UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2006

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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
None		None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

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 þ No o

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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o          Accelerated filer þ          Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

The aggregate market value of the Common Stock, no par value per share, held by non-affiliates of the registrant as of September 30, 2005 was approximately $152,630,178 (based on the closing price of such stock as quoted on the NASDAQ National Market of $5.79 on such date).

The number of shares outstanding of the registrant’s Common Stock, no par value per share, was 35,649,895 as of June 12, 2006.

Part III incorporates information by reference to portions of the registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholders.

 

 

NAVARRE CORPORATION
FORM 10-K

TABLE OF CONTENTS

				Page
PART I
Item 1.		Business			3
Item 1A.		Risk Factors			11
Item 1B.		Unresolved Staff Comments			21
Item 2.		Properties			21
Item 3.		Legal Proceedings			21
Item 4.		Submission of Matters to a Vote of Security Holders			21
PART II
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities			22
Item 6.		Selected Financial Data			23
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk			35
Item 8.		Financial Statements and Supplementary Data			36
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			36
Item 9A.		Controls and Procedures			36
Item 9B.		Other Information			37
PART III
Item 10.		Directors and Executive Officers of the Registrant			37
Item 11.		Executive Compensation			37
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			37
Item 13.		Certain Relationships and Related Transactions			37
Item 14.		Principal Accountant Fees and Services			37
PART IV
Item 15.		Exhibits and Financial Statement Schedules			38
		Signatures			44
Addendum to Licensing and Distribution Agreements
Consent of Independent Registered Public Accounting Firm - Grant Thornton LLP
Consent of Independent Registered Public Accounting Firm - Ernst & Young LLP
Certification of the CEO Pursuant to Section 302
Certification of the CFO Pursuant to Section 302
Certification of the CEO Pursuant to Section 906
Certification of the CFO Pursuant to Section 906

PART I

Item 1 — Business

Overview

     Navarre Corporation is a distributor and publisher of physical and digital home entertainment and multimedia products, including PC software, CD audio, DVD video, video games and accessories. Since inception in 1983, we have established distribution relationships with major retailers including Best Buy, Wal-Mart/Sam’s Club and CompUSA, and we currently distribute to over 19,000 retail and distribution center locations throughout the United States and Canada. We believe that our established relationships throughout the supply chain, our broad product offering and our distribution facility permit us to offer industry-leading home entertainment and multimedia products to our retail customers and to provide access to attractive retail channels for the publishers of such products.

     Historically, our business has focused on providing distribution services for third party vendors. Over the past three years, we have expanded our business to include the licensing and publishing of home entertainment and multimedia content, primarily through our acquisitions of publishers in select markets. By expanding our product offerings through such acquisitions, we believe that we can leverage both our sales experience and distribution capabilities to drive increased retail penetration and more effective distribution of such products, and enable content developers and publishers that we acquire to focus more on their core competencies.

     Our business is divided into three segments—Distribution, Publishing and Other.

     Distribution. 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 PC software and video game publishers and developers, independent and major music labels, and independent and major motion picture studios. These vendors provide us with PC software, CD audio, DVD video, and video games and accessories which we, in turn, distribute to our retail customers. Our distribution business focuses on providing vendors and retailers with a range of value-added services including: vendor-managed inventory, Internet-based ordering, electronic data interchange services, fulfillment services and retailer-oriented marketing services. Our vendors include Symantec Corporation, Adobe Systems, Inc., McAfee, Inc., and Dreamcatcher Interactive, Inc. Our digital strategy consists primarily of the sale of independent music titles through online digital music retailers such as iTunes, Napster and Rhapsody. The Company also continues to explore additional digital distribution opportunities for our other product categories.

     Publishing. Through our publishing business, which generally has higher gross margins than our distribution business, we own or license various PC software, CD audio and DVD video titles, and we package, brand, market and sell directly to retailers, third party distributors and our distribution business. Our publishing business currently consists of Encore Software, Inc. (“Encore”), BCI Eclipse Company, LLC (“BCI”), FUNimation Productions, Ltd. and The FUNimation Store, Ltd. (together, “FUNimation”). Encore, which we acquired in July 2002, licenses and publishes personal productivity, genealogy, education and interactive gaming PC products, including titles such as Print Shop, Print Master, PC Tool’s Spyware Doctor and Hoyle PC Gaming products. BCI, which we acquired in November 2003, is a provider of niche DVD and video products such as He-man and the Masters of the Universe and in-house produced CDs and DVDs. FUNimation, acquired on May 11, 2005, is a leading anime content provider in the United States and licenses and publishes titles such as Dragon Ball Z, Fullmetal Alchemist, Code Lyoko, Samari Seven, Burst Angel, Noddy, Yu Yu Hakusho and Degrassi.

     Other. The other segment consists of a variable interest entity (“VIE”), Mix & Burn, Inc. (“Mix & Burn”), included in our consolidated results during the period commencing December 31, 2003, and ending December 31, 2005, in accordance with the provisions of FIN 46(R). Mix & Burn designs and markets digital music delivery services for music and other specialty retailers. During the three months ended December 31, 2005, the Company deconsolidated Mix & Burn, as the Company was no longer deemed to be the primary beneficiary of this VIE.

Strategy

     We seek to continue to grow our distribution and publishing businesses, through a combination of organic growth and targeted acquisitions, intended to leverage the complementary strengths of our businesses. We intend to execute this strategy as follows:

•

Acquisitions of Attractive Content. We seek to continue to expand our publishing business through the acquisition or licensing of well-established titles or other attractive content. We believe these acquisitions and/or licenses will help position us to increase our net sales in our publishing business, which historically has had higher margins than our distribution business, and will allow us to distribute additional home entertainment and multimedia content through our distribution business. In addition,

we believe that by allowing the management of these publishing companies to focus on content licensing and marketing rather than on distribution operations, they will be able to devote more time and greater resources to their core competency, publishing. We believe that leveraging the core assets and strengths of our distribution business will provide broader retail penetration, distribution expertise and other services for our content and increase sales of our publishing products. We may also seek selective acquisitions of distribution businesses.

	•		Distribute a Broader Range and Larger Volume of Products. We seek to distribute a broader range and larger volume of home entertainment and multimedia products to our retail customers by providing a broad selection of products and capitalizing on our customer relationships. We seek to capture additional business from new and existing retail customers by providing them with a lower “all-in” cost of procuring merchandise and getting product to retailers’ shelves through efficient distribution. We expect that providing additional products to retailers will enable us to gain category management opportunities and enhance our reputation for product distribution expertise. We believe our strategic account associates located throughout the United States and Canada will help position us to improve the retail penetration of our published products to new and existing retail customers.
	•		Integrating Our Technology and Systems with Retailers. We seek to enhance the link in the supply chain between us and our publishers and retail customers through the integration of our respective information and technology systems, including inventory management tools, replenishment systems and point-of-sale information. We believe this integration will lead to better in-stock levels of product, improved on-time arrivals of product to the customer, enhanced inventory management and lower return rates for our customers, thereby strengthening customer relationships.
	•		Providing Value-Added Services. We believe that due to increasing retailer logistic needs and demands, including demands for new technology standards such as GTIN® (global trade item number), RFID (radio frequency identification devices) and VMI (vendor managed inventory), many publishers will be required to decide whether to spend additional resources to update their distribution capabilities or to select a distributor such as us that intends to offer such services. We believe that implementing and offering these and other technologies should position us well to capture additional business from existing and new publishers.

     Our overall goal is to create a structure that leverages the complementary strengths of our businesses: publishing, which provides brand management and marketing, licensing, and home video sales; and distribution, which provides enhanced distribution, logistics and customer relations.

Competitive Strengths

     We believe that we possess the following competitive strengths:

	•		Value-Added Services. We offer a wide range of distribution services and procurement solutions intended to capitalize on our broad understanding of the products that we distribute, the procurement process and the supply chain, as well as our logistics expertise and systems capabilities. We believe that our advanced distribution infrastructure enables us to provide customized procurement programs for our retail customers at a lower overall cost than many of our competitors. In addition, we believe that our information technology systems provide cost-effective interfacing with our customers’ information technology systems, supporting integration of the procurement process. We believe that our focus on providing customer-specific and cost-effective solutions is a key benefit that we provide to our retail customers.
	•		Broad Product Offering. We provide our retail customers with a broad selection of home entertainment and multimedia products that we believe allows us to better serve their home entertainment and multimedia product requirements. In addition, we regularly survey the markets we serve for new products with significant retail potential, that come from publishers we currently have relationships with as well as those we have not distributed for in the past.
	•		Established Content in our Publishing Business. We currently license a number of well-known home entertainment and multimedia titles. Encore publishes leading titles in the education, productivity, kids and games software categories, including Print Shop, Print Master, PC Tool’s Spyware Doctor, and Hoyle PC Gaming Products. In addition, our BCI subsidiary currently publishes home video for He-man and the Masters of the Universe, the television shows Rides and Overhaulin’, both featured on The Learning Channel, and PRIDE Fighting Championships, featured on Pay-Per-View. Through our FUNimation business we also license and distribute a portfolio of established anime and children’s entertainment titles in the United States, including Dragon Ball Z, Fullmetal Alchemist, Code Lyoko, Samari Seven, Burst Angel, Noddy, Yu Yu Hakusho and Degrassi.

	•		Established Relationships with Publishers and Retailers. Since our founding in 1983, we have established distribution relationships with major retailers including Best Buy, Wal-Mart/Sam’s Club and CompUSA, and we currently distribute to over 19,000 retail and distribution center locations throughout the United States and Canada. We believe our strong relationships throughout the supply chain, broad product offering and our distribution facility permit us to offer industry-leading home entertainment and multimedia products to our retail customers and provide access to attractive retail channels for publishers of these products. We believe our relationships with leading publishers and our efficient distribution of their products should provide opportunities for us to secure distribution rights to leading products in the future. We believe that these relationships give us a competitive advantage in the markets in which we operate and provide us with attractive channels to distribute current and future products offered by our publishing business.
	•		Efficient Operations and Operating Leverage. We believe that our competitive position is enhanced by our efficient operations, which are based on extensive use of automation and technology in our distribution facility; centralization of functions such as purchasing, accounting and information systems; and economies of scale. Our warehouse facility adjacent to our corporate headquarters provides us with the ability to efficiently service our vendors and retail customers, and the capacity to increase the number of products that we distribute.

Distribution Markets

     PC Software

     According to The NPD Group, the PC software industry achieved $3.8 billion on a trailing 12 month basis ending December 31, 2005. Categories that experienced an increase during this time period were business and finance products.

     We presently have relationships with PC software publishers such as Symantec Corporation, Roxio, Inc., Adobe Systems Inc., McAfee, Inc., Dreamcatcher Interactive, Inc., Delorme, Webroot Software, Inc. and Lucas Arts Entertainment. These relationships are important to our distribution business and during the fiscal year ended March 31, 2006 each of these publishers accounted for more than $5.0 million in revenues. In the case of Symantec, sales accounted for approximately $86.9 million in net sales in the fiscal year ended March 31, 2006 and $90.8 million in net sales for the fiscal year ended March 31, 2005. During the past fiscal year, we added several publishers to our distribution roster.

     While we have agreements in place with our major suppliers, they are generally short-term agreements with terms of one to three years, 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 products at a reduced wholesale price and for us to provide a variety of distribution and fulfillment services in connection with the products. We intend to continue seeking to add publishers to attempt to further increase our market share in the PC software industry.

     Video Games Software and Accessories

     According to The NPD Group, the video games software and accessories industry was $10.5 billion in 2005 compared to $10.0 billion in 2004. According to industry sources, the installed base of video game consoles in North America is expected to grow to approximately 159.3 million users in 2010 compared to 97.1 million users in December 2005.

     We continued to expand our distribution of console-based video games in fiscal 2006. Our relationships with video game vendors such as Square Enix USA, Inc., Midway, THQ and Vivendi are important to this category of our distribution business.

     Major Label Music

     The Company distributed CD’s on behalf of major labels to a few select retailers. Generally, major music labels control distribution of their products through major music retail chains and other channels. During fiscal 2006, we exited the major label music category to focus our resources on other product categories.

     Independent Label Music

     The independent segment of the music industry currently represents approximately 13% of total music product for 2005 according to the Recording Industry Association of America (“RIAA”).

     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. We seek to increase our market share in the independent music distribution business by continuing to seek 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., Dualtone Music Group, Inc., Equity Records, Inc. and Cleopatra Records, Inc. are also important to our independent music distribution business. We have exclusive distribution 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 generally provide us with the ability to return products to our independent music labels, 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 Home Video

     According to industry sources, U.S. home video industry sales totaled $24.3 billion in 2005 compared to $24.5 billion in 2004.

     Our relationships with Universal Distribution Corp., Twentieth Century Fox Home Entertainment and Buena Vista Home Video are important to our major studio home video distribution business.

Customers

     Since our founding in 1983, we have established relationships with retailers across mass merchant, specialty and wholesale club channels, including Best Buy, Wal-Mart/Sam’s Club, CompUSA and Costco. We currently sell and distribute products to over 19,000 retail and distribution center locations throughout the United States and Canada. While a major portion of our revenues are generated from these major retailers, we also supply products to smaller independent retailers as well as through telephone sales and our business-to-business site located at www.navarre.com. See “E-Commerce”. Through these sales channels, we seek to ensure a broad reach of product throughout the country in a cost-efficient manner.

     In each of the past several years, we have had a small number of customers that accounted for 10% or more of our net sales. During the fiscal year ended March 31, 2006, sales to two customers, Best Buy and Wal-Mart/Sam’s Club, accounted for approximately 18%, and 12%, respectively, of our total net sales. During the fiscal year ended March 31, 2005, sales to these customers represented approximately 19% and 20%, respectively, of our total net sales.

Navarre’s Distribution Business Model

     Vendor Relationships

     We view our vendors as customers and work to manage retail relationships to make their business easier and more productive. By doing so, we believe that our reputation as a service-oriented organization has helped us expand our vendor roster. We believe that major companies like Adobe Systems, Symantec Corporation, Buena Vista, Universal, Lucas Arts, Konami and Square Enix have been added to our vendor roster because of our reputation as a service-driven organization.

     Furthermore, our dedication to smaller, second-tier vendors has helped to complement our vendor roster. Many of these vendors do not have the leverage necessary to manage their business effectively with major retailers. We provide these vendors the opportunity to access shelf space and assist in the solicitation, logistics, promotion and management of products. We also conduct one-on-one meetings with smaller vendors to give them the opportunity to establish crucial business relationships with our retail customers. Examples of these vendors are as follows: Dreamcatcher Interactive, Inc., First Look Home Entertainment, Hart Sharp Video, Intec Inc. and Majesco.

     Retail Services

     Along with the value added sales functions that we provide to vendors, we also have the ability to customize shipments to each individual customer. In the case of the warehouse club channel, we may “pre-sticker” multiple different labels, based on the vendor/customer preference. We assemble creative marketing programs, which include pallet programs, product bundles and

specialized packaging. We also create multi-vendor assortments for the club channel, providing the retailer with a broad assortment of products. Our marketing and creative services department designs and produces a variety of advertising vehicles including in-store flyers, direct mail pieces and magazine/newspaper ads, as well as free standing displayers for retail.

     We are committed to offering first-rate information flow for all vendors. We understand the importance of sharing sell-through, inventory, sales forecasts, promotional forecasts, SKU status and all SKU data with the respective vendor. We provide the aforementioned information via a secure online portal, for vendors. Furthermore, each individual account manager has account-specific information that is shared on a regular basis with appropriate vendors. We also accommodate specialized reporting requests for our vendors, which we believe helps in the management of their business.

     Warehouse Systems

     A primary focus of our distribution business is logistics and supply chain management. As customer demands become more sophisticated, we have continued to update our technology. In fiscal 2005, we made a significant investment in a new, highly-automated material handling facility which we believe will improve our overall long-term efficiency and assist in reducing costs for both vendors and customers. With our returns processing system, we seek to process returns and issue both credit and vendor deductions within 48 hours of receipt. We believe that our inventory system offers better in-stock levels of product, improved on-time arrivals of product to the customer, enhanced inventory management and lower return rates for our customers, thereby strengthening our customer relationships.

     E-Commerce

     During fiscal year 2006, 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 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.

Publishing Markets

     In July 2002 and November 2003, we acquired Encore and BCI, respectively. Encore is a publisher of PC products and BCI is a provider of niche DVD/video and audio products. Both of these businesses exclusively own or license and produce PC/DVD/video products. Encore has an exclusive co-publishing agreement with Riverdeep, Inc. (“Riverdeep”) 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. Encore also has exclusive licensing agreements with Vivendi and The United States Playing Card Company, Inc. for the sales and marketing of the Hoyle brand of family entertainment software products. FUNimation, acquired on May 11, 2005, is a leading anime content provider in the United States.

     Encore

     Encore publishes leading titles in the education, productivity, kids and games software categories, including Print Shop, Print Master, PC Tool’s Spyware Doctor and Hoyle PC Gaming products. According to the NPD Group, Encore’s published brands, when combined, rank as the sixth largest PC Software publisher in North America, by dollar sales. According to The NPD Group, for the twelve months ended March 31, 2006, the Hoyle brand held a 12.0% share of the PC Games category based on units sold, and Hoyle Card Games held the #1 rank in this category.

     Encore focuses on retail sales and marketing of its licensed content, without the distraction and financial risk of significant content development. The benefit to our licensed vendors is they can focus on their core competencies of content development and delivery.

     Encore continues to evaluate emerging PC software brands that have the potential to become successful franchises. Encore continues to focus on establishing relationships with developed brands that are seeking to change their business models.

     Encore’s strategy is to continue to license quality branded PC software titles. It has experience in signing single-brand products as well as taking on multiple titles in single agreements, as demonstrated by the signing of the Riverdeep and Hoyle publishing agreements.

     Encore’s corporate headquarters are located in Los Angeles, California. Encore’s distribution, assembly and fulfillment operations relocated from Los Angeles, California, to Minneapolis, Minnesota, in January 2005.

     BCI

     BCI is a developer, licensor, packager and marketer of entertainment video and audio products. Since 1988, BCI has sought to redefine the standards and concepts in the budget DVD category. We believe that BCI was among one of the first vendors to introduce five-pack, ten-pack and 20-pack DVDs to the marketplace. We also believe that BCI was one of the first to introduce “dollar” DVDs to the “dollar store” marketplace.

     BCI’s portfolio of titles represents both licensed titles, in-house produced CDs and DVDs from production groups, and specialty television programming. BCI’s home video titles include He-Man and the Masters of the Universe, Rides and Overhaulin’, featured on The Learning Channel, and PRIDE Fighting Championships, featured on Pay-Per-View.

     FUNimation

     On May 11, 2005, we completed the acquisition of 100% of the general and limited partnership interests of FUNimation Productions, Ltd. and The FUNimation Store, Ltd., which are based in Fort Worth, Texas (together, “FUNimation”). FUNimation is a leading content provider in the United States market for anime which it licenses from Japanese rights holders and translates and adapts the content for television programming and home videos, primarily targeting audiences between the ages of 6 and 17. In addition, FUNimation licenses other children’s entertainment content. FUNimation leverages its licensed content into various revenue streams, including television broadcast, DVD home video distribution, and licensing of merchandising rights for toys, video games and trading cards. FUNimation’s licensed titles include Dragon Ball Z, Fullmetal Alchemist, Code Lyoko, Samurai Seven, Burst Angel, Noddy, Yu Yu Hakusho and Degrassi.

     FUNimation identifies, based on its own market research, properties that it believes can be successfully adapted to the U.S. anime and children’s content market. This market research generally involves analyzing television ratings, merchandise sales trends, home video sales, anime magazines and popularity polls in both the U.S. and Japanese markets. After identifying a property that has the potential for success in the United States, FUNimation seeks to capitalize on its relationships with Japanese rights holders and its reputation as a content provider of anime in the United States to obtain the commercial rights to such property, primarily for television programming, home video distribution and merchandising.

     Broadcast. For television programming, FUNimation translates and adapts its licensed anime titles to conform to U.S. television programming standards. FUNimation performs most of its production work in-house at its production facility in Fort Worth, Texas.

     Home Video Distribution. FUNimation seeks to increase the revenue derived from its licensed properties through home video distribution. FUNimation also currently provides home video distribution services for other children’s content providers, including 4Kids Entertainment, Nelvana and Alliance Atlantis. A majority of its home videos are sold directly to major retail chains. According to Nielsen VideoScan, in 2005, FUNimation was ranked as one of the leading distributors of anime home video in the United States.

     Licensing and Merchandising. For properties which FUNimation controls the merchandise rights, it seeks to further leverage its licensed content by sub-licensing these rights to manufacturers of children’s and other products. FUNimation has developed a network of over 80 license partners, including JAKKS Pacific, Atari, ODM, SCORE Entertainment and Scholastic for the merchandising of toys, video games, apparel, trading and collectible card games and books. FUNimation manages its properties for consistent and accurate portrayal throughout the marketplace. FUNimation receives royalties from its sublicensees based on a predetermined royalty rate, subject to guaranteed minimums in certain cases.

     Retail Sales and Web Sites. FUNimation operates websites devoted to the anime fan base. Typically, as part of its brand management strategy, FUNimation will develop an interactive site for each licensed property. These sites provide information about upcoming episodes and the characters associated with the show. In addition, FUNimation’s properties are supported by its in-house Internet store, the Z-Store, which sells home videos and licensed merchandise.

Competition

     All aspects of our business are highly competitive. Our competitors include other national and regional businesses, as well as some suppliers that sell directly to retailers. Certain 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:

	•		obtain exclusive national distribution contracts and licenses with independent music labels and manufacturers;
	•		obtain proprietary publishing rights with various rights holders and brand owners;
	•		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 consumer interest in our proprietary products; and
	•		maintain operating expenses at an appropriate level.

     In the PC 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 pre-recorded music industry, we face competition from the major label distribution companies, as well as other national independent distributors, such as Koch Entertainment, RED Music Distribution, Alternative Distribution Alliance, Ryko Distribution, Fontana Distribution and Caroline Distribution, as well as from other entities that sell directly to retailers. FUNimation’s competitors include: 4Kids, ADV Films, Geneon Entertainment, Bandai, Ventura, Media Blasters and Buena Vista.

     We believe that competition in all of our businesses will remain intense. The keys to our growth and profitability include: (i) customer service, (ii) continued focus on improvements and operating efficiencies, (iii) the ability to license and develop proprietary products, and (iv) the ability to attract new content, quality labels, studios and software publishers. We also believe that over the next several years, the PC software distribution industry and pre-recorded music distribution industry, will continue to further consolidate.

Backlog

     Because a substantial portion of 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.

Employees

     As of March 31, 2006, we had 780 employees, including 206 in administration, finance, merchandising and licensing, 127 in sales and marketing and 447 in production and distribution. These employees are not subject to collective bargaining agreements and are not represented by unions. We consider our relations with our employees to be good.

Capital Resources — Financing

     Our credit agreement with GE Commercial Finance was amended and restated in its entirety on May 11, 2005 in order to provide us with the funds necessary to complete funding for the FUNimation acquisition and was again amended and restated in its entirety on June 1, 2005. The credit agreement currently provides a six-year $115.0 million Term Loan B sub-facility, a $25.0 million five and one-half year Term Loan C sub-facility, and a five-year revolving sub-facility for up to $25.0 million. On the Term Loan B sub-facility, 80.1 million was outstanding at March 31, 2006. The Term Loan C sub-facility was paid in full during fiscal 2006. The revolving sub-facility of up to $25.0 million is available to us for our working capital and general corporate needs. There were no amounts outstanding at March 31, 2006 on the revolving sub-facility. See further discussion in Management’s Discussion & Analysis of Financial Condition, Results of Operations and Liquidity and Capital Resources.

     The loans under our senior credit facilities are variable rate obligations and are guaranteed by our subsidiaries and are secured by a first priority security interest in all of our assets and in all of the assets of our subsidiary companies, as well as the capital stock of our subsidiary companies.

     Under the credit agreement we are required to meet certain financial and non-financial covenants. The financial covenants include a variety of financial metrics that are used to determine our overall financial stability and include limitations on our capital expenditures, a minimum ratio of EBITDA to fixed charges, and a maximum of indebtedness to EBITDA. However, the revolving sub-facility has no borrowing base availability requirement.

Available Information

     We also make available, free of charge through our website, www.navarre.com, annual, quarterly and current reports (and amendments thereto) as soon as reasonably practicable after our electronic filing.

Executive Officers of the Company

     The following table sets forth our executive officers of Navarre as of June 14, 2006:

Name		Age		Position
Eric H. Paulson		61		Chairman of the Board and Chief Executive Officer
Cary L. Deacon		54		President and Chief Operating Officer
J. Reid Porter		57		Executive Vice President, Chief Financial Officer
Brian M.T. Burke		35		President of Navarre Distribution Services
Michael A. Bell		41		Chief Executive Officer of Encore
Gen Fukunaga		45		Chief Executive Officer and President of FUNimation
Edward D. Goetz		62		President of BCI Eclipse
John Turner		52		Senior Vice President of Global Logistics
Ryan F. Urness		34		General Counsel and Secretary

     Eric H. Paulson is our founder and has been our Chief Executive Officer since our inception in 1983. Prior to 1983, Mr. Paulson served as Senior Vice President and General Manager of Pickwick Distribution Companies, a distributor of home entertainment products. Mr. Paulson has been a director since 1983 except for the period January 1990 through October 1991 when Navarre was owned by Live Entertainment, Inc.

     Cary L. Deacon has been President and Chief Operating Officer of Navarre Corporation since August of 2005, and until that time was the Chief Operating Officer, Publishing and Corporate Relations Officer since joining the Company in September 2002. From September 2001 to August 2002, Mr. Deacon served as President and Chief Executive Officer of NetRadio Corporation, a media company. From July 2000 to August 2001, he served as President, Chief Operating Officer and as a member of the Board of Directors of SkyMall, Inc., an integrated specialty retailer. From August 1998 to July 2000, Mr. Deacon served as President of ValueVision International, Inc., a home-shopping network company. From May 1997 to June 1998, Mr. Deacon served as a General Partner of Marketing Advocates Inc., a marketing consulting firm. Previously, he served as SVP, EVP and COO levels with the Hudson’s Bay Company, Montgomery Wards, Saffer Advertising and Macy’s. Mr. Deacon also serves as a director of Raindance Communication, Inc. (RNDC), which provides remote communications services for business meetings and events.

     J. Reid Porter has been Executive Vice President and Chief Financial Officer since joining our Company in December 2005. From October 2001 to October 2004, Mr. Porter, served as Executive Vice President and Chief Financial Officer of IMC Global Inc., a leading producer and marketer of concentrated phosphate and potash for the agricultural industry. During his tenure at IMC Global he helped lead efforts to consolidate the agricultural nutrient industry, culminating in the October 2004 merger of IMC Global with a subsidiary of Cargill Corporation, to form what is now known as Mosaic Global Holdings Inc. From 1998 to October 2001, Mr. Porter served as Vice President and partner of Hidden Creek Industries and Chief Financial Officer of Heavy Duty Holdings, partnerships in the automotive-related and heavy-duty commercial vehicle industries, respectively. Previously, he held executive positions at Andersen Windows, Onan Corporation and McGraw-Edison Company, Inc.

     Brian M. T. Burke has been President of Navarre Distribution Services since August 2005. He previously served as Chief Operating Officer, Distribution, since February 2004, Senior Vice President and General Manager, Navarre Distribution Services since April 2001, Vice President and General Manager, Computer Products Division since July 2000 and Vice President, Computer Products Division since October 1999. Prior to that, Mr. Burke held a series of positions of increasing responsibility in Navarre Computer Products Division since joining the Company in July 1995. Previously, Mr. Burke held various marketing, sales and account manager positions with Imtron and Blue Cross/Blue Shield of Minnesota.

     Michael A. Bell is the Chief Executive Officer of Encore and has served the Company in that role since August 2002 when Encore, was acquired and became a subsidiary of the Company. Mr. Bell co-founded the acquired company, Encore Software, Inc., in October 1994 and served as its Chief Executive Officer from its founding. Prior to starting Encore Software, Inc., Mr. Bell served as Director of Sales for Paramount from 1992 to 1994. Previously, Mr. Bell served as Sales Manager for NEC, leading an entrepreneurial unit established to forge strategic relationships that helped create the then-nascent CD-ROM industry.

     Gen Fukunaga is the Chief Executive Officer and President of FUNimation Productions, Ltd., and has served in that role since May 2005 when FUNimation was acquired by the Company. Mr. Fukunaga co-founded FUNimation in 1994 and has served as its President from its founding. Prior to starting FUNimation, Mr. Fukunaga served as Product Manager of Software Development Tools for Tandem Computers. Previously, Mr. Fukunaga held a strategic consulting position with Andersen Consulting.

     Edward D. Goetz has been President of the Company’s subsidiary, BCI Eclipse, since the Company acquired the assets of BCI Eclipse, LLC in November of 2003. Mr. Goetz had also served as the President of BCI Eclipse, LLC since he joined that firm in June of 2000. Prior to joining BCI, he served as the President of Simitar Entertainment from 1984 to 2000. Previously, Mr. Goetz held various positions including National Sales Manager and VP of Media Purchasing at K-Tel International from 1974 to 1984.

     John Turner has been Senior Vice President of Global Logistics since September 2003. He previously served as Senior Vice President of Operations since December 2001, and Vice President of Operations since joining the Company in September 1995. Prior to joining Navarre, Mr. Turner was Senior Director of Distribution for Nordic Track in Chaska, MN from July 1993 to September 1995. Previously, he held various positions in logistics in the United States and in the United Kingdom.

     Ryan F. Urness has been General Counsel of Navarre since July 2004 and Secretary of Navarre since May 2004. He previously served as Assistant Secretary of Navarre since February 2004 and as Corporate Counsel since January 2003. Prior to joining Navarre a significant portion of Mr. Urness’ efforts were engaged in various matters for the Company as outside legal counsel in the Minneapolis, Minnesota office of Winthrop & Weinstine, P.A. Mr. Urness is a graduate of the University of St. Thomas and William Mitchell College of Law.

Item 1A — Risk Factors

FORWARD-LOOKING STATEMENTS / RISK FACTORS

     We make written and oral statements from time to time regarding our business and prospects, such as projections of future performance, statements of 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 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimates,” “projects,” “believes,” “expects,” “anticipates,” “intends,” “target,” “goal,” “plans,” “objective,” “should” or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, including this Annual Report, 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:

Risks Relating To Our Business And Industry

We derive a substantial portion of our total net sales from a small group of customers. A reduction in sales to any of these customers could have a material adverse effect on our net sales and profitability.

     For the fiscal year ended March 31, 2006, net sales to two customers, Best Buy and Wal-Mart/Sam’s Club accounted for approximately 18% and 12%, respectively, of our total net sales, and, in the aggregate, approximately 30% of our total net sales. For the fiscal year ended March 31, 2005, net sales to two customers, Best Buy and Wal-Mart/Sam’s Club accounted for approximately 19% and 20%, respectively, of our total net sales, and, in the aggregate, approximately 39% of our total net sales. For the fiscal year ended March 31, 2004, net sales to three customers, Best Buy, CompUSA and Sam’s Club, represented approximately 18%, 13% and 11%, respectively, of our total net sales, and, in the aggregate, approximately 42% of our total net sales. We believe that sales to a small group of customers will continue to represent a significant percentage of our total net sales. Substantially all of the products we distribute to these customers are supplied on a non-exclusive basis under arrangements that may be cancelled without cause and upon short notice, and our retail customers generally are not required to make minimum purchases. If we are unable to continue to sell our products to all or any of these customers or are unable to maintain our sales to these customers at current levels and cannot find other customers to replace these sales, there would be an adverse impact on our net sales and profitability. There can be no assurance that we will continue to recognize a significant amount of revenue from sales to any specific customer.

The loss of a significant vendor or manufacturer or a decline in the popularity of its products could negatively affect our product offerings and reduce our net sales and profitability.

     A significant portion of our increase in net sales in recent years has been due to increased sales of PC software provided by software publishers such as Symantec Corporation, Roxio, Inc., Adobe Systems Inc., McAfee, Inc. and Dreamcatcher Interactive, Inc. During the fiscal years ended March 31, 2006, 2005 and 2004, each of these publishers accounted for more than $5.0 million in net sales. The largest of these is due to sales under our agreement with Symantec which accounted for approximately $86.9 million, $91.0 million and $51.0 million in net sales for the fiscal years ended March 31, 2006, 2005 and 2004, respectively. While we have agreements in place with each of these parties, such agreements generally are short-term agreements that may be cancelled without cause and upon short notice; they generally cover the right to distribute in the United States and Canada; they do not restrict the publishers from distributing their products through other distributors or directly to retailers; and they do not guarantee product availability to us for distribution. These agreements allow us to purchase the publishers’ products at a reduced wholesale price and to provide various distribution and fulfillment services in connection with the publishers’ products. If we were to lose our right to distribute products of any of the above PC software publishers or the popularity of such product were to decrease, our net sales and profitability would be adversely impacted.

     Our future growth and success depends partly upon our ability to procure and renew popular product distribution agreements and to sell the underlying products. There can be no assurance that we will enter into new distribution agreements or that we will be able to sell products under existing distribution agreements. Further, our current distribution agreements may be terminated on short notice. The loss of a significant vendor could negatively affect our product offerings and, accordingly, our net sales. Similarly, a decrease in customer demand for such products could negatively affect our net sales.

The loss of our founder could affect the depth, quality and effectiveness of our management team. 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 Chief Executive Officer and founder, has been with us since our inception in 1983. Mr. Paulson’s employment agreement currently extends through March 31, 2007, and the loss of or change in Mr. Paulson’s services, or the failure to execute a smooth transition plan could negatively affect the operation of the 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 we do. If we are not successful in recruiting or retaining such personnel, it could have a material adverse effect on our business.

We may not be able to sustain the recent growth in our publishing segment.

     Our publishing business has grown significantly over the past three fiscal years. Our discussions of changes in financial position and results of operations of this business may not be indicative of future performance, and this segment’s financial results may significantly vary in future quarters.

We could encounter difficulties in the operation of this segment that could negatively affect its financial condition and results of operation. Accordingly, there is no assurance that we will be able to continue to grow this segment of our business. Investors should not rely on the past performance of our publishing segment as an indicator of our future growth, and there can be no assurance that we will be able to successfully implement our publishing growth strategy.

Our business is seasonal and variable in nature and, as a result, the level of sales and payment terms during our peak season could adversely affect our results of operations and liquidity.

     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 31.2%, 30.6% and 32.1% of our net sales for the fiscal years ended March 31, 2006, 2005 and 2004. As a distributor of products ultimately sold to consumers, our business is affected by the pattern of seasonality common to other suppliers of retailers, particularly during the holiday season. Because of this seasonality, if we or our customers experience a weak holiday season or if we provide extended payment terms for sales during the holiday season or determine to increase our inventory levels to meet anticipated retail customer demand, our financial results and liquidity or could be negatively affected. In addition, our borrowing levels and inventory levels can increase substantially during this time. For example, during the 2004 holiday season, we increased our inventory of certain PC software products to satisfy potential retail customer demand for such products, which temporarily caused our inventory and borrowing levels to be higher than usual. In addition to seasonality issues, other factors contribute to the variability of our revenues and cash flows in our business segments on a quarterly basis. These factors include:

	•		the popularity of the pre-recorded music, DVD and PC software titles released during the quarter;
	•		product marketing and promotional activities;
	•		the opening and closing of retail stores by our major customers;
	•		the extension, termination or non-renewal of existing distribution agreements and licenses; and
	•		general economic changes affecting the buying pattern of retailers, particularly those changes affecting consumer demand for home entertainment products and PC software.

Pending litigation or regulatory inquiry may subject us to significant litigation costs, judgments or penalties and could divert management attention.

     We are involved in a number of litigation matters, including shareholder class action suits and derivative suits, as well as an informal inquiry by the U.S. Securities and Exchange Commission. Irrespective of the validity of the assertions made in these suits or the positions asserted in these proceedings or any final resolution in these matters, we could incur substantial costs and management’s attention could be diverted, which could adversely affect our business, financial condition or operating results.

A substantial portion of FUNimation’s revenues typically derive from a small number of licensed properties and a small number of licensors and FUNimation’s content is highly concentrated in the anime genre.

     FUNimation derives a substantial portion of its revenues from a small number of properties and such properties usually generate revenues only for a limited period of time. Additionally, FUNimation’s content is concentrated in the anime sector and its revenues are highly subject to the changing trends in the toy, game and entertainment businesses. In particular, one licensed property accounted for $9.7 million, or 27% of FUNimation’s net sales for the fiscal year ended March 31, 2006. FUNimation’s revenues may fluctuate significantly from year to year due to, among other reasons, the popularity of its licensed properties and the timing of entering into new licensing contracts.

     During the fiscal year ended March 31, 2006, 61% of FUNimation’s revenues, were derived from sales of products under multiple licensing arrangements with three licensors. The loss of any of these licensing relationships could have a material negative effect on FUNimation’s revenues.

FUNimation’s revenues are substantially dependent on television exposure for its licensed properties.

     The ability for certain anime and children’s entertainment content to gain television exposure is an important promotional vehicle for home video sales and licensing opportunities. To the extent that FUNimation’s content is not able to gain television exposure, sales of these products could be limited. Similarly, demand for properties broadcast on television generally is based on television ratings. In addition, FUNimation does not own the broadcast rights for some of its properties, so it depends on third parties to secure or renew broadcast rights for such content. A decline in television ratings or programming time of FUNimation’s licensed properties could adversely affect FUNimation’s revenues.

FUNimation’s revenues are dependent on consumer preferences and demand.

     FUNimation’s business and operating results depend upon the appeal of its properties, product concepts and programming to consumers, including the popularity of anime in the United States market and trends in the toy, game and entertainment businesses. A decline in the popularity of its existing properties or the failure of new properties and product concepts to achieve and sustain market acceptance could result in reduced overall revenues, which could have a material adverse effect on FUNimation’s business, financial condition and results of operations. Consumer preferences with respect to entertainment are continuously changing and are difficult to predict and can vary from months to years and entertainment properties often have short life cycles. There can be no assurances that:

	•		any of FUNimation’s current properties, product concepts or programming will continue to be popular for any significant period of time;
	•		any new properties, product concepts or programming FUNimation represents or produces will achieve an adequate degree of popularity; or
	•		any property’s life cycle will be sufficient to permit FUNimation to profitably recover advance payments, guarantees, development, marketing, royalties and other costs.

     FUNimation’s failure to successfully anticipate, identify and react to consumer preferences could have a material adverse effect on FUNimation’s revenues, profitability and results of operations. In addition, changes in consumer preferences may cause its revenues and net income to vary significantly between comparable periods.

If we fail to meet our significant working capital requirements or if our working capital requirements increase substantially, our business and prospects could be adversely affected.

     As a distributor and publisher, we purchase and license products directly from manufacturers and content developers for resale to retailers. As a result, we have significant working capital requirements, principally to acquire inventory, procure licenses and finance accounts receivable. Our working capital needs will increase as our inventory, licensing activities and accounts receivable increase in response to our growth. In addition, license advances, prepayments to enhance margins, investments, and inventory increases to meet customer requirements could increase our working capital needs. The failure to obtain additional financing or maintain working capital credit facilities on reasonable terms in the future could adversely affect our business. In addition, if the cost of financing is too expensive or not available, it could require a reduction in our distribution or publishing activities.

     We rely upon bank borrowings to fund our general working capital needs and it may be necessary for us to secure additional financing in the future depending upon the growth of our business and the possible financing of additional acquisitions. If we were

unable to borrow under our credit facility or otherwise unable to secure sufficient financing on acceptable terms or at all, our future growth and profitability could be adversely affected.

Product returns or inventory obsolescence could reduce our sales and profitability or negatively impact our liquidity.

     We maintain a significant investment in product inventory. Like other companies operating in our industry, product returns from our retail customers are significant when expressed as a percentage of revenues. Adverse financial or other developments with respect to a particular supplier or product could cause a significant decline in the value and marketability of our products, possibly making it difficult for us to return products to a supplier or recover our initial product acquisition costs. Under such circumstances, our sales and profitability, including our liquidity, could be adversely affected. We maintain a sales return reserve based on historical product line experience rates. There can be no assurance that our reserves will be adequate to cover potential returns.

We are subject to the risk that our inventory values may decline due to, among other things, changes in demand and that protective terms under our supplier agreements may not adequately cover the decline in values, which could result in lower gross margins or inventory write-downs.

     The demand for products that we sell and distribute is subject to rapid technological change, new and enhanced product specification requirements, consumer preferences and evolving industry standards. These changes may cause our inventory to decline substantially in value or to become obsolete which may occur in a short period of time. We generally are entitled to receive a credit from certain suppliers for products returned to us based upon the terms and conditions with those suppliers, including maintaining a minimum level of inventory of their products and limitations on the amount of product that can be returned and/or restocking fees. If major suppliers decrease or eliminate the availability of price protection or inventory returnability to us, such a change in policy could lower our gross margins or cause us to record inventory write-downs. 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. As a result, these policies do not protect us in all cases from declines in inventory value or product demand. We offer no assurance that price protection or inventory returnability terms may not change or be eliminated in the future, that unforeseen new product developments will not materially adversely affect our revenues or profitability or that we will successfully manage our existing and future inventories.

     In our publishing business, prices could decline due to decreased demand and, therefore, there may be greater risk of declines in inventory value. To the extent that our publishing business has not properly reserved for inventory exposure or price reductions needed to sell remaining inventory, our profitability may suffer.

We have significant credit exposure and negative trends or other factors could cause us significant credit loss.

     We provide credit to our customers for a significant portion of our net sales. During the holiday season, certain of our retail customers may request and be granted extended payment terms. Extended terms could require additional borrowings under our credit facilities. We are subject to the risk that our customers will not pay for the products they have purchased. This risk may increase if our customers experience decreases in demand for their products and services or become less financially stable due to adverse economic conditions or otherwise. If there is a substantial deterioration in the collectibility of our receivables, our earnings and cash flows could be adversely affected.

     In addition, from time to time, we may make royalty advances, or loans to, or invest in, other businesses. These business or investment opportunities may not be successful, which could result in the loss of our invested capital.

We may not be able to adequately adjust our cost structure in a timely fashion in response to a decrease in net sales, which may cause our profitability to suffer.

     A significant portion of selling, general and administrative expense is comprised of personnel, facilities and costs of invested capital. In the event of a significant downturn in net sales, we may not be able to exit facilities, reduce personnel, improve business processes, reduce inventory or make other significant changes to our cost structure without significant disruption to our operations or without significant termination and exit costs. Additionally, if management is not be able to implement such actions in a timely manner or at all to offset a shortfall in net sales and gross profit, our profitability would suffer.

Our distribution and publishing businesses operate in highly competitive industries and compete with large national firms. Further competition, among other things, could reduce our sales volume and margins.

     The business of distributing home entertainment and multimedia products is highly competitive. Our competitors in the distribution business 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/BMG Music Entertainment, EMI, Ingram Micro and Tech Data Corporation. Our competitors in the publishing business include both independent national publishers as well as large international firms. These competitors include Ventura, Madacy, Direct Source, Platinum Image, Topics, Vivendi and Buena Vista. Certain of our competitors have substantially greater financial and other resources than we have. Our ability to compete effectively in the future depends upon a number of factors, including our ability to:

	•		obtain exclusive national distribution contracts and licenses with independent music labels and manufacturers;
	•		obtain proprietary publishing rights with various rights holders and brand owners;
	•		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 consumer interest in our proprietary products; and
	•		maintain operating expenses at an appropriate level.

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

     In addition, FUNimation’s business depends upon its ability to procure and renew agreements to license certain rights for attractive titles on favorable terms. Competition for attractive children’s anime and children’s entertainment content and television broadcasting slots is intense. FUNimation’s principal competitors in the anime sector are media companies such as AD Vision, 4Kids Entertainment, VIZ and Geneon and Japanese rights holders operating in the United States. FUNimation also competes with various toy companies, other licensing companies, numerous others acting as licensing representatives and large media companies such as Disney and Time Warner. Many of FUNimation’s competitors have substantially greater resources than FUNimation and own or license properties which are more commercially successful than FUNimation’s properties. There are low barriers to enter the licensing and brand management business and therefore there is potential for new competitors to enter the market.

     Competition in the home entertainment and multimedia products industries is intense and is often based on price. Distributors generally experience low gross profit margins and operating margins. Consequently, our distribution profitability is highly dependent upon achieving effective cost and management controls and maintaining sales volumes. A material decrease in our gross profit margins or sales volumes would harm our financial results.

We depend on third party shipping and fulfillment companies for the delivery of our products.

     We rely almost entirely on arrangements with third party shipping and fulfillment companies, principally UPS and Federal Express, 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 on a timely basis 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. Furthermore, an increase in amounts charged by these shipping companies could negatively affect our gross margins and earnings.

We depend on a variety of systems for our operations, and a failure of these systems could disrupt our business and harm our reputation and net sales and negatively impact our results of operations.

     We depend on a variety of systems for our operations. Certain of these systems are operated by third parties and their performance may be outside of our control. These systems support our operating functions, including inventory management, order processing, shipping, receiving and accounting. Any failures or significant downtime in our systems 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 systems are comprised of a number of legacy, internally-developed applications, they can be harder to upgrade and may not be adaptable to commercially available software. As our needs for technology evolve, we may experience difficulty or significant cost in upgrading or significantly replacing our systems.

     We also rely on the Internet for a portion 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. Our website could experience material breakdowns, disruptions or breaches in security. 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 our products and services. Although we seek to enhance our customer information systems by adding new features, 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.

Technology developments, particularly in the electronic downloading arena, may adversely affect our net sales, margins and results of operations.

     Home entertainment products have traditionally been marketed and delivered on a physical delivery basis. If, in the future, these products are increasingly marketed and delivered through technology transfers, such as electronic downloading through the Internet or similar delivery methods, then our retail and wholesale distribution business could be negatively impacted. As electronic downloading grows through Internet retailers, competition between suppliers to electronic retailers in traditional ways will intensify and likely negatively impact our net 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 vendor and customer relationships to facilitate electronic downloading or if the terms of these arrangements differ from those related to our physical product sales, our business may be materially harmed.

We may not be successful in implementing our acquisition strategy, and future acquisitions could result in disruptions to our business by, among other things, distracting management time and diverting financial resources. Further, if we are unsuccessful in integrating acquired companies into our business, it could materially and adversely affect our financial condition and operating results.

     One of our growth strategies is the acquisition of complementary businesses. 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’s 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 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 that would reduce future reported earnings (goodwill impairments), ensuring acquired companies’ compliance with the requirements of the Sarbanes-Oxley Act of 2002 and potential loss of customers or key employees of acquired businesses. We cannot assure you that if we make any future acquisitions, investments, strategic alliances or joint ventures they will be completed in a timely manner or achieve anticipated synergies, that they will be structured or financed in a way that will enhance our business or creditworthiness or that they will meet our strategic objectives or otherwise be successful. In addition, we may not be able to secure the financing necessary to consummate future acquisitions, and future acquisitions and investments could involve the issuance of additional equity securities or the incurrence of additional debt, which could harm our financial condition or creditworthiness.

Increased counterfeiting or piracy may negatively affect the demand for our home entertainment products.

     The recorded music and motion picture industries have been adversely affected by counterfeiting of audiocassettes, CDs and DVDs, piracy and parallel imports, and also by websites and technologies that allow consumers to illegally download and access music and video. Increased proliferation of these alternative access methods to these products could impair our ability to generate net sales and could cause our business to suffer.

We may not be able to successfully protect our intellectual property rights.

     We rely on a combination of copyright, trademark and other proprietary rights laws to protect the intellectual property we license. Third parties may try to challenge the ownership by us or our licensors of such intellectual property. In addition, our business is subject to the risk of third parties infringing on our intellectual property rights or those of our licensors and producing counterfeit products. We may need to resort to litigation in the future to protect our intellectual property rights or those of our licensors, which could result in substantial costs and diversion of resources and could have a material adverse effect on our business and competitive position.

Interruption of our business or catastrophic loss at any of our facilities could lead to a curtailment or shutdown of our business.

     We receive, manage and distribute our inventory from a centralized warehouse and distribution facility that is located adjacent to our corporate headquarters. An interruption in the operation of or in the service capabilities at this facility or our separate returns processing center as a result of equipment failure or other reasons could result in our inability to distribute products, which would reduce our net sales and earnings for the affected period. In the event of a stoppage at such facilities, even if only temporary, or if we experience delays as a result of events that are beyond our control, delivery times to our customers and our relationship with such customers could be severely affected. Any significant delay in deliveries to our customers could lead to increased returns or

cancellations and cause us to lose future sales. Our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions, violent weather conditions or other natural disasters. We may experience a shutdown of our facilities or periods of reduced production as a result of equipment failure, delays in deliveries or catastrophic loss, which could have a material adverse effect on our business, results of operations or financial condition.

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, or other disruptions in our business, which could negatively affect our operating results. We do not carry insurance covering such terrorist or military actions, and even if we were to seek such coverage and such coverage were available, the cost likely would not be commercially reasonable.

Legislative actions, higher director and officer insurance costs and potential new accounting pronouncements are likely to cause our general and administrative expenses to increase and impact our future financial condition and results of operations.

     In order to comply with the Sarbanes-Oxley Act of 2002, as well as changes to the NASDAQ listing standards and rules adopted by the Securities and Exchange Commission, we have been required to strengthen our internal controls, hire additional personnel and retain additional legal, accounting and advisory services, all of which have caused and could continue to cause our general and administrative costs to increase. In addition, insurers have increased and could continue to increase premiums for our directors’ and officers’ insurance policies.

     Our financial statements are prepared in accordance with U.S. generally accepted accounting principles. These principles are subject to interpretation by various governing bodies, including the FASB, the Public Company Accounting Oversight Board (the “PCAOB”), and the SEC, who create and interpret appropriate accounting standards. A change from current accounting standards could have a significant adverse effect on our results of operations. For example, the FASB’s new guidance that addresses the accounting for share-based payments, FAS No. 123R. will become effective for the Company beginning in its first quarter of fiscal 2007. FAS 123R as amended requires compensation cost relating to all share-based payments to employees to be recognized in the financial statements based on their fair values. We currently expect the amount of share-based compensation expense related to the options outstanding and un-vested at March 31, 2006 included in operating expenses to be approximately $176,000 in fiscal 2007.

Any material weakness or significant deficiency in our internal controls may adversely affect our ability to report our financial results on a timely and accurate basis.

     Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies evaluate and report on their internal control structure and procedures over financial reporting. In addition, our independent auditors must report on management’s evaluation as well as evaluate our internal control structure and procedures. If any material weaknesses are identified in the future which we are unable to successfully address, our ability to report our financial results on a timely and accurate basis may be adversely affected.

Risks Relating to Indebtedness

The level of our indebtedness could adversely affect our financial condition.

     We have significant debt service obligations. As of March 31, 2006, our total indebtedness under our credit agreement is $80.1 million. We also have the ability to borrow an additional $25.0 million under this credit agreement.

     The level of our indebtedness could have important consequences. For example, it could:

	•		make it more difficult for us to satisfy our obligations with respect to other indebtedness;
	•		increase our vulnerability to adverse economic and industry conditions;
	•		require us to dedicate a substantial portion of our cash flow from operations to the payment of our indebtedness, thereby reducing the availability of cash to fund working capital and capital expenditures and for other general corporate purposes;
	•		restrict us from making strategic acquisitions, acquiring new content or exploring other business opportunities;

	•		limit our ability to obtain financing for working capital, capital expenditures, general corporate purposes or acquisitions;
	•		place us at a disadvantage compared to our competitors that have less indebtedness; and
	•		limit our flexibility in planning for, or reacting to, changes in our business and industry.

Our outstanding indebtedness bears interest at variable rates. Any increase in interest rates will reduce funds available to us for our operations and future business opportunities and will adversely affect our leveraged capital structure.

     Our debt service requirements will be impacted by changing interest rates. Of our $80.1 million in debt outstanding at March 31, 2006, $27.1 million is subject to variable interest rates, as the remaining portion is covered by an interest rate swap. A 100-basis point change in LIBOR would cause our projected annual interest expense to change by approximately $271,000. The fluctuation in our debt service requirements, in addition to interest rate changes, may be impacted by future borrowings under our credit facility or other alternative financing arrangements.

We may be unable to generate sufficient cash flow to service our debt obligations.

     Our ability to make payments on and to refinance our indebtedness and to fund our operations, working capital and capital expenditures, depends on our ability to generate cash in the future, which is subject to general economic, industry, financial, competitive, operating, legislative, regulatory and other factors that are beyond our control. Additionally, if the interest rate swap is removed or principal payments are made early, additional expense may be incurred.

     We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our credit agreement in an amount sufficient to enable us to pay amounts due on our indebtedness or to fund our other liquidity needs.

     We may need to refinance all or a portion of our indebtedness on or before maturity. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:

	•		our financial condition at the time;
	•		restrictions in our credit agreement or other outstanding indebtedness; and
	•		other factors, including the condition of the financial markets or the distribution and publishing markets.

     As a result, we may not be able to refinance any of our indebtedness on commercially reasonable terms, or at all. If we do not generate sufficient cash flow from operations, and additional borrowings or refinancings or proceeds of asset sales are not available to us, we may not have sufficient cash to enable us to meet all of our obligations.

We may be able to incur additional indebtedness, which could further exacerbate the risks associated with our current indebtedness level.

     We and our subsidiaries may be able to incur substantial additional indebtedness in the future. Although our credit facility contains restrictions on the incurrence of additional indebtedness, debt incurred in compliance with these restrictions could be substantial. Our revolving working capital credit facility provided pursuant to a credit agreement, permits total borrowings of up to an additional $25.0 million. In addition, our credit agreement will not prevent us from incurring certain other obligations. If we and our subsidiaries incur additional indebtedness or other obligations, the related risks that we and they face could be magnified.

Our credit agreement contains significant restrictions that limit our operating and financial flexibility.

     Our credit agreement requires us to maintain specified financial ratios and we may be unable to meet such ratios. All of these restrictions may limit our ability to execute our business strategy. Moreover, if operating results fall below current levels, we may be unable to comply with these covenants. If that occurs, our lenders could accelerate our indebtedness, in which case we may not be able to repay all of our indebtedness.

Risks Relating to Our Common Stock

Our common stock price has been volatile. Fluctuations in our stock price could impair our ability to raise capital and make an investment in our securities undesirable.

     The market price of our common stock has fluctuated significantly. We believe factors such as 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. In addition, 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. Fluctuations in our stock price could impair our ability to raise capital and make an investment in our securities undesirable. During the period from April 1, 2005 to March 31, 2006, the last reported price of our common stock as quoted on the NASDAQ National Market ranged from a low of $3.45 to a high of $9.21.

The exercise of outstanding warrants and options may adversely affect our stock price.

     Our stock option plans authorize the issuance of options to purchase 7.7 million shares of our common stock. As of March 31, 2006, options and warrants to purchase 4,937,101 shares of our common stock were outstanding. Approximately 2,937,300 options and warrants were exercisable as of March 31, 2006. Warrants totaling 1,596,001 were issued in connection with the private placement completed in March 2006. Our outstanding 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, our ability 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 permit us to issue preferred stock, which could allow us to delay or block a third party from acquiring us. The holders of preferred stock could also have 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 currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

     We currently do not plan to declare dividends on shares of our common stock in the foreseeable future. Further, the payment of dividends by us is restricted by our credit facility. Consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates and you sell your shares at a profit.

Our directors may not be held personally liable for certain actions, which could discourage shareholder suits against them.

     Minnesota law and our articles of incorporation and bylaws provide that our directors shall not be personally liable to us or our shareholders for monetary damages for breach of fiduciary duty as a director, with certain exceptions. These provisions may discourage shareholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by shareholders on behalf of us against a director. In addition, our bylaws provide for mandatory indemnification of directors and officers to the fullest extent permitted by Minnesota law.

Other Risks

     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 or the publishing 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.

     Thus, the foregoing is not a complete description of all risks relevant to our future performance, and the foregoing risk factors should be read and understood together with and in the context of similar discussions which may be contained in the documents that we file with the SEC in the future. We undertake no obligation to release publicly any revision to the foregoing or any update to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Item 1B. Unresolved Staff Comments

     Not applicable.

Item 2. Properties

Distribution

     Located in the Minneapolis suburb of New Hope, Minnesota, our corporate headquarters is made up of 321,555 square feet of combined office and warehouse space situated on three contiguous properties. The leases for two of the properties expire on June 30, 2019 and the lease for the third property expires on February 29, 2016. These leased properties include approximately 44,000 square feet of office space; approximately 72,125 square feet of space utilized in the manufacturing and assembly of new products; and approximately 205,430 square feet of space devoted to warehousing, product picking and shipping. Our product returns processing facility is located in the Minneapolis suburb of Brooklyn Center which consists of approximately 73,900 square feet of warehouse space. The lease for this property expires on November 30, 2010. We also operate a satellite sales office in Bentonville, Arkansas which resides in 2,000 square feet of leased office space. The lease for this space expires on February 28, 2007. The present aggregate base monthly rent for all Navarre facilities is approximately $189,690.

Publishing

     Encore currently operates its offices out of approximately 13,216 square feet of leased office space located in Los Angeles, California. This lease currently provides for base monthly payments to be made in the amount of $25,771 and expires April 30, 2010. BCI operates its offices out of 6,534 square feet of leased office space located in Newbury Park, California. This lease currently provides for base monthly payments to be made in the amount of $7,668 and expires March 9, 2007. FUNimation operates its office out of 23,474 square feet of leased space located in Forth Worth, Texas. This lease currently provides for base monthly rental payments to be made in the amount of $16,108 and expires July 31, 2009.

     We believe that our facilities are adequate for our present operations as well as for the incorporation of growth. We continually explore alternatives to certain of these facilities that could expand our capacities and enhance efficiencies, and we believe we can renew or obtain replacement or additional space, if required, on commercially reasonable terms.

Item 3. Legal Proceedings

     See Litigation discussion in Note 21 to the Company’s consolidated financial statements included herein.

Item 4. Submission of Matters to a Vote of Security Holders

     There were no matters submitted to a vote of shareholders, through the solicitation of proxies or otherwise, during the fourth quarter of the fiscal year covered by this report.

PART II

Item 5. Market for Registrant’s Common Equity, and Related Stockholder Matters and Issuer Purchase of Equity Securities

     Common Stock

     Our common stock, no par value, is traded 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 2006		First				$	9.21			$	6.73
		Second					8.40				5.65
		Third					6.61				3.51
		Fourth					6.53				3.45
Fiscal 2005		First				$	14.39			$	5.84
		Second					16.37				12.65
		Third					18.13				14.27
		Fourth					19.02				6.68

     At June 14, 2006, we had an estimated 700 common shareholders of record and an estimated 9,225 beneficial owners whose shares were held by nominees or broker dealers.

     Dividend Policy

     We have never declared or paid cash dividends on our common stock. We currently intend to retain all earnings for use in our business and do not intend to pay any dividends on our common stock in the foreseeable future.

     Private Placement

     During fiscal 2006, we completed a private placement in which we sold 5,699,998 shares of common stock and issued 1,425,001 shares issuable upon exercise of five year warrants exercisable at $5.00 (excluding 171,000 placement agent warrants) issued in connection with the private placement. We sold the shares in the private placement to the selling shareholders for $3.50 per share for total proceeds to us of approximately $20.0 million and net proceeds to us of approximately $18.5 million. Such securities were offered and issued in reliance on the exemption from registration provided by Rule 506 of Regulation D and Section 4(2) of the Securities Act of 1933, as a transaction not involving a public offering of securities. The Company based such reliance upon factual representations made to the Company by the individual regarding the individual’s investment intent, sophistication, and status as an “accredited investor” (as defined in Regulation D), among other things.

     Additional Sales of Unregistered Securities

     In addition to the 2006 Private Placement, the Company completed the sales of unregistered securities described in Note 17 of the notes to the consolidated financial statements during the past three fiscal years.

     Equity Compensation Plan Information

     We adopted our 1992 Stock Option Plan and 2004 Stock Option Plan (together, the “Plans”) 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 employees of any of our subsidiaries. A maximum number of 5,224,000 shares and 2,500,000 shares, respectively, of common stock have been authorized and reserved for issuance under the Plans. The number of shares authorized may also be increased from time to time by approval of the Board and the shareholders. These Plans terminate in 2006 and 2014.

     We are authorized to grant stock options and restricted stock grants under the Plans. Stock options have a maximum term fixed by the Compensation Committee, not to exceed 10 years from the date of grant. Stock options become exercisable during their terms in the manner determined by the Compensation Committee. 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 Plans, at a price equal to fair market value. These options are designated as non-qualified stock options. Each such option granted prior to September 15, 2005, vests in five annual increments of 20% of the original option grant beginning one year from the date of grant and expires on the earlier of (i) six years from the date of the grant, and (ii) one year after the person ceases to serve as a director. Each option granted on or after September 15, 2005, vests in three annual increments of 33⅓% of the original option grant beginning one year from the date of grant, expires on the earlier of (i) ten years from the date of grant, and (ii) one year after the person ceases to serve as a director, and shall provide for the acceleration of vesting if the person ceases to serve as a director as a result of the Company’s mandatory director retirement rule.

     In March 2006, the Company accelerated the vesting of out of the money options (see Note 2 to the consolidated financial statements).

     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

Weighted-average

remaining available for

exercise

future issuance under

Number of securities to be

price of

equity

issued upon exercise of

outstanding

compensation plans

outstanding options,

options,

(excluding securities

warrants and rights

warrants and rights

reflected in column (a))

Plan Category

(a)

(b)

(c)

Equity compensation plans approved by securityholders

3,341,100

$

7.17

1,441,054

Equity compensation plans not approved by securityholders

-0-

-0-

-0-

Total

3,341,100

$

7.17

1,441,054

Item 6. Selected Financial Data

     The following selected financial data should be read in conjunction with our consolidated 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. We derived the following historical financial information from our consolidated financial statements for the fiscal years ended March 31, 2006, 2005, 2004, 2003 and 2002 which have been audited by Grant Thornton LLP (years ended March 31, 2006 and 2005) and Ernst & Young LLP (for the remaining periods).

(In thousands, except per share data)

		Fiscal Years ended March 31,
		2006(1)				2005				2004				2003				2002
Statement of operations data:
Net sales		$	686,126			$	596,615			$	470,877			$	356,816			$	303,817
Gross profit, exclusive of depreciation and amortization			107,093				91,352				58,021				45,475				32,893
Income from operations			2,684				9,711				7,067				3,597				521
Interest expense			(11,217	)			(783	)			(378	)			(194	)			(173	)
Other income (expense)			3,344				232				(458	)			447				884
Net income (loss) before tax			(5,189	)			9,160				6,231				3,850				2,712
Income tax benefit			2,014				1,006				583				—				—
Net income (loss)		$	(3,175	)		$	10,166			$	6,814			$	3,913			$	2,712
Earnings (loss) per common share:
Basic		$	(.11	)		$	.38			$	.30			$	.18			$	.12
Diluted		$	(.11	)		$	.35			$	.28			$	.18			$	.12
Weighted average shares outstanding:
Basic			29,898				26,830				22,780				21,616				22,553
Diluted			29,898				28,782				24,112				21,841				22,575
Balance sheet data:(2)
Total assets		$	309,614			$	195,892			$	154,579			$	109,665			$	87,368
Short-term borrowings			5,115				334				651				805				—
Long-term debt			75,352				237				—				268				—
Temporary equity — Unregistered common stock			16,634				—				—				—				—
Shareholders’ equity			88,906				77,284				53,078				28,263				24,350

(1)			Includes acquisition of FUNimation completed May 11, 2005 (see Note 3 to the consolidated financial statements).
(2)			Includes 2006 Private Placement (see Note 18 to the consolidated financial statements).

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

     We are a distributor and publisher of physical and digital home entertainment and multimedia products, including PC software, CD audio, DVD video, video games and accessories. Since our founding in 1983, we have established distribution relationships with major retailers including Best Buy, Wal-Mart/Sam’s Club, CompUSA and Costco, and we currently distribute to over 19,000 retail and distribution center locations throughout the United States and Canada. We believe that our established relationships throughout the supply chain, our broad product offering and our distribution facility permit us to offer industry-leading home entertainment and multimedia products to our retail customers and to provide access to attractive retail channels for the publishers of such products.

     Historically, our business focused on providing distribution services for third party vendors. Over the past three years, we expanded our business to include the licensing and publishing of home entertainment and multimedia content, primarily through our acquisitions of publishers in select markets. By expanding our product offerings through such acquisitions, we believe that we can leverage both our sales experience and distribution capabilities to drive increased retail penetration and more effective distribution of such products, and enable content developers and publishers that we acquire to focus more on their core competencies.

     Our business is divided into three segments—Distribution, Publishing and Other.

     Distribution. 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 PC software and video game publishers and developers, independent and major music labels, and independent and major motion picture studios. These vendors provide us with PC software, CD audio, DVD video, and video games and accessories which we, in turn, distribute to our retail customers. Our distribution business focuses on providing vendors and retailers with a range of value-added services including: vendor-managed inventory, Internet-based ordering, electronic data interchange services, fulfillment services and retailer-oriented marketing services. Our vendors include Symantec Corporation, Adobe Systems, Inc., McAfee, Inc., and Dreamcatcher Interactive, Inc.

     Publishing. Through our publishing business, which generally has higher gross margins than our distribution business, we own or license various PC software, CD audio and DVD video titles, and we package, brand, market and sell directly to retailers, third party distributors and our distribution business. Our publishing business currently consists of Encore Software, Inc. (“Encore”), BCI Eclipse Company, LLC (“BCI”), FUNimation Productions, Ltd. and The FUNimation Store, Ltd. (together, “FUNimation”). Encore, which we acquired in July 2002, licenses and publishes personal productivity, genealogy, education and interactive gaming PC products, including titles such as Print Shop, Print Master, PC Tool’s Spyware Doctor, and Hoyle PC Gaming products. BCI, which we acquired in November 2003, is a provider of niche DVD and video products and in-house produced CDs and DVDs. FUNimation, acquired on May 11, 2005, is a leading anime content provider in the United States and licenses and publishes titles such as Dragon Ball Z, Fullmetal Alchemist, Code Lyoko, Samari Seven, Burst Angel, Noddy, Yu Yu Hakusho and Degrassi.

     Other. The other segment consists of a variable interest entity, Mix & Burn, Inc. (“Mix & Burn”), that was included in our consolidated results during the period commencing December 31, 2003 and ending December 31, 2005, in accordance with the provisions of FIN 46(R). During the three months ended December 31, 2005, the Company deconsolidated Mix & Burn, as the Company was no longer deemed to be the primary beneficiary of this variable interest entity.

Overall Summary of Fiscal 2006 Financial Results

     Fiscal 2006 was another year of growth for Navarre Corporation. Our consolidated net sales for fiscal 2006 increased 15.0% to $686.1 million compared to $596.6 million in fiscal 2005. This increase was achieved through organic growth and the addition of FUNimation in May 2005, which increased net sales by $37.2 million (before inter-company elimination). Our gross profit increased to $107.1 million or 15.6% of net sales for fiscal 2006 compared with $91.4 million or 15.3% of net sales for fiscal 2005. The increase in gross margin percent for 2006 was primarily due to the continued expansion of our higher margin publishing segment, partially offset by a reduction in gross margin due primarily to the write-off of balances related to independent music labels during the year and increased sales of lower margin product categories in our distribution business.

     Total operating expenses for fiscal 2006 were $104.4 million or 15.2% of net sales, compared with $81.6 million or 13.7% of net sales for fiscal 2005. The increase in operating expenses in fiscal 2006 was primarily due to the write-off of accounts receivable of $12.2 million due to the bankruptcy of a major retailer customer. The Company wrote-off the entire accounts receivable balance as it does not anticipate any future recovery. Additionally, the Company recognized $5.0 million of amortization expense related to the intangible assets of FUNimation. Other operating expenses increased from the prior year, primarily due to the acquisition of FUNimation. Net loss for fiscal 2006 was $3.2 million or $0.11 per diluted share compared to net income of $10.2 million or $0.35 per diluted share for last year.

Working Capital and Debt

     Our business is working capital intensive and requires significant levels of working capital primarily to finance accounts receivable and inventories. We have relied on trade credit from vendors and amounts received on accounts receivable for our working capital needs. At March 31, 2006 we had total debt of $80.1 million related to our Term Loan B sub-facility and had zero outstanding on our $25.0 million revolving credit facility. With our focus on management of working capital, we paid approximately $59.9 million of debt during the year. Cash at March 31, 2006 was $14.3 million.

2006 Private Placement

     During fiscal 2006, we completed a private placement in which we sold 5,699,998 shares of common stock and issued 1,425,001 shares issuable upon exercise of five year warrants exercisable at $5.00 (excluding 171,000 placement agent warrants). We sold the shares in the private placement to the selling shareholders for $3.50 per share for total proceeds to us of approximately $20.0 million and net proceeds to us of approximately $18.5 million. The per share sales price of $3.50 represented a discount of approximately 8.4% of the closing price of our common stock on the date the purchase was completed. Net proceeds from the private placement, and additional cash reserves, were used to repay the Term Loan C sub-facility of the Credit Agreement.

FUNimation Acquisition

     We acquired the general and limited partnership interests of FUNimation in May 2005, a leading anime content provider in the United States, for $100.4 million subject to post-closing adjustments not to exceed $5.0 million and excess cash as defined in the purchase agreement. We funded the acquisition with cash, debt and 1,827,486 shares of Navarre common stock. During February 2006, we received a purchase price adjustment for approximately $11.1 million in conection with the acquisition (see Note 3 to the consolidated financial statements). In addition, during the five-year period following the close of the transaction, we may pay up to $17.0 million in cash to the FUNimation sellers if they achieve certain agreed-upon financial targets relating to the FUNimation business. This acquisition resulted in an increase to revenues and profits in our publishing business in fiscal 2006.

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 of America. The preparation of these consolidated 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, long-lived assets including intangible assets, goodwill, income taxes, contingencies 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

     We recognize revenue on products shipped when title and risk of loss transfers, delivery has occurred, the price to the buyer is determinable and collectibility is reasonably assured. We recognize service revenues upon delivery of the services. Service revenues represented less than 10% of total net sales for fiscal 2006, 2005 and 2004. Under specific conditions, we permit our customers to return products. We record a general reserve for sales returns and allowances against amounts due to reduce the net recognized receivables to the amounts we reasonably believe will be collected. These reserves are based on the application of our average historical gross profit percent against averages sales returns, sales discounts percent against average gross sales and specific reserves for marketing programs. Our actual sales return rates have averaged between 13% to 17% over the past three years. Although our past experience has been a good indicator of future reserve levels, there can be no assurance that our current reserve levels will be adequate in the future.

     Our distribution customers at times qualify for certain price protection benefits from our vendors. We serve as an intermediary to settle these amounts between vendors and customers. We account for these amounts as reductions of revenues with corresponding reductions in cost of sales.

     Our publishing business at times provides certain price protection, promotional monies, volume rebates and other incentives to customers. We record these amounts as reductions in revenue.

     FUNimation revenue is recognized upon meeting the recognition requirements of American Institute of Certified Public Accountants Statement of Position 00-2 (“SOP 00-2”) Accounting by Producers or Distributors of Films. Revenues from home video distribution are recognized, net of an allowance for estimated returns, in the period in which the product is available for sale by the Company’s customers (generally upon shipment to the customer and in the case of new releases, after “street date” restrictions lapse). Revenues from broadcast licensing and home video sublicensing are recognized when the programming is available to the licensee and other recognition requirements of SOP 00-2 are met. Fees received in advance of availability are deferred until revenue recognition requirements have been satisfied. Royalties on sales of licensed products are recognized in the period earned. In all instances, provisions for uncollectible amounts are provided for at the time of sale.

Production Costs and License Fees

     In accordance with accounting principles generally accepted in the United States and industry practice, the Company amortizes the costs of production using the individual-film-forecast method under which such costs are amortized for each title or group of titles in the ratio that revenue earned in the current period for such title bears to management’s estimate of the total revenues to be realized for such titles. All exploitation costs, including advertising and marketing costs are expensed as incurred.

     Management regularly reviews, and revises when necessary, its total revenue estimates on a title-by-title or group of titles basis, which may result in a change in the rate of amortization and/or a write-down of the asset to estimated fair value. The Company determines the estimated fair value for properties based on the estimated future ultimate revenues and costs in accordance with SOP No. 00-2.

     Any revisions to ultimate revenues can result in significant quart-to-quarter end year-to-year fluctuation in production cost write-downs and amortization. The commercial potential of individual films varies dramatically, and is not directly correlated with production or acquisition costs. Therefore, it is difficult to predict or project the impact that individual films will have on the Company’s results of operations. Significant fluctuations in reported income or loss can occur, particularly on a quarterly basis, depending on the release schedules, broadcast dates, the timing of advertising campaigns and the relative performance of the individual films.

     License fees represent advance license/royalty payments made to program suppliers for exclusive distribution rights. A program supplier’s share of distribution revenues (“Participation Cost”) is retained by the Company until the share equals the license fees paid to the program supplier plus recoupable production costs. Thereafter, any excess is paid to the program supplier. License fees are amortized as recouped by the Company which equals participation/royalty costs earned by the program suppliers. Participation/royalty costs are accrued/expensed in the same ratio that current period revenue for a title or group of titles bear to the estimated remaining unrecognized ultimate revenue for that title, as defined by SOP 00-2. When estimates of total revenues and costs indicate that an individual title will result in an ultimate loss, an impairment charge is recognized to the extent that license fees and production costs exceed estimated fair value, based on cash flows, in the period when estimated.

Allowance for Doubtful Accounts

     We perform periodic credit evaluations of our customers’ financial condition and generally do not require collateral. We make estimates of the uncollectibility of our accounts receivable balances with independent labels. In determining the adequacy of our allowances, we analyze customer financial statements, historical collection experience, aging of receivables, substantial down-grading of credit scores, bankruptcy filings, and other economic and industry factors. Although we utilize risk management practices and methodologies to determine the adequacy of the allowance, it is possible that the accuracy of the estimation process could be materially impacted by different judgments as to collectibility based on the information considered and further deterioration of accounts. Our largest collection risks exist for retail customers that are in bankruptcy, or at risk of bankruptcy, such as the bankruptcy of a major retailer in fiscal 2006 which resulted in a write-off of $12.2 million. If customer 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 and Intangible Assets

     We review goodwill for potential impairment annually for each reporting unit or 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 goodwill. 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. We conduct impairment testing at least once annually based on our most current business strategy in light of present industry and economic conditions, as well as future expectations. Our goodwill consisted of $81.2 million and $9.8 million as of March 31, 2006 and 2005, respectively. If the operating results for our publishing segment deteriorate considerably and are not consistent with our assumptions and estimates, we may be exposed to a goodwill impairment charge that could be material.

     We also assess potential impairment of goodwill and intangible assets when there is evidence that recent events or changes in circumstances have made recovery of an asset's carrying value unlikely. The amount of impairment loss would be recognized as the excess of the asset's carrying value over its fair value. Factors which may cause impairment include negative industry or economic trends and significant underperformance relative to historical or projected future operating results.

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 and amortizable intangible assets, 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. If our results from operations deteriorate considerably and are not consistent with our assumptions, we may be exposed to a material impairment charge.

Inventory Valuation

     Our inventories are recorded at the lower of cost or market. We use certain estimates and judgments to properly value inventory. We monitor our inventory to ensure that we properly identify inventory items that are slow-moving and non-returnable, on a timely basis. A significant risk in our distribution business is product that has been purchased from vendors that cannot be sold at full distribution prices and is not returnable to the vendors. A significant risk in our publishing business is that certain products may run out of shelf life and be returned by our customers. Generally, these products can be sold in bulk to a variety of liquidators. We establish reserves for the difference between carrying value and estimated realizable value in the periods when we first identify the lower of cost or market issue. If future demand or market conditions are less favorable than current analyses, additional inventory write-downs or reserves may be required and would be reflected in cost of sales in the period the determination is made.

Income Taxes

     Income taxes are recorded under the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and tax basis of assets and liabilities. In the preparation of our consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax exposures together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. Management reviews its deferred tax assets for recoverability on a quarterly basis and assesses the need for valuation allowances. These deferred tax assets are evaluated by considering historical levels of income, estimates of future taxable income streams and the impact of tax planning strategies. A valuation allowance is recorded to reduce deferred tax assets when it is determined that it is more likely than not that we would not be able to realize all or part of our deferred tax assets. We carried a valuation allowance against our net deferred tax assets at March 31, 2006 of $1.0 million, and a valuation allowance against our net deferred tax assets at March 31, 2005 related to the variable interest entity (“VIE”), Mix & Burn, of $974,000. We expect to operate on a fully taxable basis for fiscal 2007.

Contingencies and Litigation

     There are various claims, lawsuits and pending actions against us. If a loss arising from these actions is probable and can be reasonably estimated, we record the amount of the estimated loss. If the loss is estimated using a range within which no point is more probable than another, the minimum estimated liability is recorded. Based on current available information, we believe that the ultimate resolution of existing actions will not have a materially adverse effect on our consolidated financial

statements (see Note 21 to our consolidated financial statements). As additional information becomes available, we assess any potential liability related to existing actions and may need to revise our estimates. Future revisions of our estimates could materially impact our consolidated results of operations, cash flows or financial position.

Reconciliation of GAAP Net Sales to Net Sales Before Inter-company Eliminations

     In evaluating our financial performance and operating trends, management considers information concerning our net sales before inter-company eliminations of sales that are not prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. Management believes these non-GAAP measures are useful because they provide supplemental information that facilitates comparisons to prior periods and for the evaluations of financial results. Management uses these non-GAAP measures to evaluate its financial results, develop budgets and manage expenditures. The method the Company uses to produce non-GAAP results is not computed according to GAAP, is likely to differ from the methods used by other companies and should not be regarded as a replacement for corresponding GAAP measures. Net sales before inter-company eliminations has limitations as a supplemental measure, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. The following table represents a reconciliation of GAAP net sales to net sales before inter-company eliminations:

		Year Ended
(Unaudited)		March 31,				March 31,				March 31,
(In thousands)		2006				2005				2004
Net sales
Distribution		$	621,739			$	556,927			$	444,743
Publishing			127,612				95,777				46,177
Other			424				352				—
Net sales before inter-company eliminations			749,775				653,056				490,920
Inter-company eliminations			(63,649	)			(56,441	)			(20,043	)
Net sales as reported		$	686,126			$	596,615			$	470,877

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,
		2006				2005				2004
Net sales:
Distribution			90.6	%			93.3	%			94.4	%
Publishing			18.6				16.1				9.8
Other			0.1				0.1				—
Elimination of sales			(9.3	)			(9.5	)			(4.2	)
Total net sales			100.0				100.0				100.0
Cost of sales — exclusive of depreciation and amortization			84.4				84.7				87.7
Gross profit			15.6				15.3				12.3
Selling and marketing			4.3				3.6				3.6
Distribution and warehousing			1.5				1.5				1.3
General and administrative			6.4				8.0				5.5
Bad debt			1.7				—				—
Depreciation and amortization			1.3				0.6				0.4
Total operating expenses			15.2				13.7				10.8
Income from operations			0.4				1.6				1.5
Interest expense			(1.6	)			(0.1	)			(0.1	)
Interest income			0.1				0.1				0.1
Debt extinguishment			—				—				(0.2	)
Deconsolidation of variable interest entity			0.3				—				—
Warrant expense			(0.1	)			—				—
Other income (expense), net			0.1				—				—
Net (loss) income, before tax			(0.8	)			1.6				1.3
Tax benefit			0.3				0.1				0.1
Net (loss) income			(0.5	)%			1.7	%			1.4	%

     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 also “Business — Forward-Looking Statements/Risk Factors” in Item 1A of this Form 10-K.

Distribution Segment

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

Fiscal 2006 Results Compared With Fiscal 2005

     Net Sales

     Net sales for the distribution segment were $621.7 million (before intercompany eliminations) for fiscal 2006 compared to $556.9 million (before intercompany eliminations) for fiscal 2005. The $64.8 million or 11.6% increase in net sales for fiscal 2006 was principally due to increases in sales in all categories, except for major label music as the Company exited this category in fiscal 2006. Sales increased by $9.6 million due to the transfer of a third party software products distribution relationship with a major mass merchandiser from the publishing segment. Sales also increased in the software product group to $448.7 million for fiscal 2006 compared to $399.3 million for fiscal 2005. The increase in net sales in this product group was primarily due to continued increases in a variety of software categories, including internet security utility products where sales remained strong due to continued demand. DVD video grew to $52.8 million for fiscal 2006 from $38.9 million in fiscal 2005 and video games increased to $39.9 million in fiscal 2006 from $30.0 million in fiscal 2005, due to increased publisher and customer rosters and strong releases throughout the year. Independent music net sales increased to $71.9 million from $64.8 million in the prior year due to significant title releases during fiscal 2006. Major label music net sales decreased to $8.4 million for fiscal 2006 from $23.9 million for fiscal 2005 due to a change in buying patterns at a major retailer and the Company’s decision to exit this category during fiscal 2006. The Company exited the major label music category to focus its resources on other product categories. The Company believes future sales increases will be dependent upon the Company’s ability to continue to add new, appealing content and the strength of the retail environment.

     Gross Profit

     Gross profit for the distribution segment was $59.6 million or 9.6% of net sales for fiscal 2006 compared to $59.9 million or 10.8% of net sales for fiscal 2005. The decrease in gross profit as a percent of net sales for fiscal 2006 was primarily due to the write-off of balances related to an independent music labels and higher sales of products with lower gross margins, such as video games. We typically incur lower operating costs as a result of the non-returnable nature of the terms of sales related to the video games category. As sales in the video games product category increase, as a portion of our total net sales, we anticipate a continued reduction in our overall gross margin percent. We expect gross profit to fluctuate depending upon the make-up of product sold in each quarter. To the extent we continue to grow the distribution segment’s share of legacy products from large vendors at a rate faster than certain entertainment products from the smaller vendors, we would expect an overall margin decrease.

     Operating Expenses

     Total operating expenses for the distribution segment were $68.2 million or 11.0% of net sales for fiscal 2006 compared to $62.1 million or 11.2% of net sales for fiscal 2005. Overall expenses for selling and marketing and bad debt expense increased, which were partially offset by a decrease in general and administrative expenses.

     Selling and marketing expenses for the distribution segment were $17.3 million or 2.8% of net sales for fiscal 2006 compared to $14.4 million or 2.6% of net sales for fiscal 2005. The increase as a percent of net sales for fiscal 2006 resulted primarily from increased sales freight costs and commissions. Freight costs as a percent of net sales, increased to 1.8% for fiscal 2006 compared to 1.7% for fiscal 2005. The increased expense incurred in freight costs was primarily due to changes in customer shipping requirements, such as shipment of product to store locations versus distribution centers and fuel surcharges. Sales commissions increased due to charges relating to merchandising services at a major mass merchandiser.

     Distribution and warehousing expenses for the distribution segment were $10.1 million or 1.6% of net sales for fiscal 2006 compared to $8.8 million or 1.6% of net sales for fiscal 2005.

     General and administration expenses for the distribution segment consist principally of executive, accounting and administrative personnel and related expenses, including professional fees. General and administration expenses for the distribution segment were $29.8 million or 4.8% of net sales for fiscal 2006 compared to $36.7 million or 6.6% of net sales for fiscal 2005. Fiscal 2005 included $2.5 million of incentive-based deferred compensation expense related to the CEO’s employment agreement and $5.8 million to acquire the remaining twenty percent ownership position in Encore. The decrease from fiscal 2005 is also due to a reduction in bonus expense of approximately $1.9 million due to the overall performance of the Company. These decreases were partially offset by an increase in professional and legal fees of approximately $800,000 and an increase in employee health benefits of approximately $1.0 million.

     Bad debt expense was $8.8 million or 1.4% as a percent of net sales for fiscal 2006 compared to $330,000 for fiscal 2005. The increase was due to the write-off of an accounts receivable of $9.0 million due to the bankruptcy of a major retailer. This was partially offset by some recoveries of other accounts receivable.

     Depreciation and amortization for the distribution segment was $2.2 million for fiscal 2006 compared to $1.8 million for fiscal 2005. The increase is principally due to the new warehouse system and equipment.

     Net operating loss for the distribution segment was $8.6 million for fiscal 2006 compared to a net operating loss of $2.2 million for fiscal 2005.

Fiscal 2005 Results Compared With Fiscal 2004

     Net Sales

     Net sales for the distribution segment were $556.9 million (before intercompany eliminations) for fiscal 2005 compared to $444.7 million (before intercompany eliminations) for fiscal 2004. The 25.2% increase in net sales for fiscal 2005 was primarily due to increases in the software and video games product groups. Sales increased in the software product group to $399.3 million for fiscal 2005 compared to $311.9 million for fiscal 2004. The increase in net sales in this product group was primarily due to continued increases in a variety of software categories, including internet security utility products where sales remained strong due to continued demand. Major label music and DVD video was $62.8 million in fiscal 2005 compared to $49.3 million in fiscal 2004. The increase in net sales in this product group was primarily due to the addition of new customers and store openings of existing customers. Video games increased to $30.1 million in fiscal 2005 compared to $21.8 million in fiscal 2004 due to an increase in penetration of our existing customer base. Independent music increased to $64.7 million in fiscal 2005 compared to $61.7 million in fiscal 2004 due to additional growth from catalog product sales as well as sales resulting from new label relationships.

     Gross Profit

     Gross profit for the distribution segment was $59.9 million or 10.8% of net sales for fiscal 2005 compared to $48.7 million or 11.0% of net sales for fiscal 2004. The slight decrease in gross profit as a percent of net sales for fiscal 2005 was due to higher sales of products with lower gross margins, such as video games. We typically incur lower operating costs as a result of the “one-way” terms of sales related to the video games category.

     Operating Expenses

     Total operating expenses for the distribution segment were $62.1 million or 11.2% of net sales for fiscal 2005 compared to $39.4 million or 8.9% of net sales for fiscal 2004.

     Overall, certain operating expenses increased in fiscal 2005; particularly, information technology, freight and warehouse expenses related to the new warehouse and certain warehouse operating systems. The increased expense incurred in these areas was due to movement of product between warehouses, expedited freight to customers in connection with the transition to the new warehouse and information technology systems, warehouse labor costs related to additional movement of product, information technology programming labor and programming costs, and the building of racks. These operating expenses were approximately 0.6% higher during fiscal 2005 than during the prior fiscal year.

     Selling and marketing expenses for the distribution segment were $14.4 million or 2.6% of net sales for fiscal 2005 compared to $10.4 million or 2.3% of net sales for fiscal 2004. The increase in selling and marketing expenses for fiscal 2005 is primarily a result of costs increasing in relation to increased net sales and higher freight costs incurred during the transition to the new warehouse.

     Distribution and warehousing expenses for the distribution segment were $8.8 million or 1.6% of net sales for fiscal 2005 compared to $6.0 million or 1.3% of net sales for fiscal 2004. The increase in distribution and warehousing expense was primarily due to the new warehouse and implementation of the new warehouse operating system.

     General and administration expenses for the distribution segment consist principally of executive, accounting and administrative personnel and related expenses, including professional fees. General and administration expenses for the distribution segment were $37.1 million or 6.7% of net sales for fiscal 2005 compared to $21.7 million or 4.9% of net sales for fiscal 2004. The increase in general and administration expenses was primarily due to compensation expense of $5.8 million to acquire the remaining twenty percent ownership position in Encore, incentive-based deferred compensation expense of $2.5 million and compensation expense of $288,000 related to the CEO’s employment agreement, $388,000 related to a former CFO’s separation agreement, expense of $1.2 million related to Sarbanes-Oxley Act of 2002 compliance and FUNimation transaction expenses of $578,000.

     Depreciation and amortization for the distribution segment was $1.8 million for fiscal 2005 compared to $1.3 million for fiscal 2004. This increase was due to the new warehouse and warehouse systems.

     We had a net operating loss for the distribution segment of $2.2 million for fiscal 2005 compared to net income of $9.3 million for fiscal 2004.

Publishing Segment

     The publishing segment includes Encore, BCI and FUNimation. We acquired FUNimation on May 11, 2005, the assets of BCI on November 3, 2003 and the assets of Encore on July 31, 2002. Results are included from dates of acquisition.

Fiscal 2006 Results Compared With Fiscal 2005

     Net sales for the publishing segment were $127.6 million (before intercompany eliminations) for fiscal 2006 and $95.8 million (before intercompany eliminations) for fiscal 2005. Of the change in net sales, FUNimation contributed $37.2 million during fiscal 2006. The transfer of a third-party software products distribution relationship with a major mass merchandiser from the publishing segment to the distribution segment in fiscal 2005, accounted for a $9.6 million decrease in fiscal 2006 net sales. The publishing segment benefited from a strong performance of the new release, He-Man and the Masters of the Universe DVD and new versions of Print Shop and Print Master, during fiscal 2006.

     Gross profit for the publishing segment was $47.4 million or 37.1% as a percent of net sales for fiscal 2006 and $31.4 million or 32.8% as a percent of net sales for fiscal 2005. The gross margin rate increase was primarily due to the transfer of a third-party software products distribution arrangement with a mass merchandiser carrying lower than average profit margins to the distribution segment in fiscal year 2005. In addition, FUNimation’s product mix increased profit margins for fiscal 2006.

     Operating expenses for the publishing segment were $34.5 million, or 27.0% of net sales, for fiscal 2006 and $17.3 million, or 18.1% of net sales for fiscal 2005. The expense increase in fiscal 2006 was primarily due to the addition of FUNimation in May 2005, which added $17.8 million in additional expense, including $5.0 million of period amortization of intangibles related to purchase accounting and the write-off of an accounts receivable of $3.2 million due to the bankruptcy of a major retailer. Amortization expense was reduced by $2.2 million based on the adjusted purchase price allocation in the fourth quarter of fiscal 2006. The increase is also due to the advertising and marketing of new front line products, primarily He-Man and the Masters of the Universe DVD. These increases were partially offset by a reduction in bonus expense of approximately $850,000 due to the performance of the Company.

     The publishing segment had operating income of $12.9 million for fiscal 2006 and operating income of $14.0 million for fiscal 2005.

Fiscal 2005 Results Compared With Fiscal 2004

     Net sales for the publishing segment were $95.8 million (before intercompany eliminations) for fiscal 2005 and $46.2 million (before intercompany eliminations) for fiscal 2004. Fiscal 2005 included a full year of Encore and BCI revenues, whereas fiscal 2004 only included a full year of Encore revenues and five months of BCI revenues. Additionally, on April 1, 2004 Encore signed a multi-year, multi-license agreement with Riverdeep Inc. The Riverdeep license significantly increased publishing segment revenue during fiscal 2005. A significant portion of the net sales increase was due to increased sales in our Encore business.

     Gross profit for the publishing segment was $31.4 million or 32.8% as a percent of net sales for fiscal 2005 and $9.3 million or 20.1% as a percent of net sales for fiscal 2004. The lower gross profit in fiscal year 2004 was primarily due to an impairment charge for $5.6 million related to software development costs.

     Operating expenses for the publishing segment were $17.3 million, or 18.1% of net sales, for fiscal 2005, including $17.1 million for sales and marketing expenses, $8.5 million for general and administration expenses and $1.7 million for depreciation and amortization expense. For fiscal 2004, operating expenses were $11.2 million, or 24.2% of net sales, including $6.5 million for sales and marketing expenses, $4.0 million for general and administration expenses and $673,000 for depreciation and amortization expense. The 6.1% increase of net sales is a result of operating efficiencies.

     The publishing segment had operating income of $14.0 million for fiscal 2005 and $1.9 million for fiscal 2004.

Other Segment

     The other segment included the operations of Mix & Burn, a separate corporation whose operations were consolidated with our financial results during the period commencing December 31, 2003 in accordance with the provisions of FIN 46 (R). The variable interest entity was deconsolidated as of December 1, 2005 due to the Company’s determination that we were no longer the primary beneficiary as defined by FIN 46(R). Mix & Burn designs and markets digital music delivery services for music and other specialty retailers.

Fiscal 2006 Results Compared With Fiscal 2005

     Net sales for the other segment were $424,000 (before intercompany eliminations) for fiscal 2006 and $352,000 (before intercompany eliminations) for fiscal 2005. Gross profit for the other segment was $81,000 or 19.6% as a percent of net sales for fiscal 2006 and $65,000 or 18.5% as a percent of net sales for fiscal 2005. Total operating expenses for the other segment were $1.7 million for fiscal 2006 and $2.2 million for fiscal 2005. The other segment had operating losses of $1.8 million for fiscal 2006 and operating losses of $2.2 million for fiscal 2005.

Fiscal 2005 Results Compared With Fiscal 2004

     Net sales for the other segment were $352,000 (before intercompany eliminations) for fiscal 2005 and zero (before intercompany eliminations) for fiscal 2004. Gross profit for the other segment was $65,000 or 18.5% as a percent of net sales for fiscal 2005 and zero for fiscal 2004. Operating expenses for the other segment were $2.2 million for fiscal 2005 and $343,000 for fiscal 2004. The other segment had operating losses of $2.2 million for fiscal 2005 and operating losses of $343,000 for fiscal 2004.

Consolidated Other Income and Expense for All Periods

     Other income and expense, net, increased to expense of $8.0 million in fiscal 2006 from expense of $551,000 in fiscal 2005. Interest expense was $11.2 million for fiscal 2006 compared to $783,000 for fiscal 2005. The increase in interest expense for fiscal 2006 is a result of financing the FUNimation acquisition through bank debt and the write-off of debt acquisition costs of $239,000 associated with the previous debt agreement. Other income for fiscal 2006 consisted primarily of a vendor contract buy-out of $375,000, a gain on interest rate swaps of $623,000 and interest income of $777,000. This category in fiscal 2006 also included other income of $1.9 million related to the deconsolidation of the variable interest entity and $342,000 of warrant expense related to the March 2006 private placement.

     Other income and expense, net, decreased to expense of $551,000 in fiscal 2005 from expense of $836,000 in fiscal 2004. Interest expense was $783,000 for fiscal 2005 compared to $378,000 for fiscal 2004. Other expense in fiscal 2004 included debt extinguishment costs of $908,000.

Consolidated Income Tax Benefit for All Periods

     We recorded an income tax benefit for fiscal 2006 of $2.0 million, an income tax benefit of $1.0 million for fiscal 2005, and an income tax benefit of $583,000 for fiscal 2004. We utilized a portion of the existing net operating loss carryforwards in fiscal 2005 and fiscal 2004.

Consolidated Net Income (Loss) for All Periods

     Net (loss) income for the fiscal years 2006, 2005 and 2004 were $(3.2) million, $10.2 million and $6.8 million, respectively.

Market Risk

     The Company’s exposure to market risk is primarily due to the fluctuating interest rate associated with variable rate indebtedness. See “Item 7a — Quantitative and Qualitative Disclosure About Market Risk.”

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, although the percentage of net sales and earnings has declined over the past fiscal years. In fiscal 2006 our third quarter earnings were not in line with our earnings trends primarily due to the impact of the bankruptcy of a major retailer and the write-off of balances of an independent label. 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

Cash Flow Analysis

     Operating Activities

     Cash used in operating activities for fiscal 2006 totaled $7.3 million and for fiscal 2005 totaled $2.5 million, while cash provided from operating activities totaled $9.0 million in fiscal 2004.

     The net cash used in operating activities for fiscal 2006 mainly reflected our net loss, combined with various non-cash charges, including depreciation and amortization of $17.1 million, deferred taxes of $2.3 million, change in deferred revenue of $1.0 million, and a gain from the deconsolidation of Mix & Burn of $1.9 million, offset by our working capital demands. Changes in the following operating assets and liabilities are net of the effect of the addition of the FUNimation assets and liabilities due to the acquisition: accounts receivable decreased by $8.5 million, reflecting the focus on managing working capital; inventories increased by $2.7 million, primarily reflecting higher inventories required by the Company’s $89.5 million net sales increase; prepaid expenses increased by $1.3 million, primarily reflecting royalty advances in the publishing segment; production costs and license fees increased $3.0 million and $11.3 million, respectively, due primarily to new content acquisitions and income taxes receivable increased $4.4 million primarily due to timing of required tax payments.

     The net cash used in fiscal 2005 mainly reflected our net earnings, combined with various non-cash charges, including depreciation and amortization of $3.9 million and executive and stock compensation expense of $8.6 million, deferred taxes of $4.8 million, and tax benefit from employee stock plans of $2.4 million, offset by our working capital demands. Accounts receivable increased by $14.5 million, reflecting the growth in sales for fiscal 2005. Inventories increased by $10.7 million, reflecting the higher inventories required by the Company’s increased sales activities. Prepaid expenses increased by $5.9 million, primarily reflecting royalty advances in the publishing business. Accounts payable increased $4.4 million, primarily as a result of increased inventory. Accrued expenses increased $6.0 million as a result of increased bonuses and royalties payable resulting from increased profitability and sales.

     The net cash provided in fiscal 2004 reflected our net earnings, combined with various non-cash charges, including depreciation and amortization of $2.1 million, executive and stock compensation expense of $2.4 million and impairment of capitalized software development costs of $5.6 million, partially offset by our working capital demands. Accounts receivable increased by $5.2 million, inventories increased by $4.3 million, and prepaids increased by $10.3 million, which were offset by the increase in accounts payable of $13.1 million, which were a result of the Company’s increased profitability and sales.

     Investing Activities

     Cash flows used in investing activities totaled $91.0 million, $3.7 million and $16.7 million in fiscal 2006, 2005 and 2004, respectively.

     Acquisition of property and equipment totaled $2.9 million, $9.4 million and $5.0 million in fiscal 2006, 2005 and 2004 respectively. Purchases of assets in fiscal 2005 primarily related to the new warehouse and warehouse system. In fiscal 2005, the purchases of fixed assets were offset by $6.4 million in proceeds from the sale and leaseback of our new building. Purchase of intangible assets totaled $644,000, $608,000 and $1.2 million for fiscal 2006, 2005 and 2004, respectively.

     Acquisition of businesses totaled $87.1 million for fiscal 2006. In May 2005 the Company completed the acquisition of FUNimation, a leading home video distributor and licensor of Japanese animation and children’s entertainment in the United States. The Company completed this acquisition to continue to build its catalog of content and grow the publishing segment.

     Acquisition of businesses totaled $10.5 million for fiscal 2004. In November 2003, the Company completed the acquisition of the assets of BCI, a provider of niche DVD and video products and in-house produced CDs and DVDs. This transaction was made to enable the Company to provide expanded content.

     Financing Activities

     Cash flows provided from financing activities totaled $97.0 million, $7.3 million and $11.8 million for fiscal 2006, 2005 and 2004, respectively.

     The Company recorded proceeds from notes payable of $141.1 million for fiscal 2006 and debt issuance costs of $3.1 million. The Company recorded $59.9 million in repayments on notes payable, net proceeds from the 2006 private placement of $18.5 million and proceeds from the exercise of common stock options and warrants of $455,000 for fiscal 2006. The Company recorded net repayments on notes payable of $651,000, proceeds from exercise of common stock options and warrants of $8.2 million, and debt issuance costs of $527,000 for fiscal 2005. The Company recorded proceeds from the exercise of common stock options and warrants of $814,000, $11.7 million from the net proceeds of the sale of common stock, net payments on notes payable of $422,000 and debt acquisition costs of $375,000 in fiscal 2004.

Capital Resources

     In October 2001, we entered into a credit agreement with General Electric Capital Corporation as administrative agent, agent and lender, and GECC Capital Markets Group, Inc. as Lead Arranger, for a three year, $30.0 million revolving credit facility for use in connection with our working capital needs. In June 2004, this credit agreement was amended and restated to, among other things, provide for two senior secured revolving sub-facilities: a $10.0 million revolving acquisition sub-facility, and a $40.0 million revolving working capital sub-facility. The revolving working capital sub-facility allowed for borrowing up to $40.0 million, subject to a borrowing base requirement, and required that we maintain a minimum excess availability of at least $10.0 million. In addition to the provision for the two senior secured revolving sub-facilities, this credit agreement allowed for up to $10.0 million of the revolving working capital facility to be used for acquisitions, providing us with an aggregate revolving acquisition availability of up to $20.0 million, subject to a borrowing base requirement. The working capital revolving credit facility included borrowing capacity available for letters of credit and for borrowings on same-day notice, referred to as swing line loans. Under the amended and restated credit agreement, the maturity date of the revolving working capital facility was December 2007 and the maturity date of the revolving acquisition facility was June 2006.

     The credit agreement was amended and restated in its entirety on May 11, 2005 in order to provide the Company with funding to complete the FUNimation acquisition and was again amended and restated in its entirety on June 1, 2005. The credit agreement

currently provides a six-year $115.0 million Term Loan B sub-facility, a $25.0 million five and one-half year Term Loan C sub-facility, and a five-year revolving sub-facility for up to $25.0 million. The entire $115.0 million of the Term Loan B sub-facility was drawn upon on May 11, 2005 and the entire $25.0 million of the Term Loan C sub-facility was drawn at June 1, 2005. The revolving sub-facility of up to $25.0 million is available to the Company for its working capital and general corporate needs. The revolving sub-facility has no borrowing base requirement.

     During fiscal 2006 we received proceeds of $140.0 million from the Term Loan B sub-facility and the Term Loan C sub-facility in conjunction with the FUNimation acquisition. The revolving sub-facility of up to $25.0 million is available to the Company for its working capital and general corporate needs. Through March 31, 2006, the Company has paid down the $25.0 million Term Loan C sub-facility in full and repaid $34.9 million of the principal amount owed on the Term Loan B sub-facility. At March 31, 2006 there were no amounts outstanding on the revolving sub-facility and the Company did not draw on the revolving sub-facility during fiscal 2006.

     The loans under our senior credit facilities are guaranteed by our subsidiaries and are secured by a first priority security interest in all of our assets and in all of the assets of our subsidiary companies, as well as the capital stock of our subsidiary companies. During fiscal year 2006, the Company entered into several amendments to these credit facilities that, among other things, permitted the Company to (i) enter into an agreement with the FUNimation sellers that resulted in a reduction to the purchase price paid to these parties; and (ii) use the proceeds received in the March 2006 private placement, together with other available cash on hand, to pay down the Term Loan C sub-facility.

     Under the credit agreement we are required to meet certain financial and non-financial covenants. Non-financial covenants include, but are not limited to, restrictions on the amounts the Company may lend to its subsidiaries and affiliates. The financial covenants include a variety of financial metrics that are used to determine our overall financial stability and include limitations on our capital expenditures, a minimum ratio of EBITDA to fixed charges, and a maximum of indebtedness to EBITDA. We were in compliance with all the covenants related to the credit facility on March 31, 2006.

Liquidity

     During fiscal 2006, we had two significant transactions, which included the following:

During March 2006, we completed a private placement in which we sold 5,699,998 shares of common stock and issued 1,425,001 shares issuable upon exercise of five year warrants exercisable at $5.00 (excluding 171,000 placement agent warrants). We sold the shares in the private placement to the selling shareholders for $3.50 per share for total proceeds of approximately $20.0 million and net proceeds after expenses of approximately $18.5 million. The per share sales price of $3.50 represented a discount of approximately 8.4% of the closing price of our common stock on the date the purchase was completed. Net proceeds from the private placement, and additional cash reserves, were used to repay the Term Loan C sub-facility of the Credit Agreement.

On May 11, 2005 we acquired 100% of the general and limited partnership interests of FUNimation Productions, Ltd. and The FUNimation Store, Ltd. (together, “FUNimation”). As consideration for the acquisition of FUNimation, the sellers of FUNimation received $100.4 million in cash, subject to post-closing adjustments not to exceed $5.0 million and excess cash as defined in the purchase agreement, and 1,827,486 shares of Company common stock. In addition, during the five-year period following the closing of the transaction, we may pay up to an additional $17.0 million in cash to the FUNimation sellers if they achieve certain agreed-upon financial targets relating to the FUNimation business. This acquisition cost was funded with the debt structure discussed herein. During February 2006, the Company received approximately $11.1 million in purchase price adjustments related to the FUNimation acquisition.

     Our normal business was affected by the bankruptcy of a major retailer in fiscal 2006. However, we were able to manage our accounts receivable, inventory and accounts payable. In our business, we must estimate the likely demand for the products that we sell in order to ensure that we have enough of these products ready for shipment to our customers. Inventory increased $2.7 million due to the acquisition of FUNimation and to ensure that we had sufficient products to meet expected increasing demand for the coming months. The effect of this was that, at the end of fiscal 2006, we had higher inventory levels than March 31, 2005. Cash at March 31, 2006 was $14.3 million and we had no borrowings under the $25.0 million revolving portion of our credit facility.

     From time to time we are required to invest a significant amount of cash in our publishing segment in order to license content from third parties, and in our distribution segment in order to sign exclusive distribution agreements. Typically, these amounts are paid to third parties in connection with the signing of the applicable agreement and are recouped from the proceeds that we receive from the sale of products that result from these agreements. During fiscal 2006, we invested approximately $38.5 million in connection with the acquisition of licensed and exclusively distributed product in our publishing and distribution segments.

     Our cash requirements are driven by our needs to fund increases in accounts receivable, inventories, payments of obligations to creditors and advances to acquire new content. We currently believe cash and cash equivalents, funds generated from the expected results of operations and funds available under our existing credit facility will be sufficient to satisfy our working capital requirements and to finance expansion plans and strategic initiatives for fiscal year 2007 and in the foreseeable future absent significant acquisitions. Our credit agreement with GE Commercial Finance provides us with $25.0 million working capital revolving credit facility, provided that we meet certain financial covenants but without reference to a borrowing base availability requirement. At March 31, 2006, this facility had no amounts outstanding.

     We have stated our plans to grow through acquisitions; however, such opportunities will likely require the use of additional equity or debt capital, some combination thereof, or other financing.

Contractual Obligations

     The following table presents information regarding contractual obligations that exist as of March 31, 2006 by fiscal year (in thousands).

						Less
						than 1				1 — 3				4 — 5				More than 5
		Total				Year				Years				Years				Years
Operating leases		$	27,880			$	2,941			$	5,743			$	4,448			$	14,748
Capital leases			438				161				209				68				—
Note payable			80,130				5,000				10,000				10,000				55,130
License and distribution agreement			19,009				14,960				4,049				—				—
Total		$	127,457			$	23,062			$	20,001			$	14,516			$	69,878

Item 7a — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     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.

     Interest Rate Risk. Our exposure to changes in interest rates results primarily from borrowings used to fund the FUNimation acquisition. The Company uses derivative financial instruments to manage the interest rate risks associated with a portion of its variable interest rate indebtedness. As of March 31, 2006 we had $80.1 million of indebtedness, of which approximately $27.1 million was subject to interest rate fluctuations. Based on these borrowings subject to interest rate fluctuations outstanding on March 31, 2006, a 100-basis point change in LIBOR would cause the Company’s annual interest expense to change by $271,000.

     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

     The information called for by this item is set forth in the Consolidated Financial Statements and Schedule covered by the Reports of Independent Registered Public Accounting Firms at the end of this report commencing at the pages indicated below:

Reports of Independent Registered Public Accounting Firms		45
Consolidated Balance Sheets at March 31, 2006 and 2005		48
Consolidated Statements of Operations for the years ended March 31, 2006, 2005 and 2004		49
Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the years ended March 31, 2006, 2005 and 2004		50
Consolidated Statements of Cash Flows for the years ended March 31, 2006, 2005 and 2004		51
Notes to Consolidated Financial Statements		53
Valuation and Qualifying Accounts Schedule for the years ended March 31, 2006, 2005 and 2004		79

All of the foregoing Consolidated Financial Statements and Schedule are hereby incorporated in this Item 8 by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     None.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     We maintain disclosure controls and procedures (“Disclosure Controls”), as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in our Exchange Act reports, including the Company’s Annual Report on Form 10-K, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

     As required by Rule 13a-15(b) and 15d-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the date of such evaluation.

Management’s Report on Internal Control over Financial Reporting

     Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (“Internal Control”) as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company’s internal control system is designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     An internal control material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

     Management has assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2006. In making its assessment of internal control over financial reporting, management used the criteria set forth by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission in Internal Control—Integrated Framework. Based on our assessment we believe that, as of March 31, 2006, the Company’s internal control over financial reporting is effective based on those criteria.

     Grant Thornton LLP, the Company’s independent registered public accounting firm, has issued an attestation report included herein on management’s assessment of the Company’s internal control over financial reporting.

Changes in Internal Control over Financial Reporting

     There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B. Other Information

     None.

PART III

Item 10. Directors and Executive Officers of the Registrant

     We refer you to our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission (“SEC”) within 120 days after the close of our fiscal year, for information regarding this item and our directors and nominees for director. This information is incorporated by reference into this item of the report.

     Information regarding our executive officers is found in Part I, Item 1 of this report under the heading “Executive Officers of the Company”.

     We refer you to our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close of our fiscal year, for information regarding our Audit Committee members and “audit committee financial experts”. This information is incorporated by reference into this item of the report.

     We refer to our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close of our fiscal year, for information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934. This information is incorporated by reference into this item of the report.

     The information regarding the Company’s Code of Business Ethics is incorporated by reference to the information to be contained in our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close our fiscal year.

Item 11. Executive Compensation

     Information required under this item will be contained in our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close our fiscal year and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     Information required under this item will be contained in our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close our fiscal year and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

     Information required under this item will be contained in our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close our fiscal year and is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

     Information required under this item will be contained in our Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the SEC within 120 days after the close our fiscal year and is incorporated herein by reference.

PART IV

Item 15. Exhibits and Financial Statements Schedules

(a) Documents filed as part of this report -

(1)

Financial Statements. Our following consolidated financial statements and the Reports of Independent Registered Public Accounting Firms thereon are set forth at the end of this document:

	(i)		Reports of Independent Registered Public Accounting Firms.
	(ii)		Consolidated Balance Sheets as of March 31, 2006 and 2005 .
	(iii)		Consolidated Statements of Operations for the years ended March 31, 2006, 2005 and 2004 .
	(iv)		Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Loss) for the years ended March 31, 2006, 2005 and 2004 .
	(v)		Consolidated Statements of Cash Flows for the years ended March 31, 2006, 2005 and 2004.
	(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 Consolidated Financial Statements or the notes thereto.

(3)

Exhibits

Item
No.		Description
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)).
3.5		Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1 filed April 13, 2006 (File No. 000-22982)).
3.6		Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1 filed April 13, 2006 (File No. 000-22982)).
4.1		Form of Specimen Certificate for Common Stock (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1 filed April 13, 2006 (File No. 000-22982)).
4.2		Form of Warrant dated March 21, 2006 (incorporated by reference to Exhibit 4.4 to the Company’s Registration Statement on Form S-1 filed April 13, 2006 (File No. 000-22982)).
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)).

Item
No.		Description
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 *		Form of Termination Agreement for certain of 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)).
10.10		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)).
10.11		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)).
10.12		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)).
10.13		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)).
10.14		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)).
10.15		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)).
10.16		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)).
10.17		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)).
10.18		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)).
10.19		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)).
10.20		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)).
10.21		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)).
10.22		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)).
10.23		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)).
10.24		Separation Agreement dated as of March 1, 1999 between the Company and NetRadio Corporation (incorporated by

Item
No.		Description
		reference to Exhibit 10.16 to NetRadio Corporation’s Form S-1/A Registration Statement (File No. 333-73261)).
10.25		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)).
10.26		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)).
10.27		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)).
10.28		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)).
10.29		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 August 14, 2002 (File No. 0-22982)).
10.30		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 August 14, 2002 (File No. 0-22982)).
10.31		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)).
10.32		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)).
10.33		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)).
10.34		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)).
10.35		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)).
10.36		Form of Separation Agreement with Charles E. Cheney dated April 30, 2004 (incorporated by reference to Exhibit 10.41 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.37		Form of Assignment of Lease between BCI Eclipse LLC and BCI Eclipse Company, LLC dated November 3, 2003 (incorporated by reference to Exhibit 10.42 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.38		Form of Amendment No. 7 to Credit Agreement dated January 26, 2004 (incorporated by reference to Exhibit 10.43 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.39		Form of Amendment No. 8 to Credit Agreement dated March 9, 2004 (incorporated by reference to Exhibit 10.44 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.40		Form of Amendment No. 9 to Credit Agreement dated March 30, 2004 (incorporated by reference to Exhibit 10.45 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.41		Form of Amended and Restated Credit Agreement with General Electric Capital Corporation dated June 18, 2004 (incorporated by reference to Exhibit 10.46 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.42		Form of Lease Agreement between the Company and NL Ventures IV New Hope, L.P. dated May 27, 2004 (incorporated by reference to Exhibit 10.47 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.43		Form of Third Amendment to Office/Warehouse Lease between Cambridge Apartments, Inc. and the Company dated February 23, 2004 (incorporated by reference to Exhibit 10.48 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).

Item
No.		Description
10.44		Form of Fourth Amendment to Office/Warehouse Lease between Cambridge Apartments, Inc. and the Company dated June 2004 (incorporated by reference to Exhibit 10.49 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.45		Amendment No. 2 to Lease Agreement between Airport One Limited Partnership and the Company dated March 21, 2004 (incorporated by reference to Exhibit 10.50 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.46		Addendum to Lease Agreement between Cambridge Apartments, Inc. and the Company dated May 27, 2004 (incorporated by reference to Exhibit 10.51 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.47		Form of BCI Eclipse Lease Agreement effective October 1, 1999 (incorporated by reference to Exhibit 10.52 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.48		First Amendment to BCI Eclipse Lease Agreement made as of January 5, 2000 (incorporated by reference to Exhibit 10.53 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
10.49		Amended and Restated Credit Agreement dated June 18, 2004 between the Company and General Electric Capital Corporation (incorporated by reference to Exhibit 10.54 to the Company’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-22982)).
10.50		Amendment No. 1 and Limited Waiver with Respect to Amended and Restated Credit Agreement dated August 25, 2004 (incorporated by reference to Exhibit 10.55 to the Company’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-22982)).
10.51		Amendment No. 2 and Limited Waiver with Respect to Amended and Restated Credit Agreement dated October 18, 2004 (incorporated by reference to Exhibit 10.56 to the Company’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-22982)).
10.52		Lease dated October 8, 2004, between Encore Software, Inc. and Kilroy Realty, L.P., with respect to an office facility in El Segundo, California (incorporated by reference to Exhibit 10.57 to the Company’s Form 10-Q for the quarter ended September 30, 2004 (File No. 0-22982)).
10.53		Form of License and Distribution Agreement (Manufacturing Rights) (2004-2005) between Riverdeep Inc. and Encore Software, Inc. dated as of March 29, 2004 (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-Q/A for the quarter ended September 30, 2004 (File No. 0-22982)).
10.54		Form of License and Distribution Agreement (Manufacturing Rights) (2005-2007) between Riverdeep Inc. and Encore Software, Inc. dated as of March 29, 2004 (incorporated by reference to Exhibit 10.2 to the Company’s Form 10-Q/A for the quarter ended September 30, 2004 (File No. 0-22982)).
10.55		Form of Addendum #1 to Licensing and Distribution Agreements (2004-2005 and 2005-2007) between Riverdeep, Inc. and Encore Software, Inc. dated as of April 13, 2004 (incorporated by reference to Exhibit 10.3 to the Company’s Form 10-Q/A for the quarter ended September 30, 2004 (File No. 0-22982)).
10.56		Form of Addendum #2 to Licensing and Distribution agreements (2004-2005 and 2005-2007) between Riverdeep, Inc. and Encore Software, Inc. dated October 2004 (incorporated by reference to Exhibit 10.4 to the Company’s Form 10-Q/A for the quarter ended September 30, 2004 (File No. 0-22982)).
10.57 *		Navarre Corporation 2004 Stock Plan (incorporated by reference to Exhibit D to the Company’s Proxy Statement filed July 27, 2004 (File No. 0-22982)).
10.58*		Form of 2004 Stock Plan Incentive Stock Option Agreement.
10.59*		Form of 2004 Stock Plan Non-Employee Director Stock Option Agreement.
10.60		Form of Senior Debt Indenture (incorporated by reference to Exhibit 4(a) to the Company’s Registration Statement on Form S-3 filed September 28, 2004 (File No. 333-119260)).
10.61		Form of Senior Debt Indenture (incorporated by reference to Exhibit 4(c) to the Company’s Registration Statement on Form S-3 filed September 28, 2004 (File No. 333-119260)).
10.62		FUNimation Partnership Interest Purchase Agreement, dated January 10, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).

Item
No.		Description
10.63		Form of Assignment and Assumption Agreement (incorporated by reference to Exhibit 10.1(a) to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.64*		Form of Gen Fukanaga Employment Agreement (incorporated by reference to Exhibit 10.1(b) to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.65		Form of Escrow Agreement (incorporated by reference to Exhibit 10.1(c) to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.66		Form of Non-Competition Agreement (incorporated by reference to Exhibit 10.1(d) to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.67		Form of Registration Rights Agreement (incorporated by reference to Exhibit 10.1(e) to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.68		Form of Release (incorporated by reference to Exhibit 10.1(f) to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.69		Limited Waiver and Third Amendment to Amended and Restated Credit Agreement, filed January 14, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed January 14, 2005 (File No. 0-22982)).
10.70		Amendment No. 3 to Lease Agreement between Airport One Limited Partnership and the Company dated November 23, 2004 (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended December 31, 2005 (File No. 0-22982)).
10.71		Form of Addendum #3 to Licensing and Distribution Agreements (2004-2005 and 2005-2007) between Riverdeep, Inc. and Encore Software, Inc. dated November 2004 (incorporated by reference to Exhibit 10.2 to the Company’s Form 10-Q for the quarter ended December 31, 2005 (File No. 0-22982)).
10.72		Amendment No. 1 to Lease Agreement between Encore Software, Inc. and Kilroy Realty, L.P. dated December 29, 2004 (incorporated by reference to Exhibit 10.3 to the Company’s Form 10-Q for the quarter ended December 31, 2005 (File No. 0-22982)).
10.73		Limited Waiver With Respect To Amended and Restated Credit Agreement dated March 15, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed March 17, 2005 (File No. 0-22982)).
10.74		Stock Purchase Agreement between the Company and Michael Bell dated March 14, 2005 (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed March 17, 2005 (File No. 0-22982)).
10.75		Registration Rights Agreement between the Company and Michael Bell dated March 14, 2005 (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed March 17, 2005 (File No. 0-22982)).
10.76		Amendment to Stock Purchase Agreement between the Company and Michael Bell dated March 31, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April 14, 2005 (File No. 0-22982)).
10.77		Amendment to Registration Rights Agreement between the Company and Michael Bell dated March 31, 2005 (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed April 14, 2005 (File No. 0-22982)).
10.78		Limited Waiver with Respect to Amended and Restated General Electric Capital Corporation Credit Agreement dated March 31, 2005 (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed April 14, 2005 (File No. 0-22982)).
10.79		Pledge Agreement between the Company and General Electric Capital Corporation related to Encore shares dated March 31, 2005 (incorporated by reference to Exhibit 10.4 to the Company’s Form 8-K filed April 14, 2005 (File No. 0-22982)).
10.80		Amendment No. 1 to Partnership Interest Purchase Agreement dated May 11, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed May 17, 2005 (File No. 0-22982)).
10.81		Second Amended and Restated Credit Agreement dated as of May 11, 2005 between the Company and General Electric Capital Corporation (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed May 17, 2005 (File No. 0-22982)).
10.82		Form of Third Amended and Restated Credit Agreement with Lenders and General Electric Capital Corporation dated June 1, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed June 3, 2005 (File No. 0-22982)).
10.83		Form of Limited Waiver to General Electric Capital Corporation Second Amended and Restated Credit Agreement dated June 1, 2005 (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed June 3, 2005 (File No. 0-22982)).

Item
No.		Description
10.84		Office Lease dated August 1, 2004 between Cocanaugher Asset #1, Ltd. and FUNimation Productions, Ltd.
10.85		Letter dated June 14, 2005 regarding Company’s policy to use straight-line method of depreciation from Grant Thornton LLP.
10.86		Form of Addendum #6 to Licensing and Distribution Agreements (2004-2005 and 2005-2007) between Riverdeep, Inc. and Encore Software, Inc. dated October 6, 2005 (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended September 30, 2005 (File No. 000-22982)).
10.87		First Amendment and Limited Waiver to Third Amended and Restated Credit Agreement with Lenders and General Electric Capital Corporation dated October 14, 2005 (incorporated by reference to Exhibit 99.1 to the Company’s Form 8-K filed October 14, 2005 (File No. 000-22982)).
10.88		Limited Waiver with Respect to Third Amended and Restated Credit Agreement with Lenders and General Electric Capital Corporation dated November 18, 2005 (incorporated by reference to Exhibit 99.1 to the Company’s Form 8-K filed November 18, 2005 (File No. 000-22982)).
10.89*		Executive Severance Agreement between the Company and J. Reid Porter dated December 12, 2005 (incorporated by reference to Exhibit 99.1 to the Company’s Form 8-K filed December 12, 2005 (File No. 000-22982)).
10.90		Amendment No. 4. to Standard Commercial Lease between Airport One Limited Partnership and the Company dated February 2, 2006 (incorporated by reference to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended December 31, 2005 (File No. 000-22982)).
10.91		Memorandum of Understanding between the Company and the FUNimation sellers dated February 7, 2006 (incorporated by reference to Exhibit 99.1 to the Company’s Form 8-K filed February 7, 2006 (File No. 000-22982)).
10.92		Limited Waiver and Second Amendment with Respect to Third Amended and Restated Credit Agreement with Lenders and General Electric Capital Corporation dated February 7, 2006 (incorporated by reference to Exhibit 99.2 to the Company’s Form 8-K filed February 7, 2006 (File No. 000-22982)).
10.93*		Navarre Corporation Amended and Restated 2004 Stock Plan (incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form S-8 filed February 22, 2006 (File No. 000-22982)).
10.94*		Form of Lock-Up Agreement regarding the Navarre Corporation Stock Option Acceleration effective March 20, 2006 (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed March 20, 2006 (File No. 000-22982)).
10.95		Form of Securities Purchase Agreement between the Company and various purchasers dated March 21, 2006 (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 filed April 13, 2006 (File No. 000-22982)).
10.96		Form of Registration Rights Agreement between the Company and various purchasers dated March 21, 2006 (incorporated by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-1 filed April 13, 2006 (File No. 000-22982)).
10.97		Third Amendment to the Third Amended and Restated Credit Agreement with Lenders and General Electric Capital Corporation dated March 21, 2006 (incorporated by reference to Exhibit 99.2 to the Company’s Form 8-K filed March 21, 2006 (File No. 000-22982)).
10.98 ü		Addendum #7 to Licensing and Distribution Agreements (2004-2005) and (2005-2007).
10.99*		Fiscal Year 2007 Annual Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K filed April 1, 2006 (File No. 000-22982)).
10.100*		Form of Navarre Corporation 2004 Stock Plan Employee Restricted Stock Agreement (incorporated by reference to Exhibit 10.2 to the Company’s Form 8-K filed April 1, 2006 (File No. 000-22982)).
10.101*		Form of Navarre Corporation 2004 Stock Plan Director Restricted Stock Agreement (incorporated by reference to Exhibit 10.3 to the Company’s Form 8-K filed April 1, 2006 (File No. 000-22982)).
10.102*		Form of Navarre Corporation 2004 Stock Plan TSR Stock Unit Agreement (incorporated by reference to Exhibit 10.4 to the Company’s Form 8-K filed April 1, 2006 (File No. 000-22982)).
10.103*		Form of Navarre Corporation 2004 Stock Plan Performance Stock Unit Agreement (incorporated by reference to Exhibit 10.5 to the Company’s Form 8-K filed April 1, 2006 (File No. 000-22982)).
14.1		The Company’s Code of Business Conduct and Ethics (incorporated by reference to Exhibit 14.1 to the Company’s Form 10-K for the year ended March 31, 2004 (File No. 0-22982)).
21.1		Subsidiaries of the Registrant.
23.1R ü		Consent of Independent Registered Public Accounting Firm — Grant Thornton LLP
23.2 ü		Consent of Independent Registered Public Accounting Firm — Ernst & Young LLP
24.1 ü		Power of Attorney, contained on signature page
31.1 ü		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act)
31.2 ü		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act)
32.1 ü		Certifications of the Chief Executive Officer pursuant Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)
32.2 ü		Certifications of the Chief Financial Officer pursuant Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350)

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 14, 2006				By		/s/ Eric H. Paulson
						Eric H. Paulson
						Chairman of the Board
						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 J. Reid Porter, or either of them, as his or her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign 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 attorney-in-fact and agent, 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 or she might or could do in person, hereby ratifying and confirming all said attorney-in-fact and agent, 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 and Chief Executive Officer		June 14, 2006
Eric H. Paulson		(principal executive officer)
/s/ J. Reid Porter		Chief Financial Officer (principal financial		June 14, 2006
J. Reid Porter		and accounting officer)
/s/ Charles E. Cheney		Director		June 14, 2006
Charles E. Cheney
/s/ Keith A. Benson		Director		June 14, 2006
Keith A. Benson
/s/ Timothy R. Gentz		Director		June 14, 2006
Timothy R. Gentz
/s/ James G. Sippl		Director		June 14, 2006
James G. Sippl
/s/ Michael L. Snow		Director		June 14, 2006
Michael L. Snow
/s/ Tom Weyl		Director		June 14, 2006
Tom Weyl
/s/ Dickinson G. Wiltz		Director		June 14, 2006
Dickinson G. Wiltz
/s/ Richard Gary St. Marie		Director		June 14, 2006
Richard Gary St. Marie

Board of Directors and Shareholders
Navarre Corporation

     We have audited the accompanying consolidated balance sheets of Navarre Corporation and subsidiaries as of March 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity and other comprehensive income (loss), and cash flows for each of the two years in the period ended March 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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 consolidated 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 financial position of Navarre Corporation and subsidiaries as of March 31, 2006 and 2005, and the consolidated results of their operations and their consolidated cash flows for each of the two years in the period ended March 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

     Our audits were conducted for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying Schedule II of Navarre Corporation and subsidiaries is presented for purposes of complying with the rules of the Securities and Exchange Commission and is not a required part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic 2006 and 2005 consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein, in relation to the basic consolidated financial statements taken as a whole.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of March 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated June 12, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ Grant Thornton LLP
Minneapolis, Minnesota
June 12, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders
Navarre Corporation

     We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting appearing under Item 9A, that Navarre Corporation and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of March 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the internal control over financial reporting of the Company based on our audit.

     We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

     A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

     Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

     In our opinion, management’s assessment that Navarre Corporation and subsidiaries maintained effective internal control over financial reporting as of March 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by COSO. Also, in our opinion, Navarre Corporation and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of March 31, 2006, based on the criteria established in Internal Control—Integrated Framework issued by COSO.

     We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Navarre Corporation and subsidiaries as of March 31, 2006 and 2005 and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the two years in the period ended March 31, 2006 and our report dated June 12, 2006 expressed an unqualified opinion on those consolidated financial statements.

/s/ Grant Thornton LLP
Minneapolis, Minnesota
June 12, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders
Navarre Corporation

We have audited the accompanying consolidated statement of operations, shareholders’ equity and other comprehensive income (loss), and cash flows for the year ended March 31, 2004. Our audit 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 audit 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of Navarre Corporation for the year 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.

/s/ Ernst & Young LLP
Minneapolis, Minnesota

May 13, 2004

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

		March 31,
		2006				2005
Assets
Current assets:
Cash and cash equivalents		$	14,296			$	15,571
Note receivable, related parties			200				200
Accounts receivable, less allowance for doubtful accounts, vendor advances and sales returns of $19,345 and $13,815, respectively			87,653				88,732
Inventories			43,624				40,759
Prepaid expenses and other current assets			11,273				15,303
Income taxes receivable			4,408				—
Deferred tax assets — current			8,830				7,398
Total current assets			170,284				167,963
Property and equipment, net of accumulated depreciation of $8,349 and $7,259, respectively			10,298				8,152
Other assets:
Notes receivable, related parties			—				200
Goodwill			81,202				9,832
Intangible assets, net of amortization of $8,258 and $2,369, respectively			20,863				5,198
License fees, net of amortization of $5,334			13,347				—
Interest rate swap			37				—
Other assets			13,583				4,547
Total assets		$	309,614			$	195,892
Liabilities and shareholders’ equity
Current liabilities:
Note payable		$	5,000			$	250
Capital lease obligation — short term			115				84
Accounts payable			97,923				96,387
Income taxes payable			—				8
Warrant liability			2,236				—
Accrued expenses			16,646				15,067
Total current liabilities			121,920				111,796
Long-term liabilities
Note payable — long-term			75,130				—
Capital lease obligation — long-term			222				237
Deferred compensation			5,272				4,984
Deferred tax liabilities — non-current			770				1,591
Other long-term liabilities			760				—
Total liabilities			204,074				118,608
Commitments and contingencies (Note 21)
Temporary-equity — Unregistered common stock, no par value; 5,699,998 issued and outstanding (Note 18)			16,634				—
Shareholders’ equity:
Common stock, no par value:
Authorized shares — 100,000,000
Issued and outstanding shares — 29,911,097 and 27,896,080, respectively			138,292				123,481
Accumulated other comprehensive income (loss)			23				—
Accumulated deficit			(49,409	)			(46,197	)
Total shareholders’ equity			88,906				77,284
Total liabilities and shareholders’ equity		$	309,614			$	195,892

     See accompanying notes to consolidated financial statements.

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

		Fiscal Years ended March 31,
		2006				2005				2004
Net sales		$	686,126			$	596,615			$	470,877
Cost of sales (exclusive of depreciation and amortization)			579,033				505,263				412,856
Gross profit			107,093				91,352				58,021
Operating expenses:
Selling and marketing			29,320				21,483				16,895
Distribution and warehousing			10,087				8,848				6,000
General and administrative			43,632				47,365				26,182
Bad debt expense (recovery)			12,111				423				(123	)
Depreciation and amortization			9,259				3,522				2,000
Total operating expenses			104,409				81,641				50,954
Income from operations			2,684				9,711				7,067
Other income (expense):
Interest expense			(11,217	)			(783	)			(378	)
Interest income			777				473				446
Deconsolidation of variable interest entity			1,896				—				—
Debt extinguishment			—				—				(908	)
Warrant expense			(342	)			—				—
Derivative gain (loss)			623				—				—
Other income (expense), net			390				(241	)			4
Net income (loss) before income tax			(5,189	)			9,160				6,231
Income tax benefit			2,014				1,006				583
Net income (loss)		$	(3,175	)		$	10,166			$	6,814
Earnings (loss) per common share:
Basic		$	(.11	)		$	.38			$	.30
Diluted		$	(.11	)		$	.35			$	.28
Weighted average shares outstanding:
Basic			29,898				26,830				22,780
Diluted			29,898				28,782				24,112

     See accompanying notes to consolidated financial statements.

NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands, except share amounts)

														Accumulated
														Other				Total
		Common Stock								Accumulated				Comprehensive				Shareholders’				Temporary Equity — Unregistered Common Stock
		Shares				Amount				Deficit				Income (Loss)				Equity				Shares				Amount
Balance at March 31, 2003			21,616,187			$	91,404			$	(63,141	)		$	—			$	28,263				—			$	—
Shares issued upon exercise of stock options			570,231				814				—				—				814				—				—
Shares issued with private placement			2,631,547				11,735				—				—				11,735				—				—
Shares issued with acquisition of BCI			1,000,000				5,080				—				—				5,080				—				—
Value of warrants issued to Hilco			—				372				—				—				372				—				—
Other — variable interest entity			—				36				(36	)			—				—				—				—
Net income			—				—				6,814				—				6,814				—				—
Balance at March 31, 2004			25,817,965				109,441				(56,363	)			—				53,078				—				—
Shares issued upon exercise of stock options and warrants			1,778,115				8,238				—				—				8,238				—				—
Shares issued upon repurchase of Encore stock			300,000				2,400				—				—				2,400				—				—
Tax benefit from employee stock option plans			—				2,428				—				—				2,428				—				—
Stock-based compensation expense			—				269				—				—				269				—				—
Reclassification of stock-based compensation accrual			—				705				—				—				705				—				—
Net income			—				—				10,166				—				10,166				—				—
Balance at March 31, 2005			27,896,080				123,481				(46,197	)			—				77,284				—				—
Shares issued upon exercise of stock options and warrants			187,531				455				—				—				455				—				—
Shares issued with acquisition of FUNimation			1,827,486				14,144				—				—				14,144				—				—
Shares issued with private placement, net of expenses $1,421			—				—				—				—				—				5,699,998				16,634
Other			—				(37	)			(37	)			—				(74	)			—				—
Tax benefit from employee stock option plans			—				249				—				—				249				—				—
Net loss			—				—				(3,175	)			—				(3,175	)			—				—
Unrealized gain on derivative instrument, net of tax of $14			—				—				—				23				23				—				—
Comprehensive loss			—				—				—				—				(3,152	)			—				—
Balance at March 31, 2006			29,911,097			$	138,292			$	(49,409	)		$	23			$	88,906				5,699,998			$	16,634

     See accompanying notes to consolidated financial statements.

NAVARRE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

		Fiscal Years ended March 31,
		2006				2005				2004
Operating activities:
Net income (loss)		$	(3,175	)		$	10,166			$	6,814
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization			9,384				3,673				2,000
Amortization of deferred financing costs			523				240				87
Write-off of acquisition costs			239				—				—
Amortization of license fees			5,334				—				—
Amortization of production costs			1,875				—				—
Change in deferred revenue			(954	)			—				—
Stock-based compensation expense			—				269				705
Deferred compensation expense			288				2,838				1,738
Compensation expense incurred with repurchase of Encore Stock			—				5,800				—
Expense related to warrant exercise			—				—				372
Write-off of notes receivable			200				200				200
Impairment of capitalized software development costs			—				465				5,588
Tax benefit from employee stock option plans			249				2,428				—
Loss on disposal of property and equipment			37				82				—
Deferred income taxes			(2,266	)			(4,771	)			(1,036	)
Change in fair market value of warrants			342				—				—
Gain on deconsolidation of variable interest entity			(1,896	)			—				—
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable			8,483				(14,459	)			(5,212	)
Inventories			(2,671	)			(10,702	)			(4,252	)
Prepaid expenses			(1,302	)			(5,925	)			(10,284	)
Income taxes receivable			(4,408	)			—				—
Other assets			143				(3,129	)			(7	)
Production costs			(3,044	)			—				—
License fees			(11,263	)			—				—
Accounts payable			(731	)			4,441				13,115
Income taxes payable			(8	)			(113	)			121
Accrued expenses			(2,684	)			5,992				(992	)
Net cash (used in) provided by operating activities			(7,305	)			(2,505	)			8,957
Investing activities:
Acquisitions, net of cash acquired			(87,085	)			—				(10,465	)
Purchases of property and equipment			(2,899	)			(9,375	)			(5,048	)
Proceeds from sale of property and equipment			—				—				60
Net proceeds from sale leaseback			—				6,401				—
Purchases of intangible assets			(644	)			(608	)			(1,246	)
Payment of earn-out related to an acquisition			(350	)			(88	)			—
Deconsolidation of variable interest entity			(18	)			—				—
Net cash used in investing activities			(90,996	)			(3,670	)			(16,699	)
Financing activities:
Proceeds from note payable, bank			—				117,197				75,930
Payments on note payable, bank			—				(117,197	)			(75,930	)
Repayment of note payable			(59,870	)			(651	)			(1,073	)
Proceeds of note payable			141,075				250				651
Debt acquisition costs			(3,071	)			(527	)			(375	)
Repayments of capital lease obligations			(91	)			(59	)			—
Proceeds from sale of common stock and warrants			18,528				—				11,735
Proceeds from exercise of common stock options and warrants			455				8,238				814
Net cash provided by financing activities			97,026				7,251				11,752
Net increase (decrease) in cash			(1,275	)			1,076				4,010
Cash at beginning of year			15,571				14,495				10,485
Cash at end of year		$	14,296			$	15,571			$	14,495
Supplemental cash flow information:
Cash paid for:
Interest		$	9,328			$	771			$	353
Income taxes			4,421				1,449				324