM 3. LEGAL PROCEEDINGS

In the normal course of our business, we are involved in a number of
routine litigation matters that are incidental to the operation of our business.
These matters generally include 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 results of operation. In addition, we are
subject to the litigation listed below.

BOB GRADY AND WILSON MEADOWS V. NAVARRE CORPORATION. ET. AL

On 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. 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 filed a Notice of Appeal with the Eleventh Circuit Court of
Appeals. However, Plaintiffs did not timely file their papers as required by
appellate rules of procedure, and the appeal was administratively dismissed on
August 25, 2003. Plaintiffs moved to re-open the appeal, the Company opposed the
motion, but on September 22, 2003, the Court granted the request and accepted
the late filed papers. The Company filed its responsive appeal brief on October
22, 2003. The Court heard oral arguments on March 11, 2004.

In an Opinion filed on June 21, 2004, the Court of Appeals affirmed in
part and vacated in part the District Court's grant of summary judgment to
Company, and remanded the case to the District Court for further proceedings.
The Court of Appeals affirmed the District Court's grant of summary judgment to
the Company on Plaintiffs' non-copyright infringement claims and on certain of
Plaintiffs' copyright infringement claims. However, the Court of Appeals
reversed the District Court's grant of summary judgment to the Company on
another of Plaintiffs' copyright infringement claims, and remanded the case to
the District Court for further proceedings on that claim.

Because of the contingencies and uncertainties associated with litigation,
it is difficult, if not impossible, to opine with respect to the exposure to the
Company, if any, at this juncture.

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 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.

A jury trial commenced on May 24, 2004. During the course of the trial,
the parties settled the matter at nuisance value.

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 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. Plaintiff has not
specified in its Amended Complaint the damages it is seeking, but has demanded
in excess of $4 million.

The Company answered Plaintiff's Amended Complaint on March 29, 2004,
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. By Order dated March 26, 2004, the Court granted the Company's
motion on the negligent misrepresentation claim, but denied the motion in all
other respects. Cloud Ten requested that the Court reconsider its ruling on the
negligent misrepresentation claim. The Company opposed the request, and the
Court denied the request for reconsideration. The parties participated in
mediation on May 3, 2004, but no settlement was reached. The parties continue to
discuss settlement. On June 14, the Court set the matter for trial during the
July 2004 block or the September 2004 block. Plaintiff has suggested it would
like to change the date for trial.

Because of the contingencies and uncertainties associated with litigation
of this kind, it is difficult, if not impossible, to opine with respect to the
exposure to the Company if any, at this juncture.

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. The action has not been filed with the
Court.

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. No
further action has been taken by either party.

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 have reached an agreement to settle
for $20,000, subject to bankruptcy court approval. We were recently advised that
bankruptcy approval of the settlement has been secured. We are in the process of
consummating the settlement.

AMERICAN GRAMAPHONE AND NAVARRE CORPORATION ARBITRATION
AMERICAN ARBITRATION ASSOCIATION, AAA FILE NO. 72 140 00263 04 SUBR.

On March 5, 2004, American Gramaphone commenced an arbitration proceeding
against the Company in California. Navarre has objected to the locale choice of
American Gramaphone and American Gramaphone has agreed that the arbitration
should occur in either Omaha, Nebraska or Minneapolis, Minnesota. The AAA has
not yet ruled on the locale issue. The arbitration dispute stems from the
Company's distribution of 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 Gramaphone, LLC has
notified the Company that it believes sums in excess of $250,000 are owed to it.
The Company disputes these claims.

On June 11, 2004, the parties reached an agreement to settle this matter,
in conjunction with the next matter listed, and the settlement documents are
being prepared by American Gramaphone's counsel.

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. 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. On March 8, 2004, the Court
granted Plaintiff's motion for temporary injunction.

On June 11, 2004, the parties agreed to settle the matter, in conjunction
with the prior case, and the settlement documents are being prepared by
Plaintiff's counsel.

MICHAEL J. MATTHEWS D/B/A MJM MANAGEMENT V. NAVARRE CORPORATION, ET AL.

On January 2, 2004, Plaintiff commenced this action against the Company
and others by filing with the District Court of Harris County, Texas,
Plaintiff's Original Petition and Application for Temporary Restraining Order.
Plaintiff served the Company by mail on or about January 12, 2004. While the
Plaintiff alleges five causes of action, the only claim alleged against the
Company is for business disparagement in connection with the Company's
distribution of certain works of "Silk," which Plaintiff claims contained
information regarding the business manager of "Silk" which was defamatory as to
Plaintiff.

The Company filed a petition to remove the matter to the United States
District Court for the Southern District of Texas, Houston Division, on February
4, 2004, and filed a motion to dismiss Plaintiff's Complaint against the Company
with prejudice on the merits for failure to state a claim. Plaintiff's counsel
has indicated that Plaintiff intends to dismiss the claims against Navarre
voluntarily, but to date no such dismissal petition has been filed by Plaintiff.
The Court has not yet ruled on the Company's motion to dismiss.

DATA BECKER CORPORATION CLAIM

On April 5, 2004, the Company received correspondence from Stewart F.
Grossman, the Assignee for the Benefit of Creditors of Data Becker Corporation
("Data"). The Assignee asserts that the Company owes the Assignee $307,201.28 in
connection with the Company's distribution of Data's products. The Company has
asserted rights of setoff and recoupment arising from potential product returns.
At present, no suit has been commenced against the Company by the Assignee. The
Company and the Assignee are in the process of discussing their respective
positions.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders during the
three-month period ended March 31, 2004.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

PRICE RANGE OF COMMON STOCK

Our Common Stock has been quoted on The NASDAQ Stock Market under the
symbol NAVR. The following table presents the range of high and low closing sale
prices for our stock for each period indicated as reported on The NASDAQ Stock
Market. Such prices reflect inter-dealer prices, do not include adjustments for
retail mark-ups, markdowns or commissions and may not necessarily represent
actual transactions.

QUARTER HIGH LOW
----------------------------------------

Fiscal 2004 First $ 2.37 $ 1.67
Second 3.00 1.96
Third 7.13 2.74
Fourth 7.44 5.85

Fiscal 2003 First $ 1.80 $ 1.11
Second 1.67 1.20
Third 2.66 1.02
Fourth 2.40 1.52

HOLDERS AND DIVIDENDS

At June 15, 2004, we had 703 common shareholders of record and an
estimated 9,800 beneficial owners whose shares were held by nominees or broker
dealers. We have never paid any dividends on our common stock and do not intend
to pay any dividends on our common stock in the foreseeable future.

EQUITY COMPENSATION PLAN INFORMATION

We adopted our 1992 Stock Option Plan to attract and retain persons to
perform services for us by providing an incentive to these persons through
equity participation in the Company and by rewarding such persons who contribute
to the achievement of our economic objectives. Eligible recipients are all
employees including, without limitation, officers and directors who are also our
employees as well as our non-employee directors, consultants and independent
contractors or of any of our subsidiaries. A maximum number of 5,224,000 shares
of common stock have been authorized and reserved for issuance under the Plan.
The number of shares authorized

may also be increased from time to time by approval of the Board and the
shareholders. The Plan terminates on July 1, 2006.

We are authorized to grant stock options and restricted stock grants under
the Plan. Options generally vest in increments of 20% of the original option
grant beginning one year from the date of grant and expire six years from the
date of grant, subject to early termination upon death, disability or
termination of employment. Performance-based options are subject to variable
accounting and will be recognized when, and if, the criteria are met for
vesting.

On April 1 of each year, each director who is not an employee of Navarre
is granted an option to purchase 6,000 shares of common stock under the Plan, at
a price equal to fair market value. These options are designated as
non-qualified stock options and are subject to the same terms and provisions as
are then in effect with respect to granting of non-qualified stock options to
salaried officers and key employees of Navarre. These options vest in increments
of 20% of the original option grant beginning one year from the date of grant
and expire six years from the date of grant.

We are entitled to (a) withhold and deduct from future wages of the
participant (or from other amounts that may be due and owing to the participant
from us), or make other arrangements for the collection of, all legally required
amounts necessary to satisfy any and all federal, state and local withholding
and employment-related tax requirements (i) attributable to the grant or
exercise of an option or a restricted stock award or to a disqualifying
disposition of stock received upon exercise of an incentive stock option, or
(ii) otherwise incurred with respect to an option or a restricted stock award,
or (iii) require the participant promptly to remit the amount of such
withholding to us before taking any action with respect to an option or a
restricted stock award.

The following table below presents our Equity Compensation Plan
information:

Number of securities
remaining available for future
Plan Category Number of securities to be issuance under equity
issued upon exercise of Weighted-average exercise compensation plans
outstanding options, price of outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))

(a) (b) (c)
Equity compensation plans
approved by security holders 2,927,200 $3.41 357,154

Equity compensation plans
not approved by security
holders -0- -0- -0-
========= ===== =======
Total 2,927,200 $3.41 357,154
========= ===== =======

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data should be read in conjunction with
our financial statements and related notes, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and other financial
information appearing elsewhere in this annual report on Form 10-K. We derived
the following historical financial information from the consolidated financial
statements of Navarre for the fiscal years ended March 31, 2004, 2003, 2002,
2001 and 2000 which have been audited by Ernst & Young LLP.

(In thousands, except per share data)
FISCAL YEARS ENDED MARCH 31,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----

STATEMENT OF OPERATIONS DATA:

Net sales $ 475,244 $ 359,384 $ 303,817 $ 314,199 $ 285,165
Gross profit, exclusive of
amortization and depreciation 57,340 45,013 32,893 37,421 36,381
Income (loss) from operations 9,147 4,005 521 (2,364) (4,554)

Interest expense (378) (194) (173) (223) (476)
Other income (expense) (456) 447 884 2,000 1,399
Net income (loss) before tax 8,313 4,321 2,712 (10,925) (7,785)
Tax benefit 583 ---- ---- ---- ----

Net income (loss) $ 8,896 $ 4,321 $ 2,712 $ (10,925) $ (7,785)

Income (loss) per basic share $ .39 $ .20 $ .12 $ (.47) $ (.33)
Income (loss) per diluted share $ .37 $ .20 $ .12 $ (.47) $ (.33)
Basic weighted average common
shares outstanding 22,780 21,616 22,553 25,137 23,483
Diluted weighted average common
shares outstanding 24,112 21,841 22,575 25,137 23,483

BALANCE SHEET DATA:

Total assets $ 146,927 $ 101,129 $ 81,085 $ 93,918 $ 109,711
Short-term borrowings 651 805 ---- ---- ----
Long-term debt ---- 268 ---- ---- ----
Shareholders' equity 55,568 28,671 24,350 24,350 41,423

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

EXECUTIVE SUMMARY

Fiscal 2004 was a year of growth for Navarre Corporation. Our consolidated
net sales for fiscal 2004 increased 32% to $475.2 million compared to $359.4
million in fiscal 2003. This growth was achieved through increases in all of our
product groups. Our gross profit increased to $57.3 million or 12.1% of net
sales compared with $45.0 million or 12.5 % of net sales for fiscal 2003. The
main cause of the decrease as a percent of net sales for fiscal 2004 was due to
a $5.6 million impairment charge for the capitalized product development costs
associated with the Dare Devil video game. Total operating expenses for fiscal
2004 were $48.2 million or 10.1% of net sales, compared with $41.0 million or
11.4% of net sales for fiscal 2003. We incurred a slight increase in expenses
during fiscal 2004 due to the addition of BCI Eclipse in November 2003 as well
as $705,000 in charges related to stock-based compensation. Net income increased
to $8.9 million or $0.37 per diluted share compared to $4.3 million or $0.20 per
diluted share for last year.

We acquired the assets of BCI Eclipse in November 2003. This acquisition
strengthened our Publishing business with a provider of niche DVD/video
products. We expect this segment to grow substantially during fiscal 2005 with
the addition of business generated through our five-year exclusive agreement to
distribute Riverdeep products as announced in April 2004. In December 2003, we
completed a private placement in public equity financing ("PIPE") that netted
$11,735,000 from the sale of 2,631,547 shares of common stock with 657,887 five
year stock purchase warrants exercisable at $7.00 per share. The Company used
the net proceeds to pay off acquisition debt incurred to purchase BCI Eclipse
and the remainder was made available for, among other things, general working
capital needs.

OVERVIEW

Navarre Corporation, a Minnesota corporation formed in 1983, publishes and
distributes a broad range of home entertainment and multimedia products,
including PC software, audio and video titles and interactive games. Our
business is divided into two business segments -- Distribution and Publishing.
Through these business segments we maintain and leverage strong relationships
throughout the publishing and distribution chain.

Our broad base of customers includes: (i) wholesale clubs, (ii) mass
merchandisers, (iii) other third-party distributors, (iv) computer specialty
stores, (v) music specialty stores, (vi) book stores, (vii) office superstores,
and (viii) electronic superstores. Our customer base includes over 500
individual customers with over 18,000 locations, certain of which are
international locations.

Through our Distribution business we distribute and provide fulfillment
services in connection with a variety of finished goods that are provided by our
vendors, which include a variety of publishers, independent and major music
labels, and movie studios. These vendors provide us with PC software, CD and DVD
audio, DVD and VHS video, video games and accessories. Our Distribution business
focuses on providing retailers and publishers with high-quality services for the
broad, efficient distribution of these products, including vendor-managed
inventory, Electronic Data Interchange services, fulfillment services, and
retailer-oriented marketing services.

Much of our growth in the Publishing segment over the last two fiscal
years was accomplished by acquisition. In July 2002, we purchased the primary
assets of Encore Software, Inc., a publisher of entertainment and education PC
products. In November 2003 we purchased the primary assets of BCI Eclipse, Inc.,
a provider of niche DVD/video products. In addition, In April 2004, we signed an
exclusive five-year co-distribution agreement with Riverdeep that we expect will
significantly increase this segment's revenues and profits. This rapid growth
(and expected growth) may make this segment's results in future periods more
uncertain and less predictable.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in conformity with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we review and evaluate our estimates,
including those related to customer programs and incentives, product returns,
bad debt, inventories, investments, intangible assets, restructuring reserves
and litigation. We base our estimates on historical experience and various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results could differ from these estimates under different assumptions or
conditions.

We believe the following critical accounting policies are affected by our
judgment, estimates and/or assumptions used in the preparation of our
consolidated financial statements.

Revenue Recognition

The Company recognizes revenue at the time product is received by our
customers and title has passed, and provides a reserve for sales returns based
on the trailing twelve months' experience by product line. These assumptions
have been reasonably accurate, resulting in a sales return reserve accuracy of
approximately 99% of actual sales returns in each of the past three years. Our
actual sales return rates average between 14 to 20% over the past three years.
The Company's selling price is fixed at the time of shipment and invoicing. The
terms of our sales agreements are not contingent upon the resale of the product
by our customers, and we have no continuing obligation to our customers.

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 revenues with corresponding
reductions in cost of goods sold in the period of the initial sale to customers.

The Company does at times provide certain price protection, promotional
monies, back-end volume rebates and other incentives to customers in its
publishing business. The Company records reserves for these incentives based on
trailing twelve months' experience rates by product line. The Company records
these amounts as reductions in revenue at the time the original revenue is
recorded.

Although our past experience has been a good indicator of future return
levels and other revenue reductions, there can be no assurance that our current
reserve levels will be adequate in the future.

Allowance for Doubtful Accounts

The Company performs periodic credit evaluations of its customers'
financial condition and generally does not require collateral. Receivables
generally are due within sixty days. We evaluate the collectibility of our
accounts receivable, including advances and balances with independent labels,
based on a combination of factors. In circumstances where we are aware of a
specific customer's inability to meet their financial obligations to us (e.g.,
bankruptcy filings, substantial down-grading of credit scores), we record a
specific reserve for bad debts against amounts due to reduce the net recognized
receivable to the amounts we reasonably believe will be collected. For all other
customers, we recognize reserves for bad debts based on the length of time the
receivables are past due based on our historical experience of write-offs of
accounts with similar characteristics. Our largest collection risks exist for
retail customers that are in bankruptcy, or at risk of bankruptcy. The
occurrence of these events is infrequent, but can be material when it does
occur. For instance, although our overall rate of uncollectible sales over the
past three years has been approximately .4% of sales, the largest amounts
resulted from the bankruptcy of Pacific Coast One Stop, Inc. and Valley Media,
Inc., which resulted in write-offs of approximately $2.6 million. Although
credit losses relating to customers consistently have been within management's
expectations, if circumstances change (i.e., higher than expected defaults or an
unexpected material adverse change in a major customer's ability to meet its
financial obligations to us), our estimates of the recoverability of amounts due
could be reduced by a material amount.

Goodwill Impairment

We review goodwill for potential impairment annually for each reporting
unit and when events or changes in circumstances indicate the carrying value of
the goodwill might exceed its current fair value. We have no goodwill associated
with our Distribution segment, while our Publishing segment has two reporting
units that have goodwill - Encore and BCI Eclipse. We determine fair value using
widely accepted valuation techniques, including discounted cash flow and market
multiple analysis. These types of analyses require us to make certain
assumptions and estimates regarding industry economic factors and the
profitability of future business strategies. It is our policy to conduct
impairment testing once annually based on our most current business strategy in
light of present industry and economic conditions, as well as future
expectations. The Company's goodwill of $10.4 million as of March 31, 2004
consists of $3.1 million associated with our acquisition of Encore, and $7.3
million associated with our acquisition of BCI Eclipse LLC. Prior to a $5.6
million impairment charge for the capitalized product development costs
associated with the Dare Devil video game, Encore provided approximately $2.0
million of operating profit during the year ended March 31, 2004, while BCI
Eclipse provided approximately $1.7 million of operating profit since we
acquired it on November 3, 2003. If the operating results for Encore and BCI
Eclipse deteriorate considerably and are not consistent with our assumptions and
estimates, we may be exposed to a goodwill impairment charge that could be
material.

Cost Associated with Exit Activities

We adopted SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities on January 1, 2003. Since adoption, the present value of
costs associated with location closings, primarily future lease costs, real
estate taxes and common area maintenance, are charged to earnings when a
location is vacated. When applicable, the liability is reduced by estimated
future sublease income. Prior to our adoption of SFAS No. 146, a liability for
location closings was recognized when management made the commitment to relocate
or close the location.

Tax Matters

Income taxes are recorded under the liability method. Deferred income
taxes are provided for temporary differences between the financial reporting and
tax bases of assets and liabilities. Deferred tax assets are reduced by
valuation allowances if it is more likely than not that some portion of the
asset will not be realized. The Company's net deferred income tax assets were
completely reserved for fiscal 2002 and 2003 because of its recent history of
pre-tax losses. Reversals of these valuation reserves during fiscal 2002, 2003,
and 2004 have resulted in the recording of tax benefits associated with its
utilization of net operating loss carryforwards. In addition to recognizing tax
benefits related to utilization of net operating loss carryforwards in fiscal
2004, the Company has also recognized an additional $1.0 million of tax benefit
related to the reversal of a like amount of valuation reserve. Such amount of
valuation reserve reversal was made due to the increasing probability of its
ability to generate near-term pre-tax income. We continue to maintain a
valuation allowance on the majority of our remaining net operating loss carry
forwards, and it is possible that our fiscal 2005 results could include the
reversal of additional amounts of tax valuation reserves, which will be recorded
as a reduction of income tax expense to the extent that our taxable income
exceeds certain levels.

Capitalized Software Development Costs

Software costs incurred subsequent to the determination of the
technological feasibility of software products are capitalized. Capitalization
ceases and amortization of costs begin when the software product is available
for general release to customers or shipment has begun. The Company tests for
possible impairment whenever events or changes in circumstances, such as a
reduction in expected cash flows indicating 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.
If the carrying value is greater than the undiscounted cash flow amount, an
impairment charge is recorded in cost of goods sold in the statement of
operations for amounts necessary to reduce value of the asset to fair value. The
Company has recorded an impairment charge associated with product development
costs in fiscal 2004 of $5.6 million. The Publishing segment subsequently closed
product development activities so no such charges are expected to occur in the
future.

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."

FISCAL YEARS ENDED MARCH 31,
2004 2003 2002
------- ------- -------

Net sales:
Distribution 94.5% 99.0% 100.0%
Publishing 9.7 4.1 ----
Elimination of sales (4.2) (3.1) ----
------- ------- -------
Total net sales 100.0 100.0 100.0
Cost of sales 87.9 87.5 89.2
------- ------- -------
Gross profit, exclusive of
amortization and depreciation 12.1 12.5 10.8
Selling and marketing 3.4 3.7 2.7
Distribution and warehousing 1.3 1.5 1.7
General and administrative 4.9 5.6 5.6
Depreciation and amortization 0.4 0.6 0.5
Restructuring ---- ---- 0.2
Stock-based compensation 0.2 ---- ----
------- ------- -------
Total operating expenses 10.2 11.4 10.7
------- ------- -------
Income from operations 1.9 1.1 0.2
Debt extinguishment (0.2) ---- ----
Interest expense (0.1) (0.1) (0.1)

Other income 0.1 0.2 0.8
Tax benefit 0.2 ---- ----
--- ---- -----
Net income 1.9 1.2 0.9
=== ==== =====

Certain information in this section contains forward-looking statements.
Our actual results could differ materially from the statements contained in the
forward-looking statements as a result of a number of factors, including risks
and uncertainties inherent in our business, dependency upon key employees, the
seasonality of our business, dependency upon significant customers and vendors,
erosions in our gross profit margins, dependency upon bank borrowings, obtaining
additional financing when required, dependency upon software developers and
manufacturers, dependency upon recording artists, risks of returns and inventory
obsolescence, effect of technology developments, effect of free music downloads,
change in retailers methods of distribution and the possible volatility of our
stock price. See "Business - Forward-Looking Statements / Important Risk
Factors" in Item 1 of the Form 10-K.

DISTRIBUTION SEGMENT

The Distribution segment distributes software, video games, accessories,
major label music, and DVD video, as well as independent music.

Fiscal 2004 Results Compared With Fiscal 2003

Net Sales

Net sales for the Distribution segment were $449.1 million for fiscal 2004
compared to $355.9 million for fiscal 2003. The 26% increase in net sales for
fiscal 2004 was principally due to strong increases in sales across all of our
distribution product groups. In particular, software continues to expand its
market share presence across all categories. Internet security and anti-virus
products remained strong in light of continued virus outbreaks. Sales increased
in this product group to $317.8 million during fiscal 2004. Major label music,
DVD video and Video Games grew to $74.4 million in fiscal 2004 due to the
combinations of increased publisher and customer rosters and benefited from
strong releases throughout the year. Independent music also grew to $56.0
million in fiscal 2004 due to its increased label and artist roster and its
continued focus on catalog across all music genres. Future sales increases will
be dependent upon the Company's ability to continue to add new, appealing
content.

Gross Profit

Gross profit for the Distribution segment was $48.1 million or 10.7% as a
percent of net sales for fiscal 2004 compared to $39.2 million or 11.0% as a
percent of net sales for fiscal 2003. The decrease in gross profit as a percent
of net sales for fiscal 2004 was due to lower margins from the growth of our
video game distribution business. Video game distribution generally has a lower
margin throughout the industry, however, video games are sold on a one-way basis
with no returns by the customer allowed; therefore, the lower handling costs of
the product offset some of the lower margins as it relates to profitability. In
addition, we experienced lower margins with the continuation of the expansion of
our market share in software categories such as business and productivity which
generally have lower gross margins as much of the product is considered legacy
product; however, these product categories tend to sell at higher dollar price
points and generally have fewer returns. We expect gross profit to fluctuate
slightly depending upon the make-up of product sales each quarter as the Company
continues to expand its market share in business and productivity software and
video games. We experienced higher margins from sales of independent music in
fiscal 2004 due to our continuing efforts to sign new labels at higher
distribution rates. We would expect this trend to continue as we continue to
focus on high quality labels that provide higher overall margins. To the extent
the Company continues to grow its share of legacy products from large vendors at
a rate faster than certain entertainment products from the smaller vendors, we
would expect a slightly overall margin decrease in future years.

The Company expects gross margins to increase as our Publishing business
grows to become a larger share of our overall business. Publishing margins are
in the 38 to 42% range compared to Distribution margins which are in the 11 to
13% range.

Operating Expenses

Total operating expenses for the Distribution segment were $37.0 million
or 8.2 % as a percent of net sales for fiscal 2004 compared to $35.2 million or
9.9% as a percent of net sales for fiscal 2003.

Selling and marketing expenses for the Distribution segment were $9.8
million or 2.2% as a percent of net sales for fiscal 2004 compared to $10.7
million or 3.0% as a percent of net sales for fiscal 2003. The decrease for
fiscal 2004 resulted from our improved efforts to reduce freight costs. Freight
cost, as a percent of sales, decreased to 1.4% in fiscal 2004 compared to 1.8%
in fiscal 2003. Additionally, we recorded an expense of $680,000 in fiscal 2003
in connection with the write-off of specialty product display sales racks. The
Company manages these expenses on a percentage basis and would expect to remain
in the 2.7-3.0% of net sales range.

Distribution and warehousing expenses for the Distribution segment were
$6.0 million or 1.3% as a percent of net sales for fiscal 2004 compared to $5.5
million or 1.5% as a percent of net sales for fiscal 2003. The decrease as a
percentage of net sales resulted from overall improved efficiency of warehousing
expenses such as "one way" video game business, higher priced software
categories such as business and productivity, and in part, efficiencies
associated with a higher level of sales. The Company will continue to seek
efficiencies in this area, but will continue to manage expenses at approximately
1.5% of net sales.

General and administrative expenses for the Distribution segment consist
principally of executive, accounting and administrative personnel and related
expenses, including professional fees. General and administrative expenses for
the Distribution segment were $19.2 million or 4.3% as a percent of net sales
for fiscal 2004 compared to $17.8 million or 5.0% as a percent of net sales for
fiscal 2003. The increase in general and administrative expenses for fiscal 2004
resulted from an increase in IT expense of $476,000 which is based on sales
volume, and $891,000 for executive, accounting and administrative personnel
required as our business grows. The decrease as a percent of net sales for
general and administrative expenses for fiscal 2004 was attributable to our
continued increased efforts to control expenses as a percent of net sales. While
overall general and administrative expenses are expected to increase, we feel
that the increase will be at a rate less than our sales growth rate, thus
allowing us to leverage our existing infrastructure. We expect that expenses
will continue to be managed in a 4.8-5.2% range.

Depreciation and amortization for the Distribution segment remained flat
at $1.3 million for fiscal 2004 and for fiscal 2003.

During fiscal 2004, we recorded a non-cash charge of $705,000 for
stock-based compensation relating to the vesting of option shares exercisable
under option agreements for certain key employees.

The net operating income for the Distribution segment was $11.0 million
for fiscal 2004 compared to $4.0 million for fiscal 2003.

Fiscal 2003 Results Compared With Fiscal 2002

Net Sales

Net sales for the Distribution segment were $355.9 million for fiscal 2003
compared to $303.8 million for fiscal 2002. The 17% increase in net sales for
fiscal 2003 was due to the continued increase in our market share across all
categories of the software industry, particularly with additions to our
publisher roster of business and productivity product lines. Sales of
independent music increased due to the addition of new content that broadened
our reach across all musical genres and our rich offering of catalog titles that
continues to lessen our reliance on new releases.

Gross Profit

Gross profit for the Distribution segment was $39.2 million or 11.0% as a
percent of net sales for fiscal 2003 compared to $32.9 million or 10.8% as a
percent of net sales for fiscal 2002. The increase in gross profit and as a
percent of net sales for fiscal 2003 was attributable to higher margins on sales
of independent music from new

labels with higher distribution rates but on the other hand software categories
such as business and productivity experienced lower margins.

Operating Expenses

Total operating expenses for the Distribution segment was $35.2 million or
9.9% as a percent of net sales for fiscal 2003 compared to $32.4 million or
10.7% as a percent of net sales for fiscal 2002.

Selling and marketing expenses for the Distribution segment was $10.7
million or 3.0% as a percent of net sales for fiscal 2003 compared to $8.1
million or 2.7% as a percent of net sales for fiscal 2002. The increase in
fiscal 2003 included an expense item of $680,000 resulting from our purchase of
specialty product display sales racks for a distribution method that failed to
achieve expected results. The decrease in selling and marketing expenses and as
a percent of net sales for fiscal 2002 was due to the lower costs associated
with improved management of and communication with our vendors to reduce the
need for expedited freight.

Distribution and warehousing expenses for the Distribution segment was
$5.5 million or 1.5% as a percent of net sales for fiscal 2003 compared to $5.2
million or 1.7% as a percent of net sales for fiscal 2002. The decrease as a
percent of net sales was the effect of overall increased efficiencies as we
continue to find ways to lower the overall expenses.

Depreciation and amortization expense for the Distribution segment was
$1.3 million in fiscal 2003 compared to $1.5 million in fiscal 2002. Included in
fiscal 2002 was a charge of $356,000 associated with the relocation of the
Hawaiian location.

The net operating income for the Distribution segment was $4.0 million for
fiscal 2003 compared to $521,000 for fiscal 2002.

PUBLISHING SEGMENT

The Publishing segment includes Encore Software and BCI Eclipse. We
acquired the assets of BCI Eclipse, LLC on November 3, 2003 and the assets of
Encore Software, Inc. on July 31, 2002. No comparison of operations is included
herein for fiscal 2003 to fiscal 2002 as we had no operations in this segment in
fiscal 2002.

Fiscal 2004 Results Compared With Fiscal 2003

Net sales for the Publishing segment were $46.2 million (before
inter-company sales elimination of $20.0 million) for fiscal 2004 and $14.7
million (before inter-company sales elimination of $11.2 million) for fiscal
2003. $8.0 million of the growth was due to the addition of the BCI Eclipse
business in November 2003.

Gross profit for the Publishing segment was $9.3 million or 35.6% as a
percent of net sales for fiscal 2004 and $5.8 million or 39.4% as a percent of
net sales for fiscal 2003. The gross margin decrease was due to a $5.6 million
impairment charge for the capitalized product development costs associated with
the Dare Devil video game. The Publishing segment subsequently ceased product
development activities.

Operating expenses for the Publishing segment were $11.1 million for
fiscal 2004, including $5.7 million for sales and marketing expenses, $752,000
for licensing and development expenses, $4.0 million for general and
administration expenses and $673,000 for depreciation and amortization expense.
For fiscal 2003, operating expenses were $5.8 million, including $2.2 million
for sales and marketing expenses, $468,000 for licensing and development
expenses, $2.3 million for general and administration expenses and $822,000 for
depreciation and amortization expense, which included a charge of $501,000 for
certain intangible assets that were deemed impaired

subsequent to the acquisition of Encore. The expense increase in fiscal 2004 was
due to the addition of BCI in November 2003.

The Publishing segment had an operating loss of $1.9 million for fiscal
2004 and operating income of $41,000 for fiscal 2003.

We expect significant growth in this segment with the inclusion of BCI
Eclipse results of operations for a full year and with the addition of
approximately $45-$55 million in revenues expected to be generated from
distribution of Riverdeep products during fiscal 2005.

CONSOLIDATED OTHER INCOME AND EXPENSE

Interest expense was $378,000 for fiscal 2004, $194,000 for fiscal 2003,
and $173,000 for fiscal 2002. The increase in interest expense for fiscal 2004
resulted from our use of our line of credit and the Hilco mezzanine financing
incurred in connection with the acquisition of BCI. The increase in interest
expense for fiscal 2003 was primarily due to having a credit facility in place
for the full year. Other income, which consists principally of interest income
on available cash balances, was $452,000 for fiscal 2004, $447,000 for fiscal
2003, and $884,000 for fiscal 2002. Lower interest rates resulted in the
decrease for fiscal 2003.

During the third quarter of fiscal 2004, we recorded a non-recurring
charge incurred in connection with the complete discharge of the Hilco financing
used for the BCI Eclipse acquisition of $908,000, consisting of deferred debt
acquisition fees of $536,000 and the fair value of the warrants issued to the
lender of $372,000.

Subsequent to November 5, 1999, we owned an equity position in NetRadio
that constituted less than 50% of the outstanding equity interests in this
company. Accordingly, NetRadio results for fiscal 2003 and 2002 are reflected in
our financial statements using the equity method. Under the equity method,
Navarre reported losses or income in NetRadio for each period as "Impact of
investment in NetRadio Corporation." The impact of the investment in NetRadio
Corporation was income of $63,000 for fiscal 2003 and income of $1.5 million for
fiscal 2002. This entity was dissolved on January 15, 2003.

We recorded a tax net benefit of $583,000 for fiscal 2004. We utilized
existing net operating loss carry forwards in fiscal 2004. Because these net
operating loss carryforwards had been completely reserved, we incurred no
federal income tax expense on the majority of our earnings. As of March 31,
2004, we have approximately $10.9 million of net operating losses remaining. We
also reversed an additional $1.0 million of our deferred tax asset valuation
reserve in the fourth quarter of fiscal 2004, resulting in a further tax
benefit. We currently have a remaining valuation allowance of $6.7 million and
it is possible that our fiscal 2005 results could include the reversal of
additional amounts of tax valuation reserves, which would be recorded as a
reduction of income tax expense to the extent that our taxable income exceeds
certain levels.

MARKET RISK

Although we are subject to some interest rate risk, because we currently
have limited borrowings under our bank credit facility, weI 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.

SEASONALITY AND INFLATION

Quarterly operating results are affected by the seasonality of our
business. Specifically, our third quarter (October 1 - December 31) typically
accounts for our largest quarterly revenue figures and a substantial portion of
our earnings. As a distributor of products ultimately sold to retailers, our
business is affected by the pattern of seasonality common to other suppliers of
retailers, particularly during the holiday selling season. Inflation is not
expected to have a significant impact on our business, financial condition or
results of operations since we can generally offset the impact of inflation
through a combination of productivity gains and price increases.

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed our working capital needs through cash
generated from operations, bank borrowings, proceeds from the sale of equity
securities and management of the various components of our working capital,
including accounts receivable, inventory and accounts payable. The level of
borrowings has historically fluctuated significantly during the year. At March
31, 2004, we had net accounts receivable of $72.3 million, inventory of $30.2
million, accounts payable of $84.3 million and no bank debt.

Cash flow from operations of $7.4 million was primarily the result of net
income of $8.9 million, depreciation and amortization of $2.0 million, and
non-cash impairment charges of $1.3 million, offset by net reductions in working
capital of $4.8 million for 2004. Investing activities used $15.5 million of
cash of which $10.5 million was related with the acquisition of BCI Eclipse and
$5.0 million for the purchase of furniture, equipment and leasehold
improvements. Financing activities provided cash of $12.1 million during the
period primarily from the proceeds of a private placement of $11.7 million.

In October 2001, we entered into a credit agreement with General Electric
Capital Corporation, a/k/a GE Commercial Finance (GECC), for a three-year $30
million credit facility for use in connection with the Company's working capital
needs. In June 2004 this credit agreement was amended and restated to, among
other things, extend the term of the agreement to December of 2007 and to
provide for two senior secured facilities: a $10 million revolving acquisition
facility, and a $40 million revolving working capital facility. Additionally,
$10 million of the $40 million revolving working capital facility may be used by
the company for acquisitions, providing the Company with an aggregate revolving
acquisition availability of up to $20 million. The Company's ability to borrow
is based upon its compliance with certain requirements and financial covenants.
We anticipate that we may borrow amounts under this credit facility from time to
time during fiscal 2005 to meet our seasonal working capital requirements.

In association with GECC credit facility agreement, we also pay certain
facility and agent fees. During fiscal year 2004, the maximum amount the Company
borrowed under the credit facility was $9.1 million. As of March 31, 2004, the
Company had no balance under this facility. Interest under the GECC line of
credit is at the Index Rate plus .25% (4.5%) at March 31, 2004 and is payable
monthly. Interest paid under this facility was $378,000, $194,000, and $173,000
for the years ended March 31, 2004, 2003, and 2002, respectively.

Under this agreement the Company is required to meet certain covenants.
These covenants include a variety of financial metrics that are used to
determine the overall financial stability of the Company and include limitations
on the Company's capital expenditures, restrictions on the lending of the
Company to its subsidiaries and affiliates, a minimum EBITDA that must be
generated through the Company's operations, a minimum ratio of EBITDA to fixed
charges, and a minimum of indebtedness to EBITDA. The Company was in compliance
with these covenants as of March 31, 2004. We anticipate that we may borrow
amounts under this credit facility from time to time during fiscal 2005 to meet
our seasonal working capital requirements.

We currently believe funds generated from the expected results of
operations and available cash and cash equivalents and borrowings under our $40
million credit facility will be sufficient to satisfy our working capital
requirements and finance organic expansion plans and strategic initiatives for
the next fiscal year, and otherwise in the long-term absent significant
acquisitions. We have stated our plans to grow through acquisitions, however,
and such opportunities will likely require the use of equity or debt capital,
some combination thereof or other financing.

The Company is currently in the process of completing a new warehouse
adjacent to the Company's headquarter building in New Hope, Minnesota. The
Company funded the construction from its working capital line and a $4.55
million construction loan from the Business Bank. Upon completion, the Company
has agreed to sell the building to AIC Ventures for $6.4 million and pay off
amounts owed to the Business Bank. The Company will enter into a 15-year lease
at approximately $55,000 per month. In addition to that lease, the Company will
maintain its current lease on a 15 year basis with the headquarter building. The
Company then expects to exit out of its two remaining leased facilities within
3-4 months after completion of the new building, as those functions will move to
the new facility.

During the year ended March 31, 2003, we acquired the primary assets of
Encore Software, Inc. ("Encore") pursuant to an Amended and Restated Asset
Purchase Agreement between the Company and Encore effective as of July 10, 2002,
as amended by amendment No. 1 to the Agreement effective as of July 31, 2002
(collectively, the

"Purchase Agreement"). The transaction was approved by the Bankruptcy Court for
the Central District of California and closed on August 2, 2002. We paid
approximately $7.9 million in cash and assumed $1.6 million in debt. The assets
purchased by the Company included certain fixed assets, intellectual property,
inventory, receivables, and contract rights related to Encore's business. We
acquired Encore, an interactive publisher in the video game and PC CD-ROM
markets, to enable us to more actively participate in the high growth video game
industry and enable us to further extend our direct distribution relationships
with large retailers generating solid sell-through of Encore titles. The
acquisition was 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 allocation of the purchase price to the assets acquired
was finalized in the fourth quarter of fiscal 2003. The final purchase price
resulted in an increase of $786,000 to goodwill from our preliminary allocation.

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 $10.4 million in cash and $5.1 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
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 was 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 final statements from the date of acquisition. The purchase
price has been allocated on a preliminary basis using information currently
available. The allocation of the purchase price to the assets acquired will not
likely be finalized until the second quarter of fiscal 2005. 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 $7.3 million.

To fund the acquisition of BCI/Eclipse the Company initially took out a $6
million mezzanine loan with Hilco Capital L.P. This debt was subsequently paid
off with the funds from the Company's private placement. During the third
quarter of fiscal 2004, we recorded a non-recurring charge incurred in
connection with the complete discharge of the Hilco financing used for the BCI
Eclipse acquisition of $908,000, consisting of deferred debt acquisition fees of
$536,000 and the fair value of the warrants issued to the lender of $372,000.

CONTRACTUAL OBLIGATIONS

The following table presents information regarding contractual obligations
that exist as of March 31, 2004 by fiscal year (in thousands).

2005 2006 2007 2008 2009 THEREAFTER
---- ---- ---- ---- ---- ----------

Operating leases $1,457 $ 711 $ 546 $ 510 $ 510 $2,213
Total .......... $1,457 $ 711 $ 546 $ 510 $ 510 $2,213
====== ====== ====== ====== ====== ======

ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk refers to the risk that a change in the level of one or more
market prices, interest rates, indices, volatilities, correlations or other
market factors such as liquidity will result in losses for a certain financial
instrument or group of financial instruments. We do not hold or issue financial
instruments for trading purposes, and do not enter into forward financial
instruments to manage and reduce the impact of changes in foreign currency rates
because we have few foreign relationships and substantially all of our foreign
transactions are negotiated, invoiced and paid in U.S. dollars. Based on the
controls in place and the relative size of the financial instruments entered
into, we believe the risks associated with not using these instruments will not
have a material adverse effect on our consolidated financial position or results
of operations.

In addition, we do not engage in speculative transactions and do not use
derivative instruments or engage in hedging activities. See the Notes to
Financial Statements for a description of our accounting policies and other
information related to these financial instruments.

In the normal course of business, we are exposed to market risks,
including changes in interest rates and price changes that could affect our
operating results. As of March 31, 2004, fluctuations in interest rates,
exchange rates and price changes did not have a material effect on our financial
position or operating results.

INTEREST RATE RISK

We place our cash and cash equivalents, which generally have a term of
less than 90 days, with a high-quality financial institution and have investment
guidelines relative to diversification and maturities designed to maintain
safety and liquidity. As of March 31, 2004, we had cash and cash equivalents
totaling approximately $14.5 million. Due to the short-term nature of these
instruments, the carrying value approximates market value. If, during the fiscal
year 2005, average short-term interest rates decreased by 1.0% over fiscal year
2004 average rates, our projected interest income from short-term investments
would decrease by approximately $4,000, assuming a similar level of investments
in fiscal year 2005.

FOREIGN CURRENCY RISK

We have a limited number of foreign transactions. Substantially all of our
foreign transactions are negotiated, invoiced and paid in U.S. dollars.
Therefore, fluctuations in the value of the dollar as compared to other foreign
currencies have not had an effect on us.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See the consolidated financial statements and notes, supplementary data of
Navarre and the Report of Independent Auditors included at the end of this
document.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. CONTROLS AND PROCEDURES

DISCLOSURE CONTROLS AND PROCEDURES:

Based on their evaluation as of a date within 90 days of the filing date
of this report, the Company's principal executive officer and principal
financial officer have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 (the "Exchange Act") are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms, and to provide reasonable assurance that information required to be
disclosed by the Company in such reports is accumulated and communicated to the
Company's management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding required disclosure.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING:

There were no significant changes in the Company's internal controls over
financial reporting or in other factors that could significantly affect these
controls, for the period covered by this report, that have materially affected
or are reasonably likely to materially affect, the Company's internal control
over financial reporting. There were no significant deficiencies or material
weaknesses, and therefore there were no corrective actions taken.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information concerning the "Executive Officers of the Registrant"
required under this item will be included under the captions "Election of
Directors" and "Information Concerning Directors, Nominees and Executive
Officers" in our Proxy Statement for the Annual Meeting of Shareholders to be
held on September 13, 2004 (the "2004 Proxy Statement"), a definitive copy of
which will be filed with the Securities and Exchange Commission within 120 days
of the close of the fiscal year ended March 31, 2004, and is incorporated herein
by reference. Information concerning the compliance of the Company's officers,
directors and 10% stockholders with Section 16(a) of the Securities Exchange Act
of 1934 is incorporated by reference to the information to be contained in the
Proxy Statement under the caption "Compliance with Section 16(a)." The
information regarding Audit Committee members and "audit committee financial
experts" is incorporated by reference to the information to be contained in the
Proxy Statement under the caption "Board Committees." The information regarding
the Company's Code of Business Ethics is incorporated by reference to the
information to be contained in the Proxy Statement under the heading "Code of
Business Conduct and Ethics." A copy of the Company's Code of Business Ethics is
filed as an exhibit to this report.

ITEM 11. EXECUTIVE COMPENSATION

Information required under this item is contained in our 2004 Proxy
Statement and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required under this item is contained in our 2004 Proxy
Statement and is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Information required under this item is contained in our 2004 Proxy
Statement and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Information required under this item is contained in our 2004 Proxy
Statement and is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K

(a) Documents filed as part of this report -

(1) Financial Statements. Our following financial statements and the
Report of Independent Auditors thereon are set forth at the end of
this document:

(i) Report of Independent Auditors.

(ii) Consolidated Balance Sheets as of March 31, 2004 and 2003.

(iii) Consolidated Statements of Operations for the years ended
March 31, 2004, 2003 and 2002.

(iv) Consolidated Statements of Shareholders' Equity for the years
ended March 31, 2004, 2003 and 2002.

(v) Consolidated Statements of Cash Flows for the years ended
March 31, 2004, 2003 and 2002.

(vi) Notes to Consolidated Financial Statements

(2) Financial Statement Schedules

(i) Schedule II - Valuation and Qualifying Accounts and Reserves

Schedules other than those listed above have been omitted because
they are inapplicable or the required information is either
immaterial or shown in the Financial Statements or the notes
thereto.

(3) Exhibits

2.1 Asset Purchase Agreement dated November 3, 2003 between BCI
Eclipse Company, LLC and the Company (incorporated by
reference to Exhibit 2.1 to the Company's Form 10-Q for the
quarter ended September 30, 2003 (File No. 0-22982)).

3.1 Articles of Incorporation (incorporated by reference to
Exhibit 3.1 to the Company's Annual Report on Form 10-K for
the year ended March 31, 2000 (File No. 0-22982)).

3.2 Bylaws of the Company (incorporated by reference to Exhibit
4.2 to the Company's Registration Statement on Form S-3 (File
No. 333-111733)).

3.3 Certificate of Rights and Preferences of Series B Convertible
Preferred Stock (incorporated by reference to Exhibit 2 to the
Company's Form 8-K dated August 20, 1999 (File No. 0-22982)).

3.4 Form of Warrant Agreement (incorporated by reference to
Exhibit 10.3 to the Company's Form 8-K dated December 16, 2003
(File No. 0-22982)).

10.1* Employment Agreement dated November 1, 2001 between the
Company and Eric H. Paulson (incorporated by reference to
Exhibit 10.1 to the Company's Form 10-Q for the quarter ended
December 31, 2001 (File No. 0-22982)).

10.2* Amendment to Employment Agreement between the Company and Eric
H. Paulson (incorporated by reference to Exhibit 10.1.1 to the
Company's Form 10-Q for the quarter ended December 31, 2003
(File No. 0-22982)).

10.3* Employment Agreement dated January 2, 2002 between the Company
and Charles E. Cheney (incorporated by reference to Exhibit
10.2 to the Company's Annual Report on Form 10-K for the year
ended March 31, 2002 (File No. 0-22982)).

10.4* Employment Agreement between Encore Software, Inc. and Michael
Bell (incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the year ended March
31, 2003 (File No. 0-22982)).

10.5* Employment Agreement dated November 5, 2003, between BCI
Eclipse Company, LLC and Edward D. Goetz (incorporated by
reference to Exhibit 10.16 to the Company's Form 10-Q for the
quarter ended September 30, 2003 (File No. 0-22982)).

10.6* 1992 Stock Option Plan, amended and restated (incorporated by
reference to Exhibit 10.3 to the Company's Annual Report on
Form 10-K for the year ended March 31, 2002 (File No.
0-22982)).

10.7* 2003 Amendment to the Company's 1992 Stock Option Plan
(incorporated by reference to Exhibit 99.1 to the Company's
Registration Statement on Form S-8 (File No. 333-109056)).

10.8* Form of Individual Stock Option Agreement under 1992 Stock
Option Plan (incorporated by reference to Exhibit 10.4 to the
Company's Registration Statement on Form S-1 (No. 333-68392)).

10.9 Stock Buy and Sell Agreement dated August 24, 2002 between
Encore Software, Inc. and Michael Bell (incorporated by
reference to Exhibit 10.4 to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003 (File No.
0-22982)).

10.10 Stock Purchase Agreement dated August 24, 2002 between Encore
Software, Inc. and Michael Bell (incorporated by reference to
Exhibit 10.5 to the Company's Annual Report on Form 10-K for
the year ended March 31, 2003 (File No. 0-22982)).

10.11* Form of Termination Agreement for the Company's Executives
(incorporated by reference to Exhibit 10.2 to the Company's
Form 10-Q for the quarter ended December 31, 2001 (File No.
0-22982)).

10.12 Lease dated March 12, 1998 between the Company and Cambridge
Apartments, Inc. with respect to the corporate headquarters in
New Hope, MN (incorporated by reference to Exhibit 10.6 to the
Company's Annual Report on Form 10-K for the year ended March
31, 1999 (File No. 0-22982)).

10.13 Amendment No. 1 to Lease Agreement between the Company and
Cambridge Apartments, Inc. dated April 1, 1998 (incorporated
by reference to Exhibit 10.9.1 to the Company's Form 10-Q for
the quarter ended June 30, 2003 (File No. 0-22982)).

10.14 Amendment No. 2 to Lease Agreement between the Company and
Cambridge Apartments, Inc. dated July 14, 2003 (incorporated
by reference to Exhibit 10.9.2 to the Company's Form 10-Q for
the quarter ended June 30, 2003 (File No. 0-22982)).

10.15 Lease dated May 1, 1999 between the Company and Sunlite III,
LLP with respect to a second facility in Brooklyn Park, MN
(incorporated by reference to Exhibit 10.7 to the Company's
Annual Report on Form 10-K for the year ended March 31, 1999
(File No. 0-22982)).

10.16 Amendment Nos. 1, 2 and 3 to Lease Agreement (incorporated by
reference to Exhibit 10.10.1 to the Company's Annual Report on
Form 10-K for the year ended March 31, 2003 (File No.
0-22982)).

10.17 Lease dated December 17, 1999 between Encore and EastGroup
Properties L.P., with respect to a third facility in Gardena,
California (incorporated by reference to Exhibit 10.11 to the
Company's Annual Report on Form 10-K for the year ended March
31, 2003 (File No. 0-22982)).

10.18 First Amendment to Lease dated June 27, 2002 between Encore
and Eastgroup Properties L.P. (incorporated by reference to
Exhibit 10.11.1 to the Company's Annual Report on Form 10-K
for the year ended March 31, 2003 (File No. 0-22982)).

10.19 Credit Agreement dated October 3, 2001 between General
Electric Capital Corporation and the Company (incorporated by
reference to Exhibit 10.1 to the Company's Form 10-Q for the
quarter ended September 30, 2001 (File No. 0-22982)).

10.20 Amendment No. 1 and Limited Waiver with Respect to Credit
Agreement dated March 4, 2002 (incorporated by reference to
Exhibit 10.8.1 to the Company's Annual Report on Form 10-K for
the year ended March 31, 2002 (File No. 0-22982)).

10.21 Amendment No. 2 to Credit Agreement dated August 1, 2002
(incorporated by reference to Exhibit 10.1 to the Company's
Form 10-Q for the quarter ended September 30, 2002 (File No.
0-22982)).

10.22 Amendment No. 3 to Credit Agreement dated March 30, 2003
(incorporated by reference to Exhibit 10.12.3 to the Company's
Annual Report on Form 10-K for the year ended March 31, 2003
(File No. 0-22982)).

10.23 Amendment No. 4 to Credit Agreement dated June 24, 2003
(incorporated by reference to Exhibit 10.12.4 to the Company's
Annual Report on Form 10-K for the year ended March 31, 2003
(File No. 0-22982)).

10.24 Amendment No. 5 to Credit Agreement dated October 23, 2003
(incorporated by reference to Exhibit 10.12.5 to the Company's
Form 10-Q for the quarter ended September 30, 2003 (File No.
0-22982)).

10.25 Amendment No. 6 to Credit Agreement dated November 5, 2003
(incorporated by reference to Exhibit 10.12.6 to the Company's
Form 10-Q for the quarter ended September 30, 2003 (File No.
0-22982)).

10.26 Credit Agreement dated November 5, 2003 between Hilco Capital
LP and the Company (incorporated by reference to Exhibit 10.13
to the Company's Form 10-Q for the quarter ended September 30,
2003 (File No. 0-22982)).

10.27 Separation Agreement dated as of March 1, 1999 between the
Company and NetRadio Corporation (incorporated by reference to
Exhibit 10.16 to NetRadio Corporation's Form S-1/A
Registration Statement (File No. 333-73261)).

10.28 Term Note dated October 14, 1999, between the Company and
NetRadio Corporation (incorporated by reference to Exhibit
10.11 to the Company's Annual Report on Form 10-K for the year
ended March 31, 2000 (File No. 0-22982)).

10.29 Amendment No. 1 to Term Note dated March 26, 2001, between the
Company and NetRadio Corporation (incorporated by reference to
Exhibit 10.1 to NetRadio Corporation's Form 10-Q for the
quarter ended March 31, 2001 (File No. 0-27575)).

10.30 Amendment No. 2 to Term Note dated March 30, 2001, between the
Company and NetRadio Corporation (incorporated by reference to
Exhibit 10.2 to NetRadio Corporation's Form 10-Q for the
quarter ended March 31, 2001 (File No. 0-27575)).

10.31 Form of Warrant dated May 1, 1998 issued to investors in
connection with the Company's May 1, 1998 private placement of
Class A Convertible Preferred Stock (incorporated by reference
to Exhibit 4 to the Company's Form 8-K dated May 1, 1998 (File
No. 0-22982)).

10.32 Amended and Restated Asset Purchase Agreement effective as of
July 10, 2002 by and between the Company and Encore Software,
Inc. (incorporated by reference to Exhibit 10.1 to the
Company's Form 8-K dated July 31, 2002 (File No. 0-22982)).

10.33 Amendment No. 1 to Asset Purchase Agreement effective as of
July 31, 2002, by and among the Company, Encore Software, Inc.
and Encore Acquisition Corporation (incorporated by reference
to Exhibit 10.2 to the Company's Form 8-K dated July 31, 2002
(File No. 0-22982)).

10.34 Conditional Unsecured Promissory Note in the amount of
$650,000 dated July 31, 2002 (incorporated by reference to
Exhibit 10.3 to the Company's Form 8-K dated July 31, 2002
(File No. 0-22982)).

10.35 Unsecured Promissory Note in the amount of $500,000 dated July
31, 2002 (incorporated by reference to Exhibit 10.4 to the
Company's Form 8-K dated July 31, 2002 (File No. 0-22982)).

10.36 Agreement of Reciprocal Easements, Covenants, Conditions and
Restrictions dated June 16, 2003 (incorporated by reference to
Exhibit 10.9.3 to the Company's Form 10-Q for the quarter
ended June 30, 2003 (File No. 0-22982)).

10.37 Incentive Stock Option Agreement dated September 6, 2002
between Cary Deacon and the Company (incorporated by reference
to Exhibit 10.17 to the Company's Form 10-Q for the quarter
ended September 30, 2003 (File No. 0-22982)).

10.38 Addendum to Incentive Stock Option Agreement dated November
13, 2003 (incorporated by reference to Exhibit 10.17.1 to the
Company's Form 10-Q for the quarter ended September 30, 2003
(File No. 0-22982)).

10.39 Form of Securities Purchase Agreement dated as of December 15,
2003 among the Corporation and the various purchasers
(incorporated by reference to Exhibit 10.1 to the Company's
Form 8-K dated December 16, 2003 (File No. 0-22982)).

10.40 Form of Registration Rights Agreement dated as of December 15,
2003 among the Corporation and the various purchasers
(incorporated by reference to Exhibit 10.2 to the Company's
Form 8-K dated December 16, 2003 (File No. 0-22982)).

10.41(x) Form of Separation Agreement with Charles E. Cheney dated
April 30, 2004.

10.42(x) Form of Assignment of Lease between BCI Eclipse LLC and BCI
Eclipse Company, LLC dated November 3, 2003.

10.43(x) Form of Amendment No. 7 to Credit Agreement dated January
26, 2004.

10.44(x) Form of Amendment No. 8 to Credit Agreement dated March 9,
2004.

10.45(x) Form of Amendment No. 9 to Credit Agreement dated March 30,
2004.

10.46(x) Form of Amended and Restated Credit Agreement with General
Electric Capital Corporation dated June 18, 2004.

10.47(x) Form of Lease Agreement between Navarre Corporation and NL
Ventures IV New Hope, L.P. dated May 27, 2004.

10.48(x) Form of Third Amendment to Office/Warehouse Lease between
Cambridge Apartments, Inc. and Navarre Corporation dated
February 23, 2004.

10.49(x) Form of Fourth Amendment to Office/Warehouse Lease between
Cambridge Apartments, Inc. and Navarre Corporation dated
June 2004.

10.50(x) Amendment No. 2 to Lease Agreement between Airport One
Limited Partnership and Navarre Corporation dated March
21, 2004.

10.51(x) Addendum to Lease Agreement between Cambridge Apartments,
Inc.and Navarre Corporation dated May 27, 2004.

10.52(x) Form of BCI Eclipse Lease Agreement effective October 1,
1999.

10.53(x) First Amendment to BCI Eclipse Lease Agreement made as of
January 5, 2000.

14.1(x) Navarre Corporation Code of Business Conduct and Ethics

21.1(x) Subsidiaries of the Registrant

23.1(x) Consent of Independent Accountants - Ernst & Young LLP.

24.1(x) Power of Attorney, contained on signature page

31.1(x) Certification of Chief Executive Officer under Rules
13a-14(a)/15d-14(a) under the Securities and Exchange Act
and Section 302 of Sarbanes-Oxley Act of 2002.

31.2(x) Certification of Chief Financial Officer under Rules
13a-14(a)/15d-14(a) under the Securities and Exchange Act
and Section 302 of Sarbanes-Oxley Act of 2002.

32.1(x) Certification of Chief Executive Officer Pursuant to 18
U.S.C.Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

32.2(x) Certification of Chief Financial Officer Pursuant to 18
U.S.C.Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.

* Indicates management contract or compensatory plan or agreement.
(x)filed herewith

(b) Reports on Form 8-K - During the quarter ended March 31, 2004, the Company
filed the following Current Reports on Form 8-K:

(1) On January 21, 2004, the Company filed a Current Report on Form 8-K
dated January 22, 2004 to report its financial results for the third
quarter ended December 31, 2003.

(2) On February 20, 2004, the Company filed a Current Report on Form 8-K
dated February 17, 2004 to report the announcement of promotions of
several key executives to new leadership posts and the appointment
of a new director to the Company's Board of Directors.

(3) On February 26, 2004, the Company filed a Current Report on Form 8-K
dated February 23, 2004 to report the announcement of changes in its
financial forecast for the fiscal year 2004.

SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) 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)

June 29, 2004 By /s/ Eric H. Paulson
--------------------------------------
Eric H. Paulson
Chairman of the Board,
President and Chief Executive
Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

POWER OF ATTORNEY

Each person whose signature appears below constitutes and appoints Eric H.
Paulson and James Gilbertson as his true and lawful attorneys-in-fact and
agents, each acting alone, with full power of substitution and resubstituion,
for him and in his name, place and stead, in any and all capacities, to sign any
of all amendments to this Annual Report on Form 10-K and to file the same, with
all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, each acting alone, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all said attorneys-in-fact and agents,
each acting alone, or his substitute or substitutes, may lawfully do or cause to
be done by virtue thereof.

Signature Title Date
--------- ----- ----

/s/ Eric H. Paulson Chairman of the Board, President June 29, 2004
-------------------------------- and Chief Executive Officer
Eric H. Paulson (principal executive officer)

/s/ James Gilbertson Vice President, Chief Financial Officer June 29, 2004
-------------------------------- and Director
James Gilbertson (principal financial and accounting officer)

/s/ Charles E. Cheney Director June 29, 2004
--------------------------------
Charles E. Cheney

/s/ Timothy R. Gentz Director June 29, 2004
--------------------------------
Timothy R. Gentz

/s/ James G. Sippl Director June 29, 2004
--------------------------------
James G. Sippl

/s/ Michael L. Snow Director June 29, 2004
--------------------------------
Michael L. Snow

/s/ Tom Weyl Director June 29, 2004
--------------------------------
Tom Weyl

/s/ Dickinson G. Wiltz Director June 29, 2004
--------------------------------
Dickinson G. Wiltz

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
Navarre Corporation

We have audited the accompanying consolidated balance sheets of Navarre
Corporation as of March 31, 2004 and 2003, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended March 31, 2004. Our audits also included the
financial statement schedule listed in the Index at Item 15(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Navarre
Corporation at March 31, 2004 and 2003, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
March 31, 2004, in conformity with accounting principles generally accepted in
the United States. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.

Ernst & Young LLP
Minneapolis, Minnesota
May 13, 2004, except for footnote 5,
as to which the date is June 21, 2004

NAVARRE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)

AS OF MARCH 31,
2004 2003
---- ----

ASSETS
Current assets:
Cash $ 14,495 $ 10,485
Accounts receivable, less allowance for doubtful accounts
and sales returns of $6,351 in 2004 and $5,940 in 2003 72,316 54,787
Inventories 30,151 22,828
Prepaid expenses and other current assets 5,175 4,845
--------- ---------
Total current assets 122,137 92,945

Property and equipment, net of accumulated depreciation of
$6,650 in 2004 and $5,633 in 2003 6,914 3,585

Other assets:
Notes receivable, related parties 600 800
Goodwill 10,371 3,109
Other assets 6,905 690
--------- ---------

Total assets $ 146,927 $ 101,129
========= =========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable $ 651 $ 805
Accounts payable 84,331 67,093
Accrued expenses 6,377 4,292
--------- ---------
Total current liabilities 91,359 72,190

Note payable, long-term ---- 268
Total liabilities 91,359 72,458
--------- ---------
Shareholders' equity
Common stock, no par value:
Authorized shares - 100,000,000
Issued and outstanding shares - 25,817,965 in 2004 and 21,616,187 in 2003 109,405 91,404
Accumulated deficit (53,837) (62,733)
--------- ---------
Total shareholders' equity 55,568 28,671
--------- ---------

Total liabilities and shareholders' equity $ 146,927 $ 101,129
========= =========

See accompanying notes.

NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)

FISCAL YEARS ENDED MARCH 31,
2004 2003 2002
---- ---- ----

Net sales $ 475,244 $ 359,384 $ 303,817
Cost of sales 417,904 314,371 270,924
----------- ----------- -----------
Gross profit 57,340 45,013 32,893

Operating expenses:
Selling and marketing 16,215 13,330 8,098
Distribution and warehousing 6,000 5,514 5,202
General and administrative 23,273 20,047 16,909
Depreciation and amortization 2,000 2,117 1,491
Restructuring ---- ---- 672
Stock-based compensation 705 ---- ----
----------- ----------- -----------
48,193 41,008 32,372

Income from operations 9,147 4,005 521

Other income (expense):
Debt extinguishment (908) ---- ----
Interest expense (378) (194) (173)
Other income 452 447 884
----------- ----------- -----------

Income before equity in income of NetRadio Corp. 8,313 4,258 1,232

Equity in income of NetRadio Corp. ---- 63 1,480
----------- ----------- -----------

Net income before tax 8,313 4,321 2,712

Tax benefit 583 ---- ----
----------- ----------- -----------
Net income available to common shareholders $ 8,896 $ 4,321 $ 2,712
=========== =========== ===========

Basic income per share $ .39 $ .20 $ .12
=========== =========== ===========

Diluted income per share $ .37 $ .20 $ .12
=========== =========== ===========

Basic weighted average common shares outstanding 22,780 21,616 22,553
Diluted weighted average common shares outstanding 24,112 21,841 22,575

See accompanying notes.

NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands, except share amounts)

COMMON
SHARES COMMON ACCUMULATED
ISSUED STOCK DEFICIT
------ ------ -----------

Balance at March 31, 2001 24,030,379 $ 94,116 $ (69,766)
Repurchase of common shares (2,414,192) (2,712) ---
Net income --- --- 2,712
---------- ----------- -----------
Balance at March 31, 2002 21,616,187 $ 91,404 $ (67,054)
Net income --- --- 4,321
---------- ----------- -----------
Balance at March 31, 2003 21,616,187 $ 91,404 $ (62,733)
SHARES ISSUED UPON EXERCISE OF STOCK OPTIONS 570,231 814 ---
SHARES ISSUED WITH PRIVATE PLACEMENT 2,631,547 11,735 ---
SHARES ISSUED WITH ACQUISITION OF BCI 1,000,000 5,080 ---
VALUE OF WARRANTS ISSUED TO HILCO --- 372 ---
NET INCOME --- --- 8,896
---------- ----------- -----------
BALANCE AT MARCH 31, 2004 25,817,965 $ 109,405 $ (53,837)
========== =========== ===========

See accompanying notes.

NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

FISCAL YEARS ENDED MARCH 31
2004 2003 2002
---- ---- ----

OPERATING ACTIVITIES
Net income $ 8,896 $ 4,321 $ 2,712
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,000 2,117 1,847
Equity in income of NetRadio Corp. --- (63) (1,480)
Stock option compensation 705 --- ---
Warrant expense 372 --- ---
Write-off of notes receivable 257 258 56
Changes in operating assets and liabilities
net of effects of acquisitions:
Accounts receivable (12,205) (7,506) 5,208
Inventories (4,252) (5,495) 7,313
Prepaid expenses 372 (4,580) 46
Other assets (1,536) (1,251) (527)
Accounts payable 13,776 12,301 (12,613)
Accrued expenses (992) 1,244 (220)
----------- ----------- -----------
Net cash provided by operating activities 7,393 1,346 2,342

INVESTING ACTIVITIES
Acquisition, net of cash acquired (10,465) (7,546) ---
Notes receivable, related parties (57) (769) (289)
Payments on NetRadio Note --- 63 1,480
Purchases of equipment and leasehold improvements (4,988) (1,039) (973)
----------- ----------- -----------
Net cash (used in) provided by investing activities (15,510) (9,291) 218

FINANCING ACTIVITIES
Proceeds from note payable, bank 417,094 303,085 167,729
Payments on note payable, bank (417,094) (303,085) (167,729)
Repayment of note (422) (536) ---
Repurchase of Navarre common stock --- --- (2,712)
Proceeds from sale of common stock 11,735 --- ---
Proceeds from exercise of common stock options 814 --- ---
----------- ----------- -----------
Net cash provided by (used in) financing activities 12,127 (536) (2,712)
----------- ----------- -----------
Net increase (decrease) in cash 4,010 (8,481) (152)
Cash at beginning of year 10,485 18,966 19,118
----------- ----------- -----------
Cash at end of year $ 14,495 $ 10,485 $ 18,966
=========== =========== ===========

See accompanying notes.

NAVARRE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004

1. BUSINESS DESCRIPTION

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION

The financial statements include the accounts of the Company and its
wholly-owned subsidiary BCI Eclipse LLC and majority-owned subsidiary Encore
Software, Inc. All intercompany accounts and transactions have been eliminated.

CASH AND CASH EQUIVALENTS

The Company considers short-term investments with a maturity of three
months or less when purchased to be cash equivalents. Cash equivalents are
carried at cost, which approximates market value.

INVENTORIES

Inventories are stated at the lower of cost or market with cost determined
on the first-in, first-out (FIFO) method. Obsolescence reserves were $804,000
and $318,000 at March 31, 2004 and 2003, respectively.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Depreciation is computed
using the straight-line method for leasehold improvements and accelerated
methods for equipment over estimated useful lives. Estimated useful lives by
major asset categories are as follows.

ASSET LIFE IN YEARS
----- -------------

Furniture and Fixtures 7
Office Equipment 5
Computer Equipment 3
Warehouse Equipment 5
Leasehold Improvements 10

IMPAIRMENT OF LONG-LIVED ASSETS

In accordance with Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived
assets, such as property and equipment, are evaluated for impairment whenever
events or changes in circumstances indicate the carrying value of an asset may
not be recoverable. An impairment loss is recognized when estimated undiscounted
cash flows expected to result from the use of the asset plus net proceeds
expected from disposition of the asset (if any) are less than the carrying value
of the asset. When an impairment loss is recognized, the carrying amount of the
asset is reduced to its estimated fair value.

On January 1, 2003, the Company adopted SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. Since adoption, the present value
of costs associated with location closings, primarily future lease costs, are
charged to earnings when a location is vacated. Prior to this, the liability was
recognized when the Company made the decision to close the location.

GOODWILL AND INTANGIBLE ASSETS

Goodwill is the excess of the purchase price over the fair value of
identifiable net assets acquired in business combinations accounted for under
the purchase method. Effective April 1, 2002, the Company adopted Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets,
which eliminated the systematic amortization of goodwill. The Company reviews
goodwill for potential impairment annually for each reporting unit and when
events or changes in circumstances indicate the carrying value of the goodwill
might exceed its current fair value. The Company has no goodwill associated with
its Distribution segment, while the Publishing segment has two reporting units
that have goodwill - Encore and BCI Eclipse. The Company determines fair value
using widely accepted valuation techniques, including discounted cash flow and
market multiple analysis. These types of analyses require the Company to make
certain assumptions and estimates regarding industry economic factors and the
profitability of future business strategies. Prior to the adoption of FASB
Statement 142, goodwill was amortized on a straight-line basis over 5 to 15
years. This resulted in amortization expense for fiscal year 2002 of $356,000. A
reconciliation of reported earnings to reflect the adoption of SFAS No. 142, as
if it were effective for all fiscal years presented, is provided below.

(in thousands, except per share amounts) FISCAL YEARS ENDED MARCH 31,
2004 2003 2002
---- ---- ----

Net income, as reported $ 8,896 $ 4,321 $ 2,712
Add back goodwill amortization, net of tax ---- ---- 356
----------- ----------- -----------
Adjusted net income $ 8,896 $ 4,321 $ 3,068

Diluted income per share, as reported $ .37 $ .20 $ .12
Add back goodwill amortization ---- ---- .02
----------- ----------- -----------
Adjusted diluted income per share $ .37 $ .20 $ .14
=========== =========== ===========

In the fourth quarter of fiscal 2004, the Company completed its annual
impairment testing of goodwill related to the acquisitions of Encore and BCI
Eclipse and determined there were no impairments. Encore's fair value was based
on the then current expectations for the business in light of the existing
software environment and the uncertainty associated with software products.

Goodwill totaled $10.4 and $3.1 million at March 31, 2004 and 2003,
respectively. The change from fiscal 2003 to fiscal 2004 resulted from the
acquisition of BCI Eclipse.

The changes in the carrying amount of goodwill by segment were as follows
(in thousands):

DISTRIBUTION PUBLISHING CONSOLIDATED
------------ ---------- ------------

Balances as of March 31, 2001 $ 356 $ ---- $ 356
Systematic amortization of goodwill (356) ---- (356)
---------- ---------- -----------
Balances as of March 31, 2002 $ ---- $ ---- $ ----
Goodwill resulting from acquisitions ---- 2,323 2,323
Final purchase price allocation adjustment ---- 786 786
---------- ---------- -----------
Balances as of March 31, 2003 $ ---- $ 3,109 $ 3,109
Goodwill resulting from acquisitions ---- 7,262 7,262
---------- ---------- -----------
Balances as of March 31, 2004 $ ---- $ 10,371 $ 10,371
========== ========== ===========

Intangible assets totaled $6.1 million and $204,000 at March 31, 2004 and
2003, respectively. The change from fiscal 2003 to fiscal 2004 resulted
primarily from the acquisition of BCI Eclipse. The amortization expense of
intangible assets for fiscal 2004 was $311,000 compared to $501,000 for fiscal
2003.

The following is a schedule of estimated future amortization expense (in
thousands):

2005 $ 1,404,000
2006 $ 1,299,000
2007 $ 1,198,000
2008 $ 1,029,000
2009 $ 3,131,000

REVENUE RECOGNITION

The Company recognizes revenue at the time product is received by our
customers and title has passed, and provides a reserve for sales returns based
on the trailing twelve months' experience by product line. The Company's selling
price is fixed at the time of shipment and invoicing. The terms of our sales
agreements are not contingent upon the resale of the product by our customers,
and we have no continuing obligation to our customers.

The Company at times provides certain price protection, promotional
monies, back-end volume rebates and other incentives to customers in its
publishing business. The Company records reserves for these incentives based on
trailing twelve months' experience rates by product line. The Company records
these amounts as reductions in revenue at the time the original revenue is
recorded.

Although its past experience has been a good indicator of future return
levels and other revenue reductions, there can be no assurance that its current
reserve levels will be adequate in the future.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

the receivables are past due based on the Company's historical experience of
write-offs of accounts with similar characteristics. The Company's largest
collection risks exist for retail customers that are in bankruptcy, or at risk
of bankruptcy. The occurrence of these events is infrequent, but can be material
when it does occur. Although credit losses relating to customers consistently
have been within management's expectations, if circumstances change (i.e.,
higher than expected defaults or an unexpected material adverse change in a
major customer's ability to meet its financial obligations to the Company), the
Company estimates of the recoverability of amounts due could be reduced by a
material amount.

CLASSIFICATION OF SHIPPING COSTS

Costs incurred with the shipment of product between the Company and its
vendors are classified in cost of goods sold. These costs were $2,103,000,
$1,660,000, and $922,000 for the years ended March 31, 2004, 2003, and 2002,
respectively.

Costs incurred with the shipment of product from the Company to its
customers are classified in selling expenses. These costs were $6,448,000,
$6,259,000, and $5,366,000 for the years ended March 31, 2004, 2003, and 2002,
respectively.

STOCK-BASED COMPENSATION

The Company has a stock option plan for officers, key employees and
directors, which is described more fully in Note 7. The Company accounts for
this plan under the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25"), and related Interpretations. Under APB 25, when the exercise price
of stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized. The Company has elected to apply
disclosure-only provisions of SFAS 123 as amended by SFAS No. 148. The following
table illustrates the effect on net income and net income per share if the
Company had applied the fair value recognition provision of Financial Accounting
Standards Board Statement No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), to stock-based employee compensation.

(In thousands, except for per share data)

FISCAL YEARS ENDED MARCH 31,
2004 2003 2002
---- ---- ----

Net income, as reported $ 8,896 $ 4,321 $ 2,712

Deduct: Total stock-based compensation determined under
fair value based method for all awards (861) (694) (529)
-------- -------- -------
Adjusted net income, fair value method for all stock-based awards $ 8,035 $ 3,627 $ 2,183

Basic income per share - as reported $ .39 $ .20 $ .12
======== ======== =======
Basic income per share - SFAS No. 123 adjusted $ .35 $ .17 $ .10
======== ======== =======
Diluted income per share - as reported $ .37 $ .20 $ .12
======== ======== =======
Diluted income per share - SFAS No. 123 adjusted $ .33 $ .17 $ .10
======== ======== =======

Pro forma information regarding net income and income per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of
Statement 123. The fair value for these options was estimated at the date of
grant using the Black-Scholes option pricing model with the following
weighted-average assumptions: risk-free interest rate of 2.9%, 2.9%, and 3.5%
for fiscal 2004, 2003, and 2002, respectively; volatility factor of the expected
market price of the Company's common stock of 70%, 73%, and 117% for fiscal
2004, 2003 and 2002, respectively; expected life of the option of five years;
and no dividends.

The weighted average fair value of options granted in fiscal 2004, 2003,
and 2002 was $3.28, $0.87, and $0.91, respectively.

COMMITMENTS AND CONTINGENCIES

The Company is exposed to claims and litigation arising out of the
ordinary course of business. Management, after consulting with legal counsel,
believes the currently identified claims and litigation will not have a material
adverse effect on the Company's results of operations or its financial condition
taken as a whole.

INCOME TAXES

EARNINGS PER COMMON SHARE

The basic earnings per common share is computed by dividing net income by
the weighted average number of common shares outstanding. The following table
sets forth the computation of basic and diluted earnings per share:

(In thousands, except for per share data) FISCAL YEARS ENDED MARCH 31,
2004 2003 2002
---- ---- ----

Numerator
Net income $ 8,896 $ 4,321 $ 2,712
========== ========== ==========

Denominator for basic earnings per
share - weighted average shares 22,780 21,616 22,553

Dilutive securities: Employee Stock Options 1,332 225 22
Denominator for diluted earnings per
share - weighted average shares 24,112 21,841 22,575
========== ========== ==========

Basic earnings per share $ .39 $ .20 $ .12
========== ========== ==========
Diluted earnings per share $ .37 $ .20 $ .12
========== ========== ==========

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

VENDOR ALLOWANCES

The Company receives allowances from vendors as a result of purchasing
their products. In accordance with Emerging Issues Task Force (EITF) 02-16,
Accounting by a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor, vendor allowances are initially deferred. The deferred
amounts are then recorded as a reduction of cost of goods sold when the related
product is sold.

CAPITALIZED SOFTWARE DEVELOPMENT COSTS

Software costs incurred subsequent to the determination of the
technological feasibility of software products are capitalized. Capitalization
ceases and amortization of costs begins when the software product is available
for general release to customers or shipment has begun. 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.
If the carrying value is greater than the undiscounted cash flow amount, an
impairment charge is recorded in cost of goods sold in the statement of
operations for amounts necessary to reduce the carrying value of the asset to
fair value. The Company recorded an impairment charge associated with product
development costs in fiscal 2004 of $5.6 million.

RESTRUCTURING

In December 2001, the Company initiated actions to close a warehouse and
distribution facility in Hawaii and subsequently consolidated the operations
into its Minneapolis facility. These actions resulted in the Company recording
an aggregate charge of $831,000, including goodwill impairment of $356,000. The
charges included $672,000 classified as restructuring and $159,000 of inventory
write-downs classified in cost of sales. Through March 31, 2004, the Company has
paid or incurred all of the $831,000 charge.

3. ACQUISITIONS

On November 3, 2003, the Company 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 $10.4 million in cash and
one million shares of Navarre common stock with a value at closing of $5.1
million. There is also the possibility that, depending on BCI's ability to meet
certain goals with respect to its operating income, the Company will pay certain
additional payments to BCI Eclipse, LLC each year until 2008. The maximum amount
of these annual payments varies over that period from $87,500 to $350,000. The
assets purchased by the Company included certain fixed assets, intellectual
property, inventory, receivables and contract rights related to BCI Eclipse's
business. The acquisition of BCI Eclipse is part of the Company's strategy for
growth with expanded content ownership and gross margin enhancement. BCI
Eclipse's proprietary audio products will continue the Company's strategic
initiative 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. BCI is
headquartered in Newbury Park, California. The acquisition is being 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 the Company's financial statements from the date of
acquisition. Pro forma results of operations have not been presented for this
acquisition since the effects were not material to the Company. 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 2005. The Company will adjust the allocation of the purchase
price after obtaining more information regarding asset and liability valuation.
The preliminary allocation resulted in goodwill of $7.3 million. Under SFAS No.
142, goodwill is not amortized.

The preliminary purchase price allocation was as follows (in
thousands):

Accounts receivable, net of allowances $ 5,324
Inventories 3,071
Prepaid expenses and other current assets 702
Property and equipment 30
Other Assets 572
Identifiable intangible assets 4,420
Goodwill 7,262
Current liabilities (5,836)
--------
TOTAL PURCHASE PRICE $ 15,545

During fiscal year 2003, the Company acquired the primary assets of Encore
Software, Inc. ("Encore") pursuant to an Amended and Restated Asset Purchase
Agreement between the Company and Encore effective as of July 10, 2002, as
amended by amendment No. 1 to the Agreement effective as of July 31, 2002
(collectively, the "Purchase Agreement"). The transaction was approved by the
Bankruptcy Court for the Central District of California and closed on August 2,
2002. The Company paid approximately $7.9 million in cash and assumed $1.6
million in debt. The assets purchased by the Company included certain fixed
assets, intellectual property, inventory, receivables, and contract rights
related to Encore's business. Navarre acquired Encore, an interactive publisher
in the video game and PC CD-ROM markets, to enable it to more actively
participate in the high growth video game industry and enable it to further
extend our direct distribution relationships with large retailers generating
solid sell-through of Encore titles. The acquisition was 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 the Company's financial statements from the date of acquisition. Pro forma
results of operations have not been presented for this acquisition since the
effects were not material to the Company. The allocation of the purchase price
to the assets acquired was finalized in the fourth quarter of fiscal 2003. The
final purchase price resulted in an increase of $786,000 to goodwill from the

Company's preliminary allocation. Under SFAS No. 142, goodwill is not amortized,
but is reviewed for impairment at least annually.

The final purchase price allocation was as follows (in thousands):

Cash $ 354
Accounts receivable, net of allowances 3,333
Inventories 617
Prepaid expenses and other current assets 2,067
Property and equipment 1,134
Goodwill 3,109
Current liabilities (1,105)
-----------
TOTAL PURCHASE PRICE $ 9,509

4. RELATED PARTY TRANSACTIONS

During fiscal 2002, the Company entered into a five year amended
employment contract with its Chief Executive Officer. The agreement includes a
loan to the executive for a maximum of $1,000,000, of which $600,000 was
outstanding at March 31, 2004. Under the terms of the loan, $200,000 of the
$1,000,000 principal and all unpaid and unforgiven interest is to be forgiven by
the Company on each of March 31, 2005, 2006 and 2007. During fiscal 2004, the
Company forgave $200,000 of principal and interest. The outstanding note amount
bears an annual interest rate of 5.25%.

Subsequent to the Company's acquisition of the assets of Encore Software,
Inc. ("Encore") 2002, the Company entered into a five-year agreement on August
24, with Michael Bell, to serve as Chief Executive Officer of Encore Software,
Inc. On the same date, it also entered into a stock purchase agreement with Mr.
Bell under which he acquired 20,000 of the 100,000 outstanding shares of Encore.
In connection with the stock purchase, a stock buy and sell agreement was
entered into between Mr. Bell and Encore.

During fiscal 2003, the Company paid a consulting fee of $187,000 to
Michael Snow, a member of the Company's Board of Directors, for consulting
services provided in conjunction with the acquisition of Encore Software, Inc.

5. BANK FINANCING AND DEBT

On June 21, 2004, the Company finalized an amendment and restatement of
its Credit Agreement with GE Capital. Under the terms of the amended and
restated agreement a new $10 million revolving credit facility has been
established for use by the Company in connection with equity or asset-based
acquisitions. The revised agreement also permits the Company to utilize up to
$10 million of the existing $40 million revolving credit facility for such
acquisitions. Previously, this $40 million facility was restricted for use only
in connection with the Company's working capital needs. In addition, the
agreement has been extended to December 2007.

On October 3, 2001, the Company entered into an agreement with General
Electric Capital Corporation for a three-year $30 million credit facility. On
June 24, 2003, the Company amended the agreement and increased the credit
facility to $40 million and extended the agreement until June 2007. In
association with this agreement, the Company also pays certain facility and
agent fees. During fiscal year 2004, the maximum amount the Company borrowed
under the credit facility was $9.1 million. As of March 31, 2004, the Company
had no balance under this facility. Under this agreement the Company is required
to meet certain covenants. The Company is in compliance with these covenants as
of March 31, 2004.

Interest under the GE Capital line of credit is at the Index Rate plus
..25% (4.25%) at March 31, 2004 and is payable monthly.

Interest paid was $378,000, $194,000, and $173,000 for the years ended
March 31, 2004, 2003, and 2002, respectively.

In connection with the BCI acquisition the Company entered into a new
agreement with Hilco Capital, L.P. for a four-year $6 million credit facility on
November 5, 2003. The Company 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. In December 2003,
we completed a private placement to institutional and other accredited investors
of 2,631,547 shares of common stock and 657,887 shares of common stock issuable
upon exercise of warrants. The net proceeds were used to discharge our
approximate $6.6 million debt to Hilco Capital, LP incurred in connection with
the BCI Eclipse acquisition and the remainder was made available for, among
other things, general working capital needs. 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.

6. SHAREHOLDERS' EQUITY

On October 17, 2000, Navarre announced that its board of directors had
authorized it to repurchase up to 5,000,000 shares of Navarre common stock or
approximately twenty percent of its outstanding common stock, in market or
private transactions. During the year ending March 31, 2002, Navarre repurchased
2,414,192 shares for an average price of $1.23. Navarre did not repurchase any
shares during the fiscal years ended March 31, 2003 or March 31, 2004.

On December 15, 2003, the Company completed a private placement to
institutional and other accredited investors of 2,631,547 shares of common stock
and 657,887 shares of common stock issuable upon exercise of warrants. The
Company sold the securities for $4.75 per share for total proceeds of
approximately $12,500,000 and net proceeds of approximately $11,735,000. The per
share price of $4.75 represented a discount of approximately 15% of the closing
price of the Company's common stock on the date the purchase was completed. The
net proceeds were used to discharge the Company's approximate $6.6 million debt
to Hilco Capital, LP incurred in connection with the BCI Eclipse acquisition and
the remainder was made available for, among other things, general working
capital needs.

The warrants issued to the placement investors are five-year warrants
exercisable at any time after the sixth month anniversary of the date of
issuance at $7.00 per share. The warrants contain customary anti-dilution
provisions and a cashless exercise provision that is applicable only if a
registration statement permitting sale of the underlying shares is not then
available. In addition, the Company has the right after the first anniversary
date of the warrant to require cash exercise of the warrant if, among other
things, the volume weighted average price of our common stock exceeds $12.00 per
share for each of 30 consecutive trading days. Furthermore, each warrant
includes a provision that limits the number of shares obtainable upon exercise
to ensure that the holder does not exceed 4.99% and 9.99% of the Company issued
and outstanding shares of common stock.

The Company issued to its agent in the private placement, Craig-Hallum
Capital Group, LLC, a warrant to purchase 131,577 shares. The warrant expires on
December 14, 2005 and is exercisable at $7.00 per share. The warrant contains
customary anti-dilution and piggyback registration rights, although, if the
shares underlying the warrant are included in any registration statement filed
pursuant to the placement purchaser registration rights agreement, then those
registration rights and obligations apply to the agent's warrant. The warrant
does not contain a cashless exercise provision and includes a mandatory exercise
provision that allows the Company to require exercise in full of the warrant
within ten days of notice that the average closing price of its common stock is
equal to or greater than $10.50 per share for any 30 consecutive trading days.
The Company exercised the mandatory exercise provision on June 9, 2004 and the
warrant was exercised on June 10, 2004.

On April 28, 2004, the Company registered for resale by the selling
shareholders the shares of common stock and the shares of common stock issuable
upon exercise of the warrants issued in the private placement under a
registration statement on Form S-3. This registration statement also covered the
registration of 131,577 shares issuable upon the exercise of the agent's warrant
as well as 320,000 shares issuable upon the exercise of a warrant issued to
Hilco Capital, LP, which provided financing in connection with the Company's
November 2003 acquisition of the assets of BCI Eclipse and 1,000,000 shares
issued in connection with the BCI Eclipse acquisition.

7. STOCK OPTIONS AND GRANTS

The Company has a stock option plan for officers, key employees and
directors. The options are granted at fair market value and expire between five
and eight years after the grant date. Option activity is summarized as follows:

PLAN OPTIONS WEIGHTED AVERAGE
AVAILABLE FOR PLAN OPTIONS EXERCISE PRICE PER
GRANT OUTSTANDING SHARE
------------- ------------ ------------------

Balance on March 31, 2001 536,945 1,763,009 $ 4.32
Additional shares authorized 750,000 ---- ----
Granted (494,000) 494,000 1.10
Canceled 141,400 (141,400) 3.78
Terminated 129,709 (129,709) 3.99
---------- --------- ----------
Balance on March 31, 2002 1,064,054 1,985,900 $ 3.77
Granted (1,294,252) 1,294,252 1.56
Canceled 151,000 (151,000) 2.60
Terminated 91,200 (91,200) 3.00
---------- --------- ----------
Balance on March 31, 2003 12,002 3,037,952 $ 2.91
ADDITIONAL SHARES AUTHORIZED 1,000,000 ---- ----
GRANTED (701,748) 701,748 4.91
EXERCISED ---- (765,600) 2.80
CANCELED 7,300 (27,300) 3.26
TERMINATED 19,600 (19,600) 2.78
---------- --------- ----------
BALANCE ON MARCH 31, 2004 357,154 2,927,200 $ 3.41
========== ========= ==========

The exercise price of options outstanding at March 31, 2004 ranged from
$0.93 to $15.38 per share, as summarized in the following table:

SHARES
OUTSTANDING WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE
RANGE OF AT MARCH 31, REMAINING SHARES EXERCISE
EXERCISE PRICE 2004 CONTRACTUAL LIFE EXERCISABLE PRICE PER SHARE
--------------- ------------ ---------------- ----------- ----------------

$0.93 to $ 1.41 741,700 3.61 years 341,100 $ 1.28
$1.48 to $ 1.91 874,000 3.55 years 147,000 $ 1.67
$2.00 to $ 5.88 606,500 2.10 years 250,070 $ 4.31
$6.00 to $15.38 705,000 3.30 years 276,600 $ 8.67
--------------- --------- ---------- --------- --------
2,927,200 3.13 YEARS 1,014,770 $ 4.10
========= ========== ========= ========

The number of options exercisable at March 31, 2004, 2003, and 2002 was
1,014,770, 1,037,000, and 753,975, respectively, at a weighted average exercise
price of $4.10, $4.24, and $4.39, per share, respectively.

The Company has granted 100,000 and 250,000 options, respectively, to two
current key employees. The options were deemed commensurate with their level of
responsibility. The options vest depending on attaining certain
performance-based criteria. The performance-based options are subject to
variable accounting and will be recognized when, and if, the criteria are met
for vesting. Certain criteria was met and some of the options have vested,
therefore, the Company recorded stock-based compensation expense of $705,000.
The options expire September 21, 2006 and September 6, 2008, respectively.

8. INCOME TAXES

Deferred income taxes reflect the available tax carryforwards and the net
tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax
purposes. Significant components of the Company's deferred tax assets as of
March 31, 2004 and 2003 (in thousands):

FISCAL YEARS ENDED MARCH 31,
2004 2003
-------- --------

Net operating loss carryforwards $ 4,033 $ 9,147
AMT credit carryforwards 247 --------
Collectability reserves 4,478 3,231
Allowance for sales returns 1,341 2,071
Book/tax depreciation 406 55
Reserve for sales discounts 186 167
Accrued vacations 169 267
Inventory - uniform capitalization 155 59
Book/tax intangibles (3,276) ----
------ --------
7,739 $ 14,997
Valuation allowance (6,703) (14,997)
------ -------
Total deferred tax assets $ 1,036 $ ----
======== ========

At March 31, 2004 the Company has net operating loss carryforwards of
approximately $10,909,000, which will begin to expire in 2014 subject to
limitations under Section 382 of the Internal Revenue Code. Of this amount,
approximately $1,243,000 of future net operating loss utilization will result in
tax benefits associated with stock option exercises that will not reduce tax
expense but will rather increase equity.

A reconciliation of income tax benefit to the statutory federal rate is as
follows (in thousands):

FISCAL YEARS ENDED MARCH 31,
2004 2003 2002
-------- -------- --------

Tax expense at statutory rate $ 2,826 $ 1,467 $ 922
State income taxes, net of federal benefit 260 259 162
Reversal of valuation allowance (4,117) (1,789) (1,117)
Other 448 63 33
------ ------ ------
Tax benefit $ (583) $ 0 $ 0
------ ------ ------
Effective tax rate (7)% 0% 0%
------ ------ ------

The income tax benefit of $583,000 in fiscal 2004 consisted of current
expense of $453,000 and a deferred benefit of $1,036,000. Cash paid for income
taxes was $324,075, $0, and $0 for the years ended March 31, 2004, 2003 and
2002, respectively.

The Company's net deferred income tax assets were completely reserved for
fiscal 2002 and 2003 because of its recent history of pre-tax losses. Reversals
of these valuation reserves during fiscal 2002, 2003, and 2004 have resulted in
the recording of tax benefits associated with its utilization of net operating
loss carryforwards due to the generation of taxable income. In addition to
recognizing tax benefits related to utilization of net operating loss
carryforwards in fiscal 2004, the Company has also recognized an additional $1.0
million of tax benefit related to the reversal of a like amount of valuation
reserve. Such amount of valuation reserve reversal was made due to the
increasing probability of its ability to generate near-term pre-tax income.

9. COMMITMENTS

LEASES

The Company leases substantially all of its office, warehouse and
distribution facilities. The terms of the lease agreements generally range from
2 to 15 years. The leases require payment of real estate taxes and operating
costs in addition to rent.

Total rent expense was $1,931,000, $1,779,000, and $1,736,000 for the
years ended March 31, 2004, 2003, and 2002, respectively.

The following is a schedule of future minimum rental payments required
under noncancelable operating leases as of March 31, 2004 (in thousands):

2005 $1,635
2006 711
2007 546
2008 510
2009 510
Thereafter 2,213
------
$6,125
------

10. MAJOR CUSTOMERS

The Company has three major customers who accounted for 40%, 47%, and 45%
of net sales in fiscal 2004, 2003, and 2002, respectively. Each of the three
customers accounted for over 10% of the net sales in each fiscal year.

11. 401K PLAN

The Company has a 401k plan, which covers substantially all full-time
employees. The Company contributed $113,994, $101,139, and $91,596 to the plan
for the years ended March 31, 2004, 2003, and 2002, respectively.

12. BUSINESS SEGMENTS

Navarre currently operates two business segments: Distribution and
Publishing.

Through the Company's Distribution business it distributes and provide
fulfillment services in connection with a variety of finished goods that are
provided by its vendors, which include a variety of publishers, independent and
major music labels, and movie studios. These vendors provide the Company with PC
software, CD and DVD audio, DVD and VHS video, video games and accessories. The
Company's Distribution business focuses on providing retailers and publishers
with high-quality services for the broad, efficient distribution of these
products, including vendor-managed inventory, Electronic Data Interchange
services, fulfillment services, and retailer-oriented marketing services.

Through the Company's Publishing business the Company is the
exclusive licensee or owner of PC software, CD and DVD audio, DVD and VHS video,
and video game titles. The Company's Publishing business licenses, packages,
markets and sells these products to third-party distributors, retailers, as well
as to Navarre's Distribution business.

The following table provides information by business segment for the years
ended March 31, 2004, 2003 and 2002 (in thousands):

FISCAL YEAR 2004 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
----------------------------- ------------ ------------ ------------ ------------

Net Sales: $449,106 $ 46,181 $(20,043) $475,244
Income (loss) from operations 11,021 (1,874)(1) ---- 9,147
Depreciation expense 1,209 480 ---- 1,689
Interest expense 368 636 (626) 378
Income tax benefit 583 ---- ---- 583
Capital expenditures 4,897 91 ---- 4,988
Total assets 135,568 27,499 (16,140) 146,927

FISCAL YEAR 2003 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
----------------------------- ------------ ------------ ------------ ------------

Net sales: $355,884 $14,715 $(11,215) $359,384
Income from operations 3,964 41 ---- 4,005
Depreciation expense 1,296 321 ---- 1,617
Interest expense 149 405 (360) 194
Capital expenditures 994 45 ---- 1,039
Total assets 99,155 14,797 (12,823) 101,129

FISCAL YEAR 2002 DISTRIBUTION PUBLISHING ELIMINATIONS CONSOLIDATED
----------------------------- ------------ ------------ ------------ ------------

Net sales: $303,817 ---- ---- $303,817
Income from operations 521 ---- ---- 521
Depreciation expense 1,491 ---- ---- 1,491
Interest expense 173 ---- ---- 173
Capital expenditures 973 ---- ---- 973

(1) The Company re corded an impairment charge associated with product
development costs in fiscal 2004 of $5.6 million.

13. QUARTERLY DATA - SEASONALITY (UNAUDITED)

The Company's quarterly operating results have fluctuated significantly in
the past and will likely do so in the future as a result of seasonal variations
of products ultimately sold at retail. The Company's business is affected by the
pattern of seasonality common to other suppliers of retailers, particularly the
holiday selling season. Historically, more than 60% of the Company's sales and
substantial portions of the Company's profits have been in the third and fourth
quarters of the calendar year. Due to the lower level of sales during the off
periods, the Company has historically incurred losses during these periods.

The following table sets forth certain unaudited quarterly historical
financial data for each of the eight quarters in the period ended March 31,
2004. (In thousands, except per share amounts)

QUARTER ENDED
JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
------- ------------ ----------- --------

FISCAL YEAR 2004
Net Sales $73,424 $106,166 $153,039 $142,615
Gross profit 10,049 13,499 17,856 15,936
Net income $ 308 $ 1,723 $ 3,590 $ 3,275
======= ======== ======== ========
Net income per common share:
Basic $ 0.01 $ 0.08 $ 0.16 $ 0.13
======= ======== ======== ========
Diluted $ 0.01 $ 0.08 $ 0.15 $ 0.12
======= ======== ======== ========
FISCAL YEAR 2003
Net Sales $69,974 $ 88,864 $116,897 $ 83,649
Gross profit 8,048 11,432 14,087 11,564
Net income $ 198 $ 676 $ 3,005 $ 442
======= ======== ======== ========
Net income per common share:
Basic $ 0.01 $ 0.03 $ 0.14 $ 0.02
======= ======== ======== ========
Diluted $ 0.01 $ 0.03 $ 0.14 $ 0.02
======= ======== ======== ========

NAVARRE CORPORATION

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

BALANCE AT CHARGED TO BALANCE AT
BEGINNING COSTS AND ADDITIONS/ END OF
DESCRIPTION OF PERIOD EXPENSES (DEDUCTIONS) PERIOD
-------------------------------------------------------- ---------- ----------- --------------- ----------

YEAR ENDED MARCH 31, 2004:
DEDUCTED FROM ASSET ACCOUNTS:
INVENTORY OBSOLESCENCE RESERVE $ 318,000 $ (530,000) $ 1,016,000(1) $ 804,000
ALLOWANCE FOR DOUBTFUL ACCOUNTS 673,000 (196,000) 917,000(1) 1,394,000
ALLOWANCE FOR SALES RETURNS 4,160,000 (1,406,000) 952,000(1) 3,706,000
ALLOWANCE FOR MDF AND SALES DISC 1,107,000 144,000 ---- 1,251,000
---------- ----------- ----------- ----------
TOTALS $6,258,000 $(1,988,000) $ 2,885,000 $7,155,000
========== =========== =========== ==========
Year ended March 31, 2003:
Deducted from asset accounts:
Inventory obsolescence reserve $ 0 $ 0 $ 318,000 $ 318,000
Allowance for doubtful accounts 1,111,000 93,000 (531,000)(2) 673,000
Allowance for sales returns 1,300,000 296,000 2,564,000(3) 4,160,000
Allowance for MDF and Sales Disc ---- 338,000 769,000 1,107,000
---------- ----------- ----------- ----------
Totals $2,411,000 $ 727,000 $ 3,120,000 $6,258,000
========== =========== =========== ==========
Year ended March 31, 2002:
Deducted from asset accounts:
Inventory obsolescence reserve $ 0 $ 0 $ 0 $ 0
Allowance for doubtful accounts 2,917,000 1,035,000 (2,841,000)(2) 1,111,000
Allowance for sales returns 2,069,000 (769,000) ---- 1,300,000
---------- ----------- ----------- ----------
Totals $4,986,000 $ 266,000 $(2,841,000) $2,411,000
========== =========== =========== ==========

(1) Additional reserves associated with the operations of BCI.

(2) Uncollectible accounts written off, net of recoveries.

(3) Includes additional reserves associated with the operations of Encore
Software.