e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
for the quarterly period ended December 31, 2006
or
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 |
for
the transition period from ______ to ________
Commission File Number 0-22982
NAVARRE CORPORATION
(Exact name of registrant as specified in its charter)
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Minnesota
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41-1704319 |
(State or other jurisdiction of
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(IRS Employer |
incorporation or organization)
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Identification No.) |
7400 49th Avenue North, New Hope, MN 55428
(Address of principal executive offices)
Registrants telephone number, including area code (763) 535-8333
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant 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.
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
Exchange Act). o Yes þ No
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date.
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Class
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Outstanding at February 5, 2007 |
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Common Stock, No Par Value
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36,006,495 shares |
NAVARRE CORPORATION
Index
2
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements.
NAVARRE CORPORATION
Consolidated Balance Sheets
(In thousands, except share amounts)
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December 31, |
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March 31, |
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2006 |
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2006 |
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(Unaudited) |
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(Note) |
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Assets: |
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Current assets: |
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Cash and cash equivalents |
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$ |
10,732 |
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$ |
14,296 |
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Note receivable, related parties |
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50 |
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200 |
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Accounts receivable, less allowances of $19,848 and $19,345, respectively |
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135,769 |
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87,653 |
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Inventories |
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49,024 |
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43,624 |
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Prepaid expenses and other current assets |
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16,779 |
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11,273 |
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Income tax receivable |
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4,408 |
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Deferred tax assets current |
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9,684 |
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8,830 |
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Total current assets |
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222,038 |
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170,284 |
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Property and equipment, net of accumulated depreciation of $10,561 and
$8,349, respectively |
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12,259 |
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10,298 |
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Other assets: |
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Goodwill |
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81,697 |
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81,202 |
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Intangible assets, net of amortization of $14,117 and $8,258, respectively |
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16,082 |
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20,863 |
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License fees, net of amortization of $10,630 and $5,334, respectively |
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15,512 |
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13,347 |
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Interest rate swap |
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67 |
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37 |
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Other assets |
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12,817 |
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13,583 |
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Total assets |
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$ |
360,472 |
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$ |
309,614 |
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Liabilities and shareholders equity: |
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Current liabilities: |
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Note payable short term |
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$ |
5,000 |
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$ |
5,000 |
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Capital lease obligation short term |
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106 |
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115 |
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Accounts payable |
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146,225 |
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97,923 |
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Warrant liability |
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2,236 |
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Income taxes payable |
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1,564 |
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Accrued expenses |
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13,779 |
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16,646 |
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Total current liabilities |
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166,674 |
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121,920 |
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Long-term liabilities: |
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Note payable long-term |
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71,380 |
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75,130 |
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Capital lease obligation long-term |
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146 |
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222 |
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Deferred compensation |
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6,083 |
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5,272 |
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Deferred tax liabilities non-current |
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163 |
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770 |
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Other long-term liabilities |
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760 |
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760 |
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Total liabilities |
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245,206 |
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204,074 |
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Commitments and contingencies (Note 21) |
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Temporary equity unregistered common stock, no par value; 5,699,998 issued
and outstanding (Note 18) |
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16,634 |
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Shareholders equity: |
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Common stock, no par value: |
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Authorized shares 100,000,000 |
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Issued and outstanding shares 36,004,895 and 29,911,097, respectively |
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158,338 |
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138,292 |
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Accumulated other comprehensive income |
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41 |
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23 |
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Accumulated deficit |
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(43,113 |
) |
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(49,409 |
) |
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Total shareholders equity |
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115,266 |
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88,906 |
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Total liabilities and shareholders equity |
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$ |
360,472 |
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$ |
309,614 |
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Note: The balance sheet at March 31, 2006 has been derived from the audited consolidated financial
statements at that date but does not include all of the information and footnotes required by
accounting principles generally accepted in the United States of America for complete consolidated
financial statements.
See accompanying notes to consolidated financial statements.
3
NAVARRE CORPORATION
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
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Three Months Ended |
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Nine Months Ended |
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December 31, |
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December 31, |
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2006 |
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2005 |
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2006 |
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2005 |
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Net sales |
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$ |
210,248 |
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$ |
214,841 |
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$ |
529,736 |
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$ |
514,259 |
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Cost of sales (exclusive of depreciation and amortization) |
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174,982 |
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186,614 |
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438,475 |
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432,762 |
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Gross profit |
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35,266 |
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28,227 |
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91,261 |
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81,497 |
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Operating expenses: |
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Selling and marketing |
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8,075 |
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7,819 |
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22,743 |
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22,040 |
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Distribution and warehousing |
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3,988 |
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3,067 |
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9,371 |
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7,500 |
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General and administrative |
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11,616 |
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11,321 |
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31,770 |
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32,835 |
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Bad debt expense |
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52 |
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12,259 |
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2,871 |
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12,308 |
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Depreciation and amortization |
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2,792 |
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|
3,101 |
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8,099 |
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8,273 |
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Total operating expenses |
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26,523 |
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37,567 |
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74,854 |
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82,956 |
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Income (loss) from operations |
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8,743 |
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(9,340 |
) |
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16,407 |
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(1,459 |
) |
Other income (expense): |
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Interest expense |
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(2,061 |
) |
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(2,983 |
) |
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(5,988 |
) |
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(8,179 |
) |
Interest income |
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42 |
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251 |
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|
601 |
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Warrant expense |
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(251 |
) |
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Deconsolidation of variable interest entity |
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|
1,896 |
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1,896 |
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Other income (expense), net |
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(163 |
) |
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4 |
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(107 |
) |
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383 |
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Net income (loss) before income tax |
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6,561 |
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(10,423 |
) |
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|
10,312 |
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(6,758 |
) |
Income tax (expense) benefit |
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(2,510 |
) |
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4,355 |
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(4,016 |
) |
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2,521 |
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Net income (loss) |
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$ |
4,051 |
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|
$ |
(6,068 |
) |
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$ |
6,296 |
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$ |
(4,237 |
) |
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Earnings (loss) per common share: |
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Basic |
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$ |
.11 |
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$ |
(.20 |
) |
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$ |
.18 |
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$ |
(.14 |
) |
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Diluted |
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$ |
.11 |
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|
$ |
(.20 |
) |
|
$ |
.17 |
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$ |
(.14 |
) |
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Weighted average shares outstanding: |
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Basic |
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35,868 |
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29,893 |
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35,750 |
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29,563 |
|
Diluted |
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36,271 |
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|
29,893 |
|
|
|
36,205 |
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|
29,563 |
|
See accompanying notes to consolidated financial statements.
4
NAVARRE CORPORATION
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
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Nine Months Ended |
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December 31, |
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2006 |
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2005 |
|
Operating activities: |
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|
Net income
(loss) |
|
$ |
6,296 |
|
|
$ |
(4,237 |
) |
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
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Depreciation and amortization |
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|
8,182 |
|
|
|
8,371 |
|
Amortization and write-off of deferred financing costs |
|
|
447 |
|
|
|
619 |
|
Deferred compensation expense |
|
|
811 |
|
|
|
216 |
|
Write-off of notes receivable |
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|
150 |
|
|
|
150 |
|
Amortization of license fees |
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|
5,295 |
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|
4,036 |
|
Amortization of production costs |
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1,771 |
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|
|
1,139 |
|
Share-based compensation expense |
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|
520 |
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|
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|
Tax benefit from employee stock option plans |
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|
114 |
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|
233 |
|
Gain on disposal of fixed assets |
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(16 |
) |
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|
(2 |
) |
Change in deferred revenue |
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|
610 |
|
|
|
(480 |
) |
Deferred income taxes |
|
|
(1,475 |
) |
|
|
(1,487 |
) |
Loss on derivative instruments |
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|
1 |
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|
15 |
|
Gain on deconsolidation of variable interest entity |
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|
|
|
|
|
(1,896 |
) |
Change in fair market value of warrants |
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|
251 |
|
|
|
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|
Changes in operating assets and liabilities, net of effects of acquisitions: |
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|
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|
Accounts receivable |
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|
(48,260 |
) |
|
|
(21,113 |
) |
Inventories |
|
|
(5,400 |
) |
|
|
(10,610 |
) |
Prepaid expenses |
|
|
(5,427 |
) |
|
|
(2,789 |
) |
Income taxes receivable |
|
|
4,408 |
|
|
|
(5,678 |
) |
Other assets |
|
|
1,305 |
|
|
|
151 |
|
Production costs |
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|
(2,777 |
) |
|
|
(1,570 |
) |
License fees |
|
|
(7,460 |
) |
|
|
(8,267 |
) |
Accounts payable |
|
|
48,302 |
|
|
|
27,409 |
|
Income taxes payable |
|
|
1,564 |
|
|
|
(8 |
) |
Accrued expenses |
|
|
(3,477 |
) |
|
|
(1,121 |
) |
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|
Net cash provided by (used in) operating activities |
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|
5,735 |
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(16,919 |
) |
Investing activities: |
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Acquisitions, net of cash acquired |
|
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|
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|
(98,147 |
) |
Purchases of property and equipment |
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(4,232 |
) |
|
|
(1,411 |
) |
Purchases of intangible assets |
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(1,148 |
) |
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|
(360 |
) |
Payment of earn-out related to an acquisition |
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|
(350 |
) |
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|
(350 |
) |
Other |
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|
51 |
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|
|
(55 |
) |
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|
|
|
|
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Net cash used in investing activities |
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|
(5,679 |
) |
|
|
(100,323 |
) |
Financing activities: |
|
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|
|
|
|
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|
Proceeds from note payable, line of credit |
|
|
44,297 |
|
|
|
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|
Payments on note payable, line of credit |
|
|
(44,297 |
) |
|
|
|
|
Payments on note payable |
|
|
(3,750 |
) |
|
|
(22,500 |
) |
Proceeds from note payable |
|
|
|
|
|
|
141,075 |
|
Debt acquisition costs |
|
|
(75 |
) |
|
|
(2,921 |
) |
Other |
|
|
(131 |
) |
|
|
|
|
Repayments of capital lease obligations |
|
|
(85 |
) |
|
|
(66 |
) |
Proceeds from exercise of common stock options and warrants |
|
|
421 |
|
|
|
484 |
|
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities |
|
|
(3,620 |
) |
|
|
116,072 |
|
|
|
|
|
|
|
|
Net decrease in cash |
|
|
(3,564 |
) |
|
|
(1,170 |
) |
Cash at beginning of period |
|
|
14,296 |
|
|
|
15,571 |
|
|
|
|
|
|
|
|
Cash at end of period |
|
$ |
10,732 |
|
|
$ |
14,401 |
|
|
|
|
|
|
|
|
Supplemental cash flow information: |
|
|
|
|
|
|
|
|
Cash paid for: |
|
|
|
|
|
|
|
|
Interest |
|
$ |
7,229 |
|
|
$ |
5,365 |
|
Income taxes, net of refunds |
|
|
(595 |
) |
|
|
4,421 |
|
Supplemental schedule of non-cash investing and financing activities: |
|
|
|
|
|
|
|
|
Reclassification of acquisition costs from other assets to goodwill |
|
|
|
|
|
|
1,656 |
|
Capital lease obligations incurred for the purchase of computer equipment |
|
|
|
|
|
|
84 |
|
Reclassification of prepaid royalties to other assets |
|
|
|
|
|
|
5,488 |
|
Purchase price adjustments affecting: accounts receivable and goodwill |
|
|
145 |
|
|
|
|
|
Reclassification
of warrant accrual and temporary equity to common stock |
|
|
19,120 |
|
|
|
|
|
Acquisition: |
|
|
|
|
|
|
|
|
Fair value of assets acquired |
|
$ |
|
|
|
$ |
125,135 |
|
Less: Liabilities assumed |
|
|
|
|
|
|
8,705 |
|
Fair value of stock issued |
|
|
|
|
|
|
14,144 |
|
Cash acquired |
|
|
|
|
|
|
4,139 |
|
|
|
|
|
|
|
|
Acquisition net of cash acquired |
|
$ |
|
|
|
$ |
98,147 |
|
|
|
|
|
|
|
|
Deconsolidation of variable interest entity: |
|
|
|
|
|
|
|
|
Assets, including cash |
|
$ |
|
|
|
$ |
641 |
|
Less: Liabilities |
|
|
|
|
|
|
2,537 |
|
|
|
|
|
|
|
|
Net Liabilities |
|
$ |
|
|
|
$ |
1,896 |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
5
NAVARRE CORPORATION
Notes to Consolidated Financial Statements
(Unaudited)
Note 1 Organization and Basis of Presentation
Navarre Corporation (the Company or Navarre), a Minnesota corporation formed in 1983,
publishes and distributes physical and digital home entertainment and multimedia products,
including PC software, CD audio, DVD video, video games and accessories. The business is divided
into two business segments distribution and publishing. Through these business segments, the
Company maintains and leverages strong relationships throughout the publishing and distribution
chain. In fiscal 2006, the Company had a third segment titled other and included the operations
of a variable interest entity, which was deconsolidated during the third quarter of fiscal 2006 as
further discussed in Note 3.
The accompanying unaudited consolidated financial statements of Navarre Corporation have been
prepared in accordance with accounting principles generally accepted in the United States of
America for interim financial information and with the instructions to Form 10-Q and Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete consolidated financial
statements. The accompanying unaudited consolidated financial statements for the three and nine
months ended December 31, 2005 include the consolidation of the variable interest entity (VIE),
Mix & Burn, Inc. (Mix & Burn).
All intercompany accounts and transactions have been eliminated. In the opinion of management,
all adjustments (consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Because of the seasonal nature of the Companys business, the
operating results for the three and nine month periods ended December 31, 2006 are not necessarily
indicative of the results that may be expected for the fiscal year ending March 31, 2007. For
further information, refer to the consolidated financial statements and footnotes thereto included
in Navarre Corporations Annual Report on Form 10-K for the year ended March 31, 2006.
Certain fiscal year 2006 amounts have been reclassified to conform to the fiscal year 2007
presentation.
Segment Reporting
The Companys current presentation of segment data consists of two operating and reportable
segments distribution and publishing. In fiscal 2006, the Companys presentation included a third
operating and reportable segment titled other. The other segment consisted of the variable
interest entity, Mix & Burn, which was deconsolidated in December 2005. In light of the
deconsolidation of Mix & Burn, the Company re-evaluated its application of Financial Accounting
Standards Board (FASB) Statement 131, Disclosure about Segments of an Enterprise and Related Information, (SFAS 131) and
revised its operations and reportable segments to historical presentation before the inclusion of
the other segment.
Revenue Recognition
Revenue on products shipped is recognized when title and risk of loss transfers, delivery has
occurred, the price to the buyer is determinable and collectibility is reasonably assured. Service
revenues are recognized upon delivery of the services. Service revenues represented less than 10%
of total net sales for the three and nine months ended December 31, 2006 and December 31, 2005. The
Company, under specific conditions, permits its customers to return products. The Company records a
reserve for sales returns and other allowances against amounts due in order to reduce the net
recognized receivables to the amounts the Company reasonably believes will be collected. These
reserves are established based on the application of the Companys historical gross profit percent
against average sales returns, sales discounts percent against average gross sales and specific
reserves for marketing programs.
The Companys distribution customers at times qualify for certain price protection benefits
from the Companys vendors. The Company serves as an intermediary to settle these amounts between
vendors and customers. The Company accounts for these amounts as reductions of revenues with
corresponding reductions in cost of sales.
The Companys publishing business at times provides certain price protection, promotional
funds, volume rebates and other incentives to customers. The Company records these amounts as
reductions in revenue.
6
FUNimation Productions, Ltd. and the FUNimation Store, Ltd. (FUNimation) revenue is
recognized upon meeting the recognition requirements of American Institute of Certified Public
Accountants Statement of Position (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 Companys customers (generally upon
receipt by 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. Revenues
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 at the time of sale.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R (SFAS 123R), Share-Based Payment. SFAS No.
123R requires the recognition of compensation cost relating to share-based payment transactions in
financial statements. That cost is measured based on fair value of the equity instruments or liability instruments issued as of the grant date,
based on the estimated number of awards that are expected to vest. SFAS 123R covers a wide range of
share-based compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights, and employee share purchase plans. Statement
123R replaces FASB Statement 123, Accounting for Stock-Based Compensation, and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees. The original effective date for Statement
123R was fiscal 2006. However, in April 2005, the Securities and Exchange Commission (SEC) adopted
a new rule that amended the effective date for SFAS No. 123R. The Company adopted SFAS No. 123R
effective April 1, 2006 using the modified prospective method. The impact of adopting this Standard
is discussed in Note 4, Share-Based Compensation.
In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for
Uncertainty in Income Taxes an Interpretation of FASB Statement 109. FIN 48 prescribes a
comprehensive model for recognizing, measuring, presenting and disclosing in the financial
statements tax positions taken or expected to be taken on a tax return, including the decision
whether to file or not to file in a particular jurisdiction. FIN 48 is effective for fiscal years
beginning after December 15, 2006 (April 1, 2007 for the
Company). If there are changes in net assets as a result of the
application of FIN 48, these will be accounted for as an adjustment to retained earnings. The
Company is currently assessing the impact of FIN 48 on its consolidated financial position and
results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS
No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring
use of fair value, establishes a framework for measuring fair value, and expands disclosure about
such fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15,
2007. The Company is currently assessing the impact of SFAS 157 on its consolidated financial
position and results of operations.
In September 2006, the FASB issued FASB Staff Position (FSP) AUG AIR-1, Accounting for
Planned Major Maintenance Activities (FSP AUG AIR-1). FSP AUG AIR-1 amends the guidance on the
accounting for planned major maintenance activities; specifically it precludes the use of the
previously acceptable accrue in advance method. FSP AUG AIR-1 is effective for fiscal years
beginning after December 15, 2006. The Company believes the implementation of this standard will
not have a material impact on the consolidated financial position or results of operations.
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) 108, Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements (SAB 108). SAB 108 requires that public companies utilize a dual-approach to assessing
the quantitative effects of financial misstatements. This dual approach includes both an income
statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must
be applied to annual financial statements for fiscal years ending after November 15, 2006. The
Company is currently assessing the impact of adopting SAB 108 but does not expect that it will have a material
effect on the consolidated financial position or results of operations.
7
Note 2 Acquisitions
FUNimation
On May 11, 2005, the Company completed the acquisition of 100% of the general and limited
partnership interests of FUNimation, a leading home video distributor and licensor of Japanese
animation (anime) and childrens entertainment in the United States. The acquisition of
FUNimation was a continuation of the Companys strategy for growth by expanding content ownership
and gross margin enhancement. The purchase price consisted of $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 the Companys common stock. In addition, during the five-year
period following the closing of the transaction, the Company may pay up to an additional $17.0
million in cash if certain financial targets are met, which amount will be included as part of the
purchase price and thus increase goodwill in subsequent periods. During February 2006, the Company
came to an agreement with the FUNimation sellers which resulted in the Company receiving a purchase
price adjustment of $11.1 million in cash in exchange for a broad release of all claims that the
Company might have against sellers.
Purchase Price
The purchase price was allocated to the underlying assets and liabilities based on their
estimated fair values. The acquisition was accounted for using the purchase method in accordance
with FASB No. 141, Business Combinations. Accordingly, the net assets were recorded at their
estimated fair values and operating results were included in the Companys consolidated financial
statements from the date of acquisition.
The purchase price allocation resulted in goodwill of $71.2 million, intangibles of $1.5
million related to a trademark, which will not be amortized and other intangibles of $20.1 million
related to license and distribution arrangements, which will be amortized over a period between
five to seven and one half years, based on revenue streams.
The purchase price allocation is as follows (in thousands):
|
|
|
|
|
Accounts receivable
|
|
$ |
7,052 |
|
Inventories
|
|
|
315 |
|
Prepaid expenses and other current assets
|
|
|
53 |
|
Property and equipment
|
|
|
2,037 |
|
License fees
|
|
|
7,125 |
|
Production costs
|
|
|
2,608 |
|
Goodwill
|
|
|
71,165 |
|
License arrangements and other intangibles
|
|
|
21,646 |
|
Current liabilities
|
|
|
(9,116 |
) |
|
|
|
|
Total purchase price, less cash acquired
|
|
$ |
102,885 |
|
|
|
|
|
The results of FUNimation have been included in the consolidated financial statements since
the date of acquisition of May 11, 2005. Unaudited pro forma results of operations
for the nine months ended December 31, 2005 are included below. Such pro forma information
assumes that the above acquisition had occurred as of April 1, 2005. This summary is not
necessarily indicative of what the Companys results of operations would have been had the
companies been a combined entity during the nine months ended December 31, 2005, nor does it
represent results of operations for any future periods. Pro forma adjustments consist primarily of
interest expense and amortization expense:
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
December 31, 2005 |
|
|
|
As reported |
|
|
Pro forma |
|
Net sales |
|
$ |
514,259 |
|
|
$ |
520,334 |
|
Net income |
|
|
(4,237 |
) |
|
|
(3,162 |
) |
Earnings per common share: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
(.14 |
) |
|
$ |
(.11 |
) |
|
|
|
|
|
|
|
Diluted |
|
$ |
(.14 |
) |
|
$ |
(.11 |
) |
|
|
|
|
|
|
|
8
Note 3 Mix & Burn
Variable Interest Entity
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities (FIN 46(R)). FIN 46(R), along with its related
interpretations, clarifies the application of Accounting Research Bulletin No. 51, Consolidated
Financial Statements, to certain entities in which equity investors do not have the characteristics
of a controlling financial interest or do not have sufficient equity at risk for the entity to
finance activities without additional subordinated financial support. FIN 46(R) clarifies how
companies should identify a VIE, assess whether they have a variable interest in that entity, and
determine the primary beneficiary from among the variable interest holders to conclude as to which
entity should consolidate the assets, liabilities, non-controlling interests and results of
activities of a VIE in its consolidated financial statements. A company that absorbs a majority of
a VIEs expected residual losses, returns, or both, is the primary beneficiary and is required to
consolidate the VIEs financial results into its consolidated financial statements. FIN 46(R) also
requires disclosure of certain information where the reporting company is the primary beneficiary
or holds significant variable interests in a VIE but is not the primary beneficiary.
The Company adopted FIN 46(R) with respect to its investment in Mix & Burn during the quarter
ended December 31, 2003. During the quarter ended December 31, 2005, the Company deconsolidated Mix
& Burn, as the Company was deemed to no longer be the primary beneficiary. A reconsideration event
was caused by additional funding Mix & Burn received from a third party.
Mix & Burns financial results were consolidated with those of the Company for the period
December 31, 2003 through the deconsolidation date, December 1, 2005. Mix & Burn had net sales of
$169,000 and $424,000 for the three and nine months ended December 31, 2005, which are included in the consolidated financial statements. Mix & Burn had
net operating losses of $487,000 and $1.6 million for the three and nine months ended December 31,
2005. Mix & Burn had a $2.5 million note payable to the Company, which was written off through
deconsolidation during the three months ended December 31, 2005.
Investment
The Company owned a 45% equity interest in Mix & Burn through March 16, 2006. As of December
31, 2006 and March 31, 2006 the Company owned a 7% interest in Mix & Burn and accounts for the
investment under the cost method. At December 31, 2006 and March 31, 2006 this investment was
recorded at zero due to the continued losses experienced by Mix & Burn, which exceeded the
Companys loans and equity investments in Mix & Burn.
Note 4 Share-Based Compensation
Effective April 1, 2006, the start of the first quarter of fiscal 2007, the Company began
recording compensation expense associated with equity compensation awards over the vesting period
based on their grant date fair value in accordance with SFAS 123R as interpreted by SEC Staff
Accounting Bulletin 107. SFAS 123R supersedes APB 25 and SFAS No. 95, Statement of Cash Flows.
Generally, the approach in SFAS 123R is similar to the approach described in SFAS No. 123,
Accounting for Stock-Based Compensation (SFAS 123). However, SFAS 123R requires all share-based
payments to employees and non-employee directors, including grants of employee stock options, to be
recognized in the statement of operations based on their fair values at the date of grant.
Prior to the adoption of SFAS 123R, the Company utilized the intrinsic-value based method of
accounting under APB 25 and related interpretations, and adopted the disclosure requirements of
SFAS 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation Transitional
Disclosure. Under the intrinsic-value based method of accounting, compensation expense for stock
options granted to the Companys employees and non-employee directors was measured as the excess of
the quoted market price of common stock at the grant date over the exercise price the employee and
non-employee directors must pay for the stock. The Companys policy is to grant stock options with
exercises prices equal to the market price of common stock on the date of grant and as a result no
compensation expense was historically recognized for stock options.
The Company adopted the modified prospective transition method provided for under SFAS 123R,
and consequently has not retroactively adjusted results from prior periods. Under this transition
method, compensation cost associated with share-based awards recognized in the nine months of
fiscal year 2007 include: (a) compensation costs for all share-based payments granted prior to, but
not yet vested as of March 31, 2006, based on the grant-date fair value estimated in accordance
with the provisions of SFAS 123, and (b) compensation cost for all share-based payments granted
subsequent to March 31, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS
123R.
9
On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123R-3, Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards. The Company is considering
whether to adopt the alternative transition method provided in the FASB Staff Position for
calculating the tax effects of stock-based compensation pursuant to SFAS 123R. The alternative
transition method includes simplified methods to establish the beginning balance of the additional
paid-in capital pool (APIC pool) related to the tax effects of employee and non-employee
directors share-based compensation, and to determine the subsequent impact on the APIC pool and
consolidated statements of cash flows of the tax effects of employee and non-employee directors
share-based compensation awards that are outstanding upon adoption of SFAS 123R.
Equity Compensation Plans
The Company currently grants stock options, restricted stock and restricted stock units under
equity compensation plans.
The Company adopted the 1992 Stock Option Plan and 2004 Stock Option Plan (together, the
Plans) to attract and retain persons to perform services for the Company by providing an
incentive to these persons through equity participation in the Company and by rewarding such
persons who contribute to the achievement of the Companys economic objectives. Eligible recipients
are all employees including, without limitation, officers and directors who are also employees as
well as non-employee directors, consultants and independent contractors or employees of any of the
Companys subsidiaries. A maximum number of 5.2 million shares and 2.5 million 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 of
Directors and the shareholders. The 1992 Stock Option Plan terminated in July 2006 and the 2004
Stock Option Plan terminates in September 2014. There are 459,000 shares remaining for grant under
the 2004 Stock Option Plan at December 31, 2006.
The Company is authorized to grant, among other equity instruments, stock options and
restricted stock grants under the 2004 Stock Option Plan. Stock options have a maximum term fixed
by the Compensation Committee of the Board of Directors, 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 of the Board of Directors. Vesting for performance-based stock awards is
subject to the performance criteria being achieved.
On April 1 of each year, each director who is not an employee of the Company is granted an
option to purchase 6,000 shares of common stock under the 2004 Stock Option Plan, with an exercise
price equal to fair market value. These options are designated as non-qualified stock options. Each 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 33 1/3% 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 Companys mandatory director
retirement policy.
The Company is 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 the Company), 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 the Company before taking any action with respect to an option or a
restricted stock award.
Restricted stock awards are non-vested stock awards that may include grants of restricted
stock or restricted stock units. Restricted stock awards are independent of option grants and are
generally subject to forfeiture if employment terminates prior to the release of the restrictions.
Such awards vest as determined by the Compensation Committee of the Board of Directors, depending
on the grant. Prior to vesting, ownership of the shares cannot be transferred. The Company expenses
the cost of the restricted stock awards, which is the grant date fair value, ratably over the
period during which the restrictions lapse. The grant date fair value is the Companys opening
stock price on the date of grant.
10
Stock Options
Option activity for the Plans for the nine months ended December 31, 2006 is summarized
as follows (in thousands, except options, contractual term and exercise price amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
average |
|
|
|
|
|
|
|
|
|
|
average |
|
|
remaining |
|
|
Aggregate |
|
|
|
Number of |
|
|
exercises |
|
|
contractual |
|
|
intrinsic |
|
|
|
options |
|
|
price |
|
|
term |
|
|
value |
|
Options outstanding, March 31, 2006: |
|
|
3,341,100 |
|
|
$ |
7.17 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
803,000 |
|
|
$ |
4.83 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(267,800 |
) |
|
$ |
1.57 |
|
|
|
|
|
|
|
|
|
Canceled |
|
|
(183,200 |
) |
|
$ |
9.16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding, December 31, 2006 |
|
|
3,693,100 |
|
|
$ |
6.97 |
|
|
|
6.0 |
|
|
$ |
1,584 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at December 31, 2006 |
|
|
2,633,500 |
|
|
$ |
8.13 |
|
|
|
5.2 |
|
|
$ |
1,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares available for future grant |
|
|
459,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
The total intrinsic value of stock options exercised during the nine months ended December 31,
2006 was $649,000. The aggregate intrinsic value in the preceding table represents the total
pre-tax intrinsic value, based on the Companys closing stock price of $3.98 as of December 31,
2006, which theoretically could have been received by the option holders had all option holders
exercised their options as of that date. The total number of in-the-money options exercisable as of
December 31, 2006 was 429,500.
As of December 31, 2006, total compensation cost related to non-vested stock options not yet
recognized was $2.1 million, which amount is expected to be recognized over the next 1.50 years on
a weighted-average basis.
During the nine months ended December 31, 2006, the Company received cash from the exercise of
stock options totaling $421,000.
Restricted Stock
Restricted stock granted to employees presently has a vesting period of one year and expense
is recognized on a straight-line basis over the vesting period, or when the performance criteria
has been met. The value of the restricted stock is established by the market price on the date of
the grant or if based on performance criteria, on the date which it is determined the performance
criteria will be met. Restricted stock award vesting is based on service criteria or achievement of
performance targets. All restricted stock awards are settled in shares of common stock.
A summary of the Companys restricted stock activity for the nine months ended December 31,
2006 is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Weighted |
|
|
average |
|
|
|
|
|
|
|
average |
|
|
remaining |
|
|
|
|
|
|
|
grant date |
|
|
contractual |
|
|
|
Shares |
|
|
fair value |
|
|
term |
|
Unvested, March 31, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
151,000 |
|
|
$ |
4.66 |
|
|
|
1.18 |
|
Vested |
|
|
(6,000 |
) |
|
$ |
4.29 |
|
|
|
|
|
Forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested, December 31, 2006 |
|
|
145,000 |
|
|
$ |
4.68 |
|
|
|
1.18 |
|
|
|
|
|
|
|
|
|
|
|
The total fair value of shares vested during the nine months ended December 31, 2006 was
approximately $26,000. The weighted average fair value of restricted stock units granted for the
nine months ended December 31, 2006 was $4.66.
As of December 31, 2006 total compensation cost related to non-vested restricted stock awards
not yet recognized was $452,000 which is expected to be recognized over the next 1.18 years on a
weighted-average basis.
11
Restricted Stock Units
On April 1, 2006, the Company awarded restricted stock units to certain key employees.
Receipt of the stock units is contingent upon the Company meeting Total Shareholder Return (TSR)
relative to an external market condition and meeting the service condition. Each participant was
granted a base number of units. The units, as determined at the end of the performance year (fiscal
2007), will be issued at the end of the third year (fiscal 2009) if the Companys average TSR
target is achieved for the fiscal period 2007 through 2009. The total number of base units granted
for fiscal 2007 was 66,000. The amount expensed for the nine months ended December 31, 2006 was
$85,000, based upon the number of units granted.
The restricted stock units calculated estimated fair value is based upon the closing market
price on the last trading day preceding the date of award and is charged to earnings on a
straight-line basis over the three year period. After vesting, the restricted stock units will be
settled by the issuance of Company common stock certificates in exchange for the restricted stock
units.
Valuation and Expense Information Under SFAS 123R
The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value
of an award. The fair value of options granted during the three and nine months ended December 31,
2006, were calculated using the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
|
Ended |
|
|
Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2006 |
|
Expected life (in years) |
|
|
5.0 |
|
|
|
5.0 |
|
Expected volatility |
|
|
69 |
% |
|
|
69 |
% |
Risk-free interest rate |
|
|
4.55 |
% |
|
|
4.60 |
% |
Expected dividend yield |
|
|
0.0 |
% |
|
|
0.0 |
% |
Weighted-average fair value of grants |
|
$ |
3.00 |
|
|
$ |
2.94 |
|
Expected life uses historical employee exercise and option expiration data to estimate the
expected life assumption for the Black-Scholes grant-date valuation. The Company believes that this
historical data is currently the best estimate of the expected term of a new option. The Company
uses a weighted-average expected life for all awards. As part of its SFAS 123R adoption, the
Company examined its historical pattern of option exercises in an effort to determine if there were
any discernable activity patterns based on certain employee populations. From this analysis, the
Company identified one employee population. Expected volatility uses the Company stocks historical
volatility for the same period of time as the expected life. The Company has no reason to believe
that its future volatility will differ from the past. The risk-free interest rate is based on the
U.S. Treasury rate in effect at the time of the grant for the same period of time as the expected
life. Expected dividend yield is zero, as the Company historically has not paid dividends.
Share-based compensation expense related to employee stock options, restricted stock and
restricted stock units under SFAS 123R for the three and nine months ended December 31, 2006 was
$220,000 and $520,000, respectively, and was included in general and administrative expenses in the
consolidated statements of operations. No amount of share-based compensation was capitalized. The
impact of applying SFAS 123R is as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
|
Ended |
|
|
Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2006 |
|
General and administrative expenses |
|
$ |
(220 |
) |
|
$ |
(520 |
) |
|
|
|
|
|
|
|
Share-based compensation expense before income taxes |
|
|
(220 |
) |
|
|
(520 |
) |
Tax benefit |
|
|
84 |
|
|
|
203 |
|
|
|
|
|
|
|
|
Share-based compensation after income taxes |
|
|
(136 |
) |
|
|
(317 |
) |
|
|
|
|
|
|
|
Effect on earnings (loss) per share: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
.00 |
|
|
$ |
(.01 |
) |
|
|
|
|
|
|
|
Diluted |
|
$ |
.00 |
|
|
$ |
(.01 |
) |
|
|
|
|
|
|
|
12
Pro Forma Information Under SFAS 123 for Periods Prior to Fiscal 2007
The following table details the effect on net loss and loss per share had share-based
compensation expense been recorded for the three and nine months ended December 31, 2005 based on
the fair-value method under SFAS 123. The reported and pro forma net income and earnings per share
for the three and nine months ended December 31, 2006 are the same, since share-based compensation
expense was calculated under the provisions of SFAS 123R.
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
|
Ended |
|
|
Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2005 |
|
|
2005 |
|
Net loss, as reported |
|
$ |
(6,068 |
) |
|
$ |
(4,237 |
) |
Deduct: Share-based compensation expense
determined under fair value based method
for all awards, net of related taxes |
|
|
(499 |
) |
|
|
(1,293 |
) |
|
|
|
|
|
|
|
Pro forma net loss |
|
$ |
(6,567 |
) |
|
$ |
(5,530 |
) |
|
|
|
|
|
|
|
Basic loss per share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
(.20 |
) |
|
$ |
(.14 |
) |
|
|
|
|
|
|
|
Pro forma |
|
$ |
(.22 |
) |
|
$ |
(.19 |
) |
|
|
|
|
|
|
|
Diluted loss per share: |
|
|
|
|
|
|
|
|
As reported |
|
$ |
(.20 |
) |
|
$ |
(.14 |
) |
|
|
|
|
|
|
|
Pro forma |
|
$ |
(.22 |
) |
|
$ |
(.19 |
) |
|
|
|
|
|
|
|
The fair value of options granted in the three months ended December 31, 2005 were estimated
at the date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions:
|
|
|
|
|
|
|
Three Months |
|
|
|
Ended |
|
|
|
December 31, |
|
|
|
2005 |
|
Expected life (in years) |
|
|
5.0 |
|
Expected volatility |
|
|
66 |
% |
Risk-free interest rate |
|
|
4.46 |
% |
Expected dividend yield |
|
|
0.0 |
% |
Weighted-average fair value of grants |
|
$ |
2.99 |
|
Note 5 Earnings Per Share
The following table sets forth the computation of basic and diluted earnings (loss) per share:
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
4,051 |
|
|
$ |
(6,068 |
) |
|
$ |
6,296 |
|
|
$ |
(4,237 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per
shareweighted-average shares |
|
|
35,868 |
|
|
|
29,893 |
|
|
|
35,750 |
|
|
|
29,563 |
|
Equivalent shares from share-based compensation plans |
|
|
403 |
|
|
|
|
|
|
|
455 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per shareadjusted
weighted-average shares |
|
|
36,271 |
|
|
|
29,893 |
|
|
|
36,205 |
|
|
|
29,563 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income (loss) per share |
|
$ |
.11 |
|
|
$ |
(.20 |
) |
|
$ |
.18 |
|
|
$ |
(.14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Dilutive income (loss) per share |
|
$ |
.11 |
|
|
$ |
(.20 |
) |
|
$ |
.17 |
|
|
$ |
(.14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Share-based compensation awards for which total employee proceeds, including unrecognized
compensation, exceed the average market price over the applicable period have an anti-dilutive
effect on earnings per share, and accordingly, are excluded from the calculation of diluted
earnings per share. Share-based compensation awards of 2.8 million and 2.5 million shares for the
three and nine
13
month periods ended December 31, 2006, respectively, were excluded from the diluted
earnings per share calculation as they were anti-dilutive. Share-based compensation awards of 2.2
million and 1.4 million shares for the three and nine month periods ended December 31, 2005,
respectively, were excluded from the diluted earnings per share calculation as they were
anti-dilutive.
The effect of the inclusion of warrants for the three and nine months ended December 31, 2006
would have been anti-dilutive. Approximately 1.6 million warrants were excluded for both the three
and nine month periods ended December 31, 2006, respectively, because the exercise prices of the
warrants was greater than the average price of the Companys common stock and therefore their
inclusion would have been anti-dilutive. There were no warrants issued or outstanding for the three
and nine months ended December 31, 2005.
Note 6 Comprehensive Income (Loss)
Other comprehensive income (loss) pertains to net unrealized gains and losses on derivatives
used to hedge interest rates on bank debt that are not included in net income (loss) but rather are
recorded directly in shareholders equity (see further discussion in Note 17).
(In thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net income (loss) |
|
$ |
4,051 |
|
|
$ |
(6,068 |
) |
|
$ |
6,296 |
|
|
$ |
(4,237 |
) |
Net unrealized gain (loss) on hedge derivatives, net of tax |
|
|
(18 |
) |
|
|
609 |
|
|
|
18 |
|
|
|
(320 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss) |
|
$ |
4,033 |
|
|
$ |
(5,459 |
) |
|
$ |
6,314 |
|
|
$ |
(4,557 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in other comprehensive income (loss) are primarily non-cash items.
Accumulated other comprehensive income (loss) balances, net of tax effects, were as follows
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Unrealized gain (loss) from: |
|
|
|
|
|
|
|
|
Hedge derivatives |
|
$ |
41 |
|
|
$ |
23 |
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss) |
|
$ |
41 |
|
|
$ |
23 |
|
|
|
|
|
|
|
|
Note 7 Shareholders Equity
The Company has 10,000,000 shares of preferred stock, no par value, which is authorized. No
preferred shares are issued or outstanding.
Note 8 Accounts Receivable
Accounts receivable consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Trade receivables |
|
$ |
150,737 |
|
|
$ |
102,722 |
|
Vendor receivables |
|
|
3,256 |
|
|
|
2,623 |
|
Other receivables |
|
|
1,624 |
|
|
|
1,653 |
|
|
|
|
|
|
|
|
|
|
$ |
155,617 |
|
|
$ |
106,998 |
|
Less: allowance for doubtful accounts, vendor receivables and sales discounts |
|
|
8,247 |
|
|
|
6,544 |
|
Less: allowance for sales returns, net margin impact |
|
|
11,601 |
|
|
|
12,801 |
|
|
|
|
|
|
|
|
Total |
|
$ |
135,769 |
|
|
$ |
87,653 |
|
|
|
|
|
|
|
|
14
Note 9 Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Prepaid royalties |
|
$ |
14,995 |
|
|
$ |
10,060 |
|
Other |
|
|
1,784 |
|
|
|
1,213 |
|
|
|
|
|
|
|
|
Total |
|
$ |
16,779 |
|
|
$ |
11,273 |
|
|
|
|
|
|
|
|
Note 10 Inventories
Inventories consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Finished products |
|
$ |
37,693 |
|
|
$ |
34,154 |
|
Consigned inventory |
|
|
4,720 |
|
|
|
4,119 |
|
Raw materials |
|
|
6,611 |
|
|
|
5,351 |
|
|
|
|
|
|
|
|
Total |
|
$ |
49,024 |
|
|
$ |
43,624 |
|
|
|
|
|
|
|
|
Consigned inventory represents inventory at the Companys customers retail locations where
revenue recognition criteria have not been met.
Note 11 License Fees
License fees consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
License fees |
|
$ |
26,142 |
|
|
$ |
18,681 |
|
Less: accumulated amortization |
|
|
10,630 |
|
|
|
5,334 |
|
|
|
|
|
|
|
|
|
|
$ |
15,512 |
|
|
$ |
13,347 |
|
|
|
|
|
|
|
|
Amortization of license fees for the three and nine month periods ended December 31, 2006 were
$2.0 million and $5.3 million, respectively, and for the three and nine month periods ended
December 31, 2005 were $1.5 million and $4.0 million, respectively. These amounts have been
included in royalty expense in cost of sales in the accompanying consolidated statements of
operations.
License fees represent fixed minimum advance payments made to program suppliers for exclusive
distribution rights. A program suppliers 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 costs earned by the program
suppliers. Participation costs are accrued 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 exceed estimated fair value, based on discounted cash flows, in the period when
such estimate is made.
Note 12 Production Costs
Production costs consisted of the following and are included in other assets (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Production costs |
|
$ |
8,431 |
|
|
$ |
5,653 |
|
Less: accumulated amortization |
|
|
3,648 |
|
|
|
1,877 |
|
|
|
|
|
|
|
|
|
|
$ |
4,783 |
|
|
|
3,776 |
|
|
|
|
|
|
|
|
15
Amortization of production costs for the three and nine month periods ended December 31, 2006
were $689,000 and $1.8 million, respectively, and for the three and nine month periods ended
December 31, 2005 were $274,000 and $1.1 million, respectively. These amounts have been included in
cost of sales in the accompanying consolidated statements of operations.
Production costs represent unamortized costs of films and television programs, which have been
produced by the Company or for which the Company has acquired distribution rights. Costs of
produced films and television programs include all production costs, which are expected to be
recovered from future revenues. Amortization of production costs is determined based on the ratio
that current revenue earned from the films and television programs bear to the ultimate future
revenue, 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 production costs exceed estimated fair value, based on discounted cash flows, in the period
when estimated.
Note 13 Property and Equipment
Property and equipment consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Land and buildings |
|
$ |
1,623 |
|
|
$ |
1,623 |
|
Furniture and fixtures |
|
|
1,106 |
|
|
|
1,052 |
|
Computer and office equipment |
|
|
6,201 |
|
|
|
5,541 |
|
Warehouse equipment |
|
|
8,685 |
|
|
|
7,062 |
|
Leasehold improvements |
|
|
1,875 |
|
|
|
1,843 |
|
Production equipment |
|
|
362 |
|
|
|
257 |
|
Construction in progress |
|
|
2,968 |
|
|
|
1,269 |
|
|
|
|
|
|
|
|
Total |
|
$ |
22,820 |
|
|
$ |
18,647 |
|
Less: accumulated depreciation and amortization |
|
|
10,561 |
|
|
|
8,349 |
|
|
|
|
|
|
|
|
Net property and equipment |
|
$ |
12,259 |
|
|
$ |
10,298 |
|
|
|
|
|
|
|
|
Note 14 Goodwill and Intangible Assets
Goodwill
As of December 31, 2006 and March 31, 2006, goodwill amounted to $81.7 million and $81.2
million, respectively. During fiscal 2007, purchase price adjustments related to the FUNimation
acquisition of $145,000 resulted in additional goodwill. Also, during fiscal 2007 purchase price
adjustments related to the annual earn-out payment of $350,000 were made relating to the BCI
acquisition resulting in additional goodwill.
The changes in the carrying amount of goodwill by segment were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution |
|
|
Publishing |
|
|
Consolidated |
|
Balances as of March 31, 2006 |
|
$ |
|
|
|
$ |
81,202 |
|
|
$ |
81,202 |
|
Goodwill adjustment related to an acquisition |
|
|
|
|
|
|
145 |
|
|
|
145 |
|
Earn-out related to an acquisition |
|
|
|
|
|
|
350 |
|
|
|
350 |
|
|
|
|
|
|
|
|
|
|
|
Balances as of December 31, 2006 |
|
$ |
|
|
|
$ |
81,697 |
|
|
$ |
81,697 |
|
|
|
|
|
|
|
|
|
|
|
Intangible assets
Other identifiable intangible assets, net of amortization, of $16.1 million and $20.9 million
as of December 31, 2006 and March 31, 2006, respectively, are being amortized (except for the
trademark) over useful lives ranging from between three and seven and one half years and are as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2006 |
|
|
|
Gross carrying |
|
|
Accumulated |
|
|
|
|
|
|
amount |
|
|
amortization |
|
|
Net |
|
Masters |
|
$ |
8,553 |
|
|
$ |
4,577 |
|
|
$ |
3,976 |
|
License relationships |
|
|
20,078 |
|
|
|
9,540 |
|
|
|
10,538 |
|
Other (not amortized) |
|
|
1,568 |
|
|
|
|
|
|
|
1,568 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
30,199 |
|
|
$ |
14,117 |
|
|
$ |
16,082 |
|
|
|
|
|
|
|
|
|
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2006 |
|
|
|
Gross carrying |
|
|
Accumulated |
|
|
|
|
|
|
amount |
|
|
amortization |
|
|
Net |
|
Masters |
|
$ |
7,475 |
|
|
$ |
3,213 |
|
|
$ |
4,262 |
|
License relationships |
|
|
20,078 |
|
|
|
5,045 |
|
|
|
15,033 |
|
Other (not amortized) |
|
|
1,568 |
|
|
|
|
|
|
|
1,568 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
29,121 |
|
|
$ |
8,258 |
|
|
$ |
20,863 |
|
|
|
|
|
|
|
|
|
|
|
Aggregate amortization expense for the three and nine month periods ended December 31, 2006
were $2.0 million and $5.9 million, respectively, and for the three and nine month periods ended
December 31, 2005 were $2.4 million and $6.3 million, respectively.
Based on the intangibles in service as of December 31, 2006, estimated future amortization
expense is as follows (in thousands):
|
|
|
|
|
Remainder of 2007 |
|
$ |
1,970 |
|
2008 |
|
|
5,291 |
|
2009 |
|
|
4,288 |
|
2010 |
|
|
2,066 |
|
2011 |
|
|
425 |
|
Debt issuance costs
Debt issuance costs are amortized over the life of the related debt and are included in other
assets. Debt issuance costs totaled $3.9 million and $3.8 million at December 31, 2006 and March
31, 2006, respectively. Accumulated amortization amounted to approximately $1.3 million and
$827,000 at December 31, 2006 and March 31, 2006, respectively. The Company wrote off net debt
issuance costs of $239,000 during first quarter of fiscal 2006. Amortization expense and the
write-off are included in interest expense in the accompanying consolidated statements of
operations.
Note 15 Accrued Expenses
Accrued expenses consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Compensation and benefits |
|
$ |
3,772 |
|
|
$ |
3,067 |
|
Royalties |
|
|
4,119 |
|
|
|
6,134 |
|
Interest |
|
|
511 |
|
|
|
1,751 |
|
Rebates |
|
|
1,556 |
|
|
|
1,354 |
|
Deferred revenue |
|
|
1,122 |
|
|
|
990 |
|
Other |
|
|
2,699 |
|
|
|
3,350 |
|
|
|
|
|
|
|
|
Total |
|
$ |
13,779 |
|
|
$ |
16,646 |
|
|
|
|
|
|
|
|
Note 16 Bank Financing and Debt
In October 2001, the Company 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
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 borrowings up to $40.0 million, subject to a borrowing
base requirement, and required that the Company 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 the Company with an aggregate revolving acquisition
availability of up to $20.0 million, subject to a borrowing base requirement. The working capital
revolving credit facility also 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.
17
The credit agreement was amended and restated on May 11, 2005 in order to provide the Company
with funding to complete the FUNimation acquisition (see Note 2) and was again amended and restated
on June 1, 2005. The credit agreement currently provides a six-year $115.0 million Term Loan B
sub-facility with quarterly payments of $1.25 million and the remaining principal due on May 11,
2011, a $25.0 million five and one-half year Term Loan C sub-facility due on November 11, 2011, and
a five-year revolving sub-facility for up to $25.0 million which expires on May 11, 2010. The
entire $115.0 million of the Term Loan B sub-facility was drawn at 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 Term Loan C was paid-in-full by March 31, 2006.
The loans under the senior credit facilities are guaranteed by the Companys subsidiaries and
are secured by a first priority security interest in all of the Companys assets and in all of the
assets of the Companys subsidiary companies, as well as the capital stock of the Companys
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.
In association with the credit agreement, the Company also pays certain facility and agent
fees. Interest under the revolving facility provided pursuant to the credit agreement was at the
index rate plus 2.25% (10.5% and 10.0% at December 31, 2006 and March 31, 2006, respectively) and
is payable monthly. As of December 31, 2006 and March 31, 2006, respectively, the Company had no
balance under the revolving working capital facilities. Interest under the Term Loan B sub-facility
was at the LIBOR rate plus 3.75% (9.1% and 8.28% as of December 31, 2006 and March 31, 2006,
respectively). The balance under the Term Loan B sub-facility was $76.4 million and $80.1 million
at December 31, 2006 and March 31, 2006, respectively.
Under the credit agreement the Company is required to meet certain financial and non-financial
covenants. Non-financial covenants include, but are not limited to, restrictions on the borrowing
of the Company to its subsidiaries and affiliates. The financial covenants include a variety of
financial metrics that are used to determine the Companys overall financial stability and include
limitations on the Companys capital expenditures, a minimum ratio of earnings before interest,
tax, depreciation and amortization (EBITDA) to fixed charges, and a maximum of indebtedness to
EBITDA. The Company was in compliance with all the covenants related to the credit facility as of
December 31, 2006.
Long-term debt consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
March 31, |
|
|
|
2006 |
|
|
2006 |
|
Term Loan B sub-facility |
|
$ |
76,380 |
|
|
$ |
80,130 |
|
Less: current portion |
|
|
5,000 |
|
|
|
5,000 |
|
|
|
|
|
|
|
|
Total long-term debt |
|
$ |
71,380 |
|
|
$ |
75,130 |
|
|
|
|
|
|
|
|
Letters of Credit
The Company is party to a letter of credit totaling $250,000 at December 31, 2006, with a
vendor. In the Companys past experience, no claims have been made against these types of financial
instruments.
Note 17 Derivative Instruments
The Company uses derivative instruments to assist in the management of exposure to interest
rates. The Company uses derivative instruments only to limit the underlying exposure to floating
interest rates, and not for speculative purposes. The Company documents relationships between
hedging instruments and the hedged items, as well as its risk-management objective and strategy for
undertaking various hedge transactions. The Company assesses, both at the hedges inception and on
an ongoing basis, whether the derivatives that are used in hedging transactions are highly
effective in offsetting changes in cash flows of the hedged item.
The Company enters into interest rate swap agreements to hedge the risk from floating rate
long-term debt to fixed rate debt. These contracts are designed as cash flow hedges with the fair
value recorded in accumulated other comprehensive income (loss), net of tax, and as a hedge asset
or liability in other long-term assets or other long-term liabilities, as applicable. Once the
forecasted transaction actually occurs, the related fair value of the derivative hedge contract is
reclassified from accumulated other comprehensive income (loss) into earnings. Any ineffectiveness
of the hedges is also recognized in earnings as incurred. On March 6, 2006, the Company entered
into an interest rate swap agreement with a notional amount of $53.0 million which expires on May
11, 2007. At December 31, 2006 and March 31, 2006, the fair value of the interest rate swap had
increased from inception by $67,000 and $37,000, respectively, and is included in other long-term
assets. As of December 31, 2006, the total realized loss on the cash flow hedge was
18
$1,000 and is reflected in other income (expense). The unrecognized after-tax portion of the
fair value of the contracts recorded in accumulated other comprehensive income was $41,000 and
$23,000 as of December 31, 2006 and March 31, 2006, respectively. See additional disclosure in Note
18 regarding derivatives.
Note 18 Private Placement
On March 21, 2006 (the Closing Date), the Company completed a private placement to
institutional and other accredited investors of 5,699,998 shares of common stock and 1,596,001
shares of common stock issuable upon exercise of warrants (the PIPE). As of December 31, 2006 and
March 31, 2006, 1,596,001 warrants exercisable at $5.00 per share were outstanding related to this
issuance, which includes a warrant to purchase 171,000 shares issued by the Company to its agent in
the private placement, Craig-Hallum Capital Group, LLC.
In accordance with the terms of the PIPE, the Company was required to file with the SEC,
within thirty (30) days from the Closing Date, a registration statement covering the common shares
issued and issuable in the PIPE. The Company was also required to cause the registration statement
to go effective on or before August 18, 2006 and to exert its best efforts to maintain the
effectiveness of the registration. The Company was subject to liquidated damages of one percent
(1%) per month of the aggregate gross proceeds ($20.0 million) with a 9% cap, as to the total
liquidated damages, if the Company failed to cause the registration statement to become effective
prior to August 18, 2006, or if, following its having been declared effective, it should cease to
be effective prior to the expiration of a period of time as is set forth in the registration rights
agreement between the Company and the PIPE purchasers. As the registration statement was declared
effective by the Securities and Exchange Commission (SEC) on July 27, 2006 and is currently
effective, the Company has not been required to pay these liquidated damages.
Under EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Companys Own Stock (EITF 00-19), the fair value of the warrants issued under the
PIPE were reported as a liability and the value of the common stock was reported as temporary
equity due to the requirement to net-cash settle the transaction. The reason for this treatment is
because EITF 00-19 requires the Company to use best efforts language in conjunction with the
discussion regarding the effectiveness of the registration statement. Otherwise, it is assumed that
the effectiveness of the registration statement is out of the Companys control, thereby assuming
net-cash settlement.
The fair value of the warrants issued in connection with the PIPE was determined using a
lattice valuation model. The assumptions utilized in computing the fair value of the warrants were
as follows for the three months ended September 30, 2006: expected life of 5 years, estimated
volatility of 70%, a risk free interest rate of 4.6% and a call option of $8.50 one year after the
Closing Date. On the Closing Date, the common stock was recorded at approximately $16.6 million, or
the difference between the net proceeds and the fair value of the warrants. The warrants were
considered a derivative financial instrument and were marked to fair value on a quarterly basis.
Any changes in fair value of the warrants was recorded in the consolidated statement of operations
as other income (expense). For the nine months ended December 31, 2006, the Company recognized
expense of $251,000 associated with the fair value adjustment of the warrants. As of March 31, 2006
the warrants had a fair value of $2.2 million. At March 31, 2006, the value of the common stock was
recorded at $16.6 million in temporary equity in the consolidated balance sheets. The Company
reclassified the $16.6 million of temporary equity to equity as of July 27, 2006, as the shares
were registered with the effectiveness of the registration statement. The Company marked to market
the warrants as of July 27, 2006 and reclassified the warrant accrual balance to equity at that
time.
Note 19 Income Taxes
The Companys effective tax rate was 38.3% for the three months ended December 31, 2006 and
41.8% for the three months ended December 31, 2005. The Companys effective tax rate for the third
quarter of fiscal 2007 was lower than third quarter of fiscal 2006 due to the inclusion of the net
operating loss of the VIE in fiscal 2006, which did not have a tax benefit to the Companys
consolidated financial statements. The Companys effective tax rate was 38.9% for the nine months
ended December 31, 2006 and 37.3% for the same period last year.
It has been determined, based on expectations of future taxable income, that a valuation
reserve is not required, except the valuation reserve related to the capital loss generated in the
third quarter of fiscal 2006. Management has determined that it is more
19
likely than not that the results of future operations will generate sufficient taxable income
to realize the deferred tax assets, except for the deferred tax assets related to the capital loss,
which has been fully reserved against with a valuation allowance.
Note 20 License and Distribution Agreement
The
Company has a license and distribution agreement
(Agreement) with a vendor that includes provisions for a license fee and target payments. The Company will incur royalty
expense for the license fee based on product sales for the year. License fee royalties were $1.6
million and $4.7 million for the three and nine months ended December 31, 2006, respectively, and
$2.2 million and $6.4 million for the three and nine months ended December 31, 2005, respectively,
and are reflected in cost of sales in the consolidated statements of operations. As of December 31,
2006 and March 31, 2006, $4.4 million and $2.8 million in target payments are reflected in prepaid
assets in the consolidated balance sheets. The target payments are non-refundable, but are offset
by royalties incurred in order to recoup the payments. The Company monitors these prepaid assets
for potential impairment based on sales activity of products provided to it under this Agreement.
Note 21 Commitments and Contingencies
Commitments Other
The Company has an agreement to purchase $125,000 of advertising for the remainder of fiscal
2007.
Litigation
In the normal course of business, the Company is involved in a number of litigation matters
that, other than the matters described immediately below, are incidental to the operation of the
Companys business. These matters generally include, among other things, collection matters with
regard to products distributed by the Company and accounts receivable owed to the Company. The
Company currently believes that the resolution of any of these pending matters will not have a
materially adverse effect on the Companys financial position or liquidity, but an adverse decision
in more than one of the matters not described below could be material to the Companys consolidated
results of operations. Because of the status of these proceedings, as well as the contingencies and
uncertainties associated with litigation, it is difficult, if not impossible, to predict the
exposure to the Company, if any, in connection with these matters.
Sybersound Records, Inc. v. BCI Eclipse, LLC, et al.
On May 12, 2005, Sybersound Records, Inc. (Sybersound) filed this action against the
Companys wholly-owned subsidiary, BCI Eclipse, LLC (BCI) and others in the Superior Court of
California, County of Los Angeles, West District, Case Number SC085498. Plaintiff alleged that BCI
and others sold unlicensed records in connection with their karaoke-related business or otherwise
failed to account for or pay licensing fees and/or royalties. Sybersound alleged that this conduct
gives BCI and others an illegal, competitive advantage in the marketplace. Based on this and
related conduct, Sybersound asserted the following causes of action: tortious interference with
business relations, unfair competition under the California Business and Professions Code, and
unfair trade practices under Californias Unfair Practices Act. Sybersound sought damages,
including punitive damages, of not less than $195.0 million dollars plus trebled actual damages,
injunctive relief, pre-judgment and post-judgment interest, costs, attorneys fees and expert fees.
On August 10, 2005, Sybersound filed a dismissal without prejudice of the case, and filed and
served a new Complaint in the United States District Court for the Central District of California
on August 11, 2005. In the new Complaint, Sybersound made similar allegations, but also alleged
that BCI was infringing on certain copyrights because of an exclusive license that Sybersound was
granted by a third party.
On November 7, 2005, the Court issued its order granting BCIs motion to dismiss as well as
other of the defendants motions to dismiss, but without prejudice to Sybersounds right to attempt
to save its claims by amending the Complaint. Sybersound served and filed an Amended Complaint on
November 21, 2005 which added various individual defendants, including BCIs president. In
addition, Sybersound added claims under the Racketeer Influenced and Corrupt Organizations Act. On
December 22, 2005, BCI served and filed its motion to dismiss Sybersounds Amended Complaint.
20
On January 6, 2006, the Court issued its order dismissing Sybersounds claims with prejudice.
An appeal of this order was filed by Sybersound on February 1, 2006 and a briefing schedule has
been set with respect to the issues present in the appeal. Sybersound has filed its opening brief
and BCI has filed its answering brief.
Sybersound Records, Inc. v. Navarre Corporation, BCI Eclipse, LLC, et al.
Sybersound Records, Inc. filed this action on or about May 12, 2005 in the Superior Court of
Justice, Toronto, Ontario, Canada, Court File Number 05-CV-289397Pd2. The factual basis for
Sybersounds claims in this case are essentially the same as those in the California action
described above. However, Sybersound has named Navarre Corporation in this case in addition to BCI.
Sybersound claims that the alleged misconduct constitutes tortious interference with economic
interests, and seeks damages of not less than $5,745,000, plus punitive damages in the amount of
$800,000, plus injunctive relief against certain of the defendants other than Navarre and BCI.
Navarre and BCI have responded to the complaint, denied liability and damages and asserted a
counterclaim against Sybersound and its principal, Jan Stevens. In their counterclaim, BCI and
Navarre seek injunctive relief enjoining Sybersound and Stevens from making false statements
regarding BCI and Navarre, declaratory relief that Sybersound and Stevens have made false
statements, and money damages for the false statements. BCI and Navarre allege that Sybersound and
Stevens are liable to Navarre and BCI under the Competition Act, Trade-marks Act and common law for
certain false statements made and published by Sybersound and Stevens, and are seeking all damages
available.
Securities Litigation Lawsuits
Several purported class action lawsuits were commenced in 2005 by various plaintiffs against
Navarre Corporation and certain of its current and former officers and directors in the United
States District Court for the State of Minnesota. The allegations in each of these lawsuits are
virtually identical, and essentially claim that the Company, and certain of its officers and/or
directors violated federal securities laws and regulations because, among other things, the
Companys financial results were materially inflated and not prepared in accordance with generally
accepted accounting principles. The Complaints allege that these accounting irregularities
benefited Company insiders including the individual defendants. The Complaints further allege that
the Company failed to properly recognize executive deferred compensation and improperly recognized
a deferred tax benefit as income. Plaintiffs cite to violation of Sec. 10(b) of the Securities
Exchange Act of 1934 (the Act) and Rule 10(b)(5), promulgated under the Act, and as to the
individual defendants only, violation of Sec. 20(a) of the Act.
Plaintiffs seek certification of the actions as a class action lawsuit, compensatory but
unspecified damages allegedly sustained as a result of the alleged wrongdoing, plus costs, counsel
fees and experts fees. The actions are identified as follows:
AVIVA Partners, Ltd. v. Navarre Corp., et al.
(Civ. No. 05-1151 (PAM/RLE))
Vivian Oh v. Navarre Corp., et al.
(Civ. No. 05-01211 (MJD/JGL))
Matthew Grabler v. Navarre Corp., et al.
(Civ. No. 05-1260 (DWF/JSM))
Defendants entered into a stipulation with counsel for plaintiffs in each of these cases to
postpone the time for bringing a motion to dismiss until after a lead plaintiff and lead counsel
were appointed by the Court, and an amended consolidated complaint was filed.
By Memorandum Opinion and Order dated December 12, 2005, the Court appointed The Pension
Group, comprised of the Operating Engineers Construction Industry and Miscellaneous Pension Fund
and Ms. Grace W. Lai, as Lead Plaintiff, and appointed the Reinhardt, Wendorf & Blanchfield law
firm as liaison counsel and the Lerach, Coughlin law firm as lead counsel. The Court also ordered
that the cases be consolidated under the caption In re Navarre Corporation Securities
Litigation, and further ordered that a Consolidated Amended Complaint be filed.
On February 3, 2006, Plaintiffs filed a Consolidated Amended Complaint with the Court. This
Consolidated Amended Complaint reiterates the allegations made in the individual complaints and
extends these allegations to the Companys restatements of its previously issued financial
statements that were made in November 2005. A hearing on Defendants motion to dismiss was held on
May 10, 2006 and by an order dated June 27, 2006, the Court granted Defendants motion to dismiss
for failure to state a claim,
21
without prejudice. The Court gave Plaintiffs 30 days to file an amended complaint in an effort
to cure the identified pleading deficiencies.
On July 28, 2006 Plaintiffs filed their Second Consolidated Amended Complaint against
Defendants. Defendants filed a motion to dismiss the renewed complaint on September 22, 2006,
asserting, among other things, that Plaintiffs had not sufficiently cured the defects present in
the original Consolidated Amended Complaint.
By a Memorandum and Order dated December 21, 2006, the Court granted Defendants motion in
part, denied it in part, and specifically removed Cary L. Deacon, Brian M.T. Burke and Charles
Cheney as individual defendants.
Defendants answered the Complaint on January 26, 2007 and anticipate that typical disclosure
requirements and discovery will proceed.
Shareholder Derivative Lawsuits
Several potential class plaintiffs have commenced shareholder derivative lawsuits on behalf of
all of Navarres shareholders, alleging claims against the Company and certain of its current and
former officers and directors. The complaints allege that shareholders have been treated unfairly
based upon the same factual allegations contained in the securities litigation lawsuit set forth
above. These actions were brought in the U.S. District Court for Minnesota, and are identified as
follows:
Shannon Binns v. Charles Cheney, et al.
(Civ. No. 05-1191 (RHK/JSM))
Karel Filip v. Charles Cheney, et al.
(Civ. No. 05-01216 (DSD/SRN))
Jeffrey Evans v. Charles Cheney, et al.
(Civ. No. 05-01216 (JMR/FLN))
Joan Brewster v. Charles Cheney, et al.
(Civ. No. 05-2044 (JRT/FLN))
William Block v. Charles Cheney, et al.
(Civ. No. 05-2067 (DSD/SRN))
While the cases filed by Evans, Brewster and Block contain more detailed, and somewhat
different factual allegations, the relief sought is essentially the same as the other shareholder
derivative actions. Counsel for all plaintiffs filed competing motions to consolidate all five
derivative actions and to have their attorneys named as lead counsel.
On July 26, 2005, the Navarres Board of Directors appointed a special litigation committee
pursuant to Minn. Stat. §302A.241 to consider whether it is in the best interests of the Company to
pursue the shareholder derivative claims. The special litigation committee retained experts,
conducted interviews with the named Defendants and others, and also contacted Plaintiffs counsel
for, and obtained, their input.
On January 19, 2006, the special litigation committee issued a comprehensive Resolution Report
(consisting of 40 pages) and Appendix (consisting of 17 exhibits) detailing its findings. The
special litigation committee resolved that the derivative actions are not meritorious and should
not be pursued, (and) that it is in the best interests of Navarre that such Derivative Complaints
be dismissed . . . On February 23, 2006, the special litigation committee issued a revised version
of its Report in response to the Companys disclosure that it had received correspondence from the
United States Securities and Exchange Commission (SEC) detailing a request that the Company
voluntarily provide certain documentation. The special litigation committee indicated that this
revised Report was provided in order to clarify that an information request and inquiry by the SEC
did not impact the conclusions reached by the special litigation committee.
On April 21, 2006 Plaintiffs Binns and Filip and Defendants entered into a stipulation of
dismissal without prejudice of those two actions. This voluntary dismissal provides Plaintiffs
Binns and Filip to refile their actions in the future if circumstances warrant, and Defendants
reserved all rights to oppose and defend against any such future actions. By Order dated May 16,
2006 the Court dismissed those actions.
22
Discovery motions were argued in the remaining cases on May 23, 2006 and the Court issued an
order on November 2, 2006 granting these motions in part and denying these motions in part.
Defendants are in the process of providing discovery materials pursuant to the Courts order.
Note 22 Related Party Transactions
Employment/Severance Agreements
The Company entered into an employment agreement with its Chief Executive Officer (CEO) in
2001, which, as amended, expires on March 31, 2007. The Company agreed in the employment agreement
to, among other things, pay severance amounts equal to a multiple of defined compensation and
benefits under certain circumstances. Upon retirement, the Company will pay approximately $2.5
million pursuant to the deferred compensation portion of the arrangement. Upon the expiration of
the contract, the Company will be required to pay this amount over a period of three years
subsequent to March 31, 2007. The Company expensed $811,000 and $216,000 of this obligation in its
consolidated financial statements for the nine months ended December 31, 2006 and 2005,
respectively. The employment agreement also contains a deferred compensation component that was
earned by the CEO upon the stock price achieving certain targets, which may be forfeited in the
event that he does not comply with certain non-compete obligations. As of March 31, 2005 all of the
targets were met. As such, $2.5 million was expensed in the consolidated financial statements as of
March 31, 2005. At December 31, 2006 and March 31, 2006, $6.1 million and $5.3 million,
respectively, had been accrued in the consolidated financial statements for the deferred
compensation amounts.
The CEOs employment agreement, also includes a loan to the executive for a maximum of $1.0
million, of which $50,000 and $200,000 were outstanding at December 31, 2006 and March 31, 2006,
respectively. Under the terms of the loan, which was entered into prior to the implementation of
the Sarbanes-Oxley Act of 2002, $200,000 of the $1.0 million principal and all unpaid and
unforgiven interest is to be forgiven by the Company on each of March 31, 2005, 2006 and 2007.
During the nine months ended December 31, 2006 and 2005, the Company forgave $150,000 and $150,000,
respectively of principal. The outstanding note amount bears an annual interest rate of 5.25%.
The Company entered into a separation agreement with a former Chief Financial Officer in
fiscal year 2004. The Company was required to pay approximately $597,000 over a period of four
years beginning May 2004. The continued payout is contingent upon the individual complying with a
non-compete agreement. This amount was accrued and expensed in fiscal year 2005.
The Company has a separation agreement with another former Chief Financial Officer. The
agreement obligated the Company to pay severance amounts equal to a multiple of defined
compensation and benefits. The Company was required to pay approximately $299,000 over a period of
one year beginning July 2005. The Company expensed $299,000 in its consolidated financial
statements for the nine months ended December 31, 2005.
Employment Agreement FUNimation
In connection with the FUNimation acquisition, the Company entered into an employment
agreement with a key FUNimation employee providing for his employment as President and Chief
Executive Officer of FUNimation Productions, Ltd. (the FUNimation CEO). Among other items, the
agreement provides the FUNimation CEO with the ability to earn two performance-based bonuses in the
event that certain financial targets are met by the FUNimation business during the fiscal years
ending March 31, 2006-2010. Specifically, if the total earnings before interest and tax (EBIT) of
FUNimation during the fiscal years ending March 31, 2006 through March 31, 2008 is in excess of
$90.0 million, the FUNimation CEO is entitled to receive a bonus payment in an amount equal to 5%
of the EBIT that exceeds $90.0 million; however, this bonus payment shall not exceed $5.0 million.
Further, if the combined EBIT of the FUNimation business is in excess of $60.0 million during the
period consisting of the fiscal years ending March 31, 2009 and 2010, the FUNimation CEO is
entitled to receive a bonus payment in an amount equal to 5% of the EBIT that exceeds $60.0
million; however, this bonus payment shall not exceed $4.0 million. No amounts have been expensed
or paid under this agreement as the targets have not been achieved.
Chief Executive Officer Investment in Mix & Burn
The Companys Chief Executive Officer made an investment in Mix & Burn in the form of a
convertible note. This note was convertible into common stock in Mix & Burn and accrued interest at
an annual rate of twelve percent. Following the insolvency of Mix & Burn, its assets were assigned
to a new entity and the Companys Chief Executive Officer did not receive any repayment of
principal or interest in connection with the convertible note. This investment was made only after
the Company determined that it would not make loans to or investments in Mix & Burn in excess of
its then existing $2.5 million aggregate principal amount of promissory notes (which was written
off during deconsolidation of the VIE).
23
Note 23 Business Segments
The presentation of segment information reflects the manner in which management organizes
segments for making operating decisions and assessing performance. On this basis, the Company
determined it historically had three reportable business segments: distribution, publishing and
other. The other segment was included from December 31, 2003 to December 31, 2005 and included the
operations of Mix & Burn (see Note 3).
Financial information by reportable business segment is included in the following summary (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended December 31, 2006 |
|
Distribution |
|
Publishing |
|
Other |
|
Eliminations |
|
Consolidated |
Net sales |
|
$ |
198,914 |
|
|
$ |
35,045 |
|
|
$ |
|
|
|
$ |
(23,711 |
) |
|
$ |
210,248 |
|
Income (loss) from operations |
|
|
3,800 |
|
|
|
4,943 |
|
|
|
|
|
|
|
|
|
|
|
8,743 |
|
Net income (loss) before income tax |
|
|
1,470 |
|
|
|
5,091 |
|
|
|
|
|
|
|
|
|
|
|
6,561 |
|
Total assets |
|
$ |
305,382 |
|
|
$ |
165,076 |
|
|
$ |
|
|
|
$ |
(109,986 |
) |
|
$ |
360,472 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended December 31, 2005 |
|
Distribution |
|
Publishing |
|
Other |
|
Eliminations |
|
Consolidated |
Net sales |
|
$ |
198,940 |
|
|
$ |
35,940 |
|
|
$ |
169 |
|
|
$ |
(20,208 |
) |
|
$ |
214,841 |
|
Income (loss) from operations |
|
|
(9,652 |
) |
|
|
799 |
|
|
|
(487 |
) |
|
|
|
|
|
|
(9,340 |
) |
Net income (loss) before income tax |
|
|
(12,555 |
) |
|
|
775 |
|
|
|
1,357 |
|
|
|
|
|
|
|
(10,423 |
) |
Total assets |
|
$ |
317,834 |
|
|
$ |
172,193 |
|
|
$ |
|
|
|
$ |
(134,160 |
) |
|
$ |
355,867 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended December 31, 2006 |
|
Distribution |
|
Publishing |
|
Other |
|
Eliminations |
|
Consolidated |
Net sales |
|
$ |
488,558 |
|
|
$ |
95,789 |
|
|
$ |
|
|
|
$ |
(54,611 |
) |
|
$ |
529,736 |
|
Income (loss) from operations |
|
|
5,093 |
|
|
|
11,314 |
|
|
|
|
|
|
|
|
|
|
|
16,407 |
|
Net income (loss) before income tax |
|
|
(1,255 |
) |
|
|
11,567 |
|
|
|
|
|
|
|
|
|
|
|
10,312 |
|
Total assets |
|
$ |
305,382 |
|
|
$ |
165,076 |
|
|
$ |
|
|
|
$ |
(109,986 |
) |
|
$ |
360,472 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended December 31, 2005 |
|
Distribution |
|
Publishing |
|
Other |
|
Eliminations |
|
Consolidated |
Net sales |
|
$ |
468,002 |
|
|
$ |
93,849 |
|
|
$ |
424 |
|
|
$ |
(48,016 |
) |
|
$ |
514,259 |
|
Income (loss) from operations |
|
|
(7,335 |
) |
|
|
7,466 |
|
|
|
(1,590 |
) |
|
|
|
|
|
|
(1,459 |
) |
Net income (loss) before income tax |
|
|
(14,192 |
) |
|
|
7,297 |
|
|
|
137 |
|
|
|
|
|
|
|
(6,758 |
) |
Total assets |
|
$ |
317,834 |
|
|
$ |
172,193 |
|
|
$ |
|
|
|
$ |
(134,160 |
) |
|
$ |
355,867 |
|
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
Executive Summary
Consolidated net sales for the third quarter of fiscal 2007 decreased 2.1% to $210.2 million
compared to $214.8 million for the third quarter of fiscal 2006. The decrease in net sales was
primarily due to a weak retail environment in general, shift in a product release and the loss of
two customers due to bankruptcy. Our gross profit was $35.3 million or 16.8% of net sales in the
third quarter fiscal 2007 compared with $28.2 million or 13.1% of net sales for the same period in
fiscal 2006. The increase in gross profit as a percent of net sales is primarily due to product
sales mix. Also, gross profit for the third quarter of fiscal 2006 included the write-off of
balances of $4.1 million related to an independent music label. Total operating expenses for the
third quarter of fiscal 2007 were $26.5 million or 12.6% of net sales, compared with $37.6 million
or 17.5% of net sales in the same period for fiscal 2006. Net income for the third quarter fiscal
2007 was $4.1 million or $.11 per diluted share compared to net loss of $6.1 million or a loss of
$0.20 per diluted share for the same period last year.
Consolidated net sales for the nine months ended December 31, 2006 increased 3.0% to $529.7
million compared to $514.3 million for the first nine months of fiscal 2006. This growth in net
sales was achieved principally through new product releases and a full nine months of operating
results from our FUNimation subsidiary. Our gross profit increased to $91.3 million or 17.2% of net
sales in the first nine months of 2007 compared with $81.5 million or 15.9% of net sales for the
same period in fiscal 2006. The increase in gross profit as a percent of net sales for the first
nine months of fiscal 2007 was primarily due to product sales mix. Also, prior year gross profit
included the write-off of balances of $4.1 million related to an independent music label. Total
operating expenses for the first nine months of fiscal 2007 were $74.9 million or 14.1% of net
sales, compared with $83.0 million or 16.1% of net sales in the same period in fiscal 2006. Net
income for the first nine months of fiscal 2007 increased to $6.3 million or $.17 per diluted share
compared to a net loss of $4.2 million or a loss of $.14 per diluted share for the same period
last year.
24
Effective
April 1, 2006, we adopted the fair value recognition provisions
of SFAS 123R for share based compensation using
the modified prospective transition method, and therefore we have not restated prior periods
results. All share-based compensation expense is recorded as general and administrative expense.
Total share-based compensation expense recorded in the three and nine months ended December 31,
2006 was $220,000 and $520,000, respectively. This amount would have been $499,000 and $1.3 million
for the three and nine months ended December 31, 2005, respectively, had we recognized share-based
expense in the consolidated statements of operations under SFAS 123. Unrecognized compensation
expense from unvested options was $2.1 million as of December 31, 2006 and is expected to be
recognized over a weighted-average period of 1.50 years.
Overview
Navarre Corporation, a Minnesota corporation formed in 1983, 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. Our business is divided into two business segments in
fiscal 2007 distribution and publishing. The other segment reported in fiscal 2006 included the
consolidation of the VIE, Mix & Burn through December 1, 2005. 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.
Our broad base of customers includes: (i) wholesale clubs, (ii) mass merchandisers, (iii)
other third-party distributors, (iv) computer specialty stores, (v) music specialty stores, (vi)
book stores, (vii) office superstores, and (viii) electronic superstores. We currently distribute
to over 19,000 retail and distribution center locations throughout the United States and Canada.
Through our distribution segment 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 music labels, major label music (through December
2005), 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 segment 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.
Through our publishing segment we own or license various PC software, CD audio, DVD video
titles and other related merchandising and broadcasting rights. Our publishing segment packages,
brands, markets and sells directly to retailers, third-party distributors, and our distribution
segment. Our publishing segment currently consists of Encore, BCI and FUNimation. Encore licenses
and publishes personal productivity, genealogy, utility, education and interactive gaming PC
products. BCI is a provider of niche CD and DVD video products. FUNimation, acquired on May 11,
2005, is a leading provider of anime home video products.
In fiscal 2006, the other segment included the operations of Mix & Burn, a third-party
separate company that was included in our consolidated results in accordance with the provisions
of FIN 46(R), through December 1, 2005. Mix & Burn designs and markets digital music delivery
services for music and other specialty retailers. During the quarter ended December 31, 2005, we
deconsolidated Mix & Burn, as we were deemed to no longer be the primary beneficiary. A
reconsideration event was caused by additional funding Mix & Burn received from a third party.
Forward-Looking Statements / Important Risk Factors
We make written and oral statements from time to time regarding our business and prospects,
such as projections of future performance, statements of managements plans and objectives,
forecasts of market trends, and other matters that are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Statements containing the words or phrases will likely result, are expected to, will
continue, is anticipated, estimates, projects, believes, expects, anticipates,
intends, target, goal, plans, objective, should or similar expressions identify
forward-looking statements, which may appear in documents, reports, filings with the SEC, including
this Report on Form 10-Q, news releases, written or oral presentations made by officers or other
representatives made by us to analysts, shareholders, investors, news organizations and others and
discussions with management and other representatives 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
25
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: the Companys revenues being derived from a small group of customers; the Companys
dependence on significant vendors; the Companys dependence upon software developers and
manufacturers and popularity of their products; the Companys dependence upon a key employee and
its Founder, namely, Eric H. Paulson, Executive Chairman; the Companys ability to attract and
retain qualified management personnel; uncertain growth in the publishing segment; the acquisition
strategy of the Company could disrupt other business segments and/or management; the seasonality
and variability in the Companys business and that decreased sales during peak season could
adversely affect its results of operations; the Companys ability to meet its significant working
capital requirements related to distributing products; the Companys ability to avoid excessive
inventory return and obsolescence losses; the potential for inventory values to decline; the
Companys credit exposure due to reseller arrangements or negative trends which could cause credit
loss; the Companys ability to adequately and timely adjust cost structure for decreased demand;
the Companys ability to compete effectively in distribution and publishing, which are highly
competitive industries; the Companys dependence on third-party shipping of its product; the
Companys dependence on information systems; technological developments, particularly in the
electronic downloading arena which could adversely impact sales, margins and results of operations;
increased counterfeiting or piracy which could negatively affect demand for the Companys products;
the Company may not be able to protect its intellectual property; interruption of the Companys
business or catastrophic loss at a facility which could curtail or shutdown its business; the
potential for future terrorist activities to disrupt operations or harm assets; pending litigation
or regulatory inquiry may subject the Company to significant costs; the Companys dependence on a
small number of licensed property and licensors in the anime genre; some revenues substantially
dependent on television exposure; some revenues dependent on consumer preferences and demand;
increased costs related to legislative actions, insurance costs and new accounting pronouncements
could impact results of operations; material weaknesses or significant deficiencies may impact the
Companys ability to report on a timely or accurate basis; the level of indebtedness could
adversely affect the Companys financial condition; a change in interest rates on our variable rate
debt could adversely impact the Companys operations; the Company may be unable to generate
sufficient cash flow to service debt obligations; the Company may incur additional debt, which
could exacerbate the risks associated with current debt levels; the Companys current debt
agreement limits our operating and financial flexibility; further fluctuations in stock price could
adversely affect the Companys ability to raise capital or make our stock undesirable; the Company
does not pay dividends on common stock, thus return on investment for investors is based on stock
appreciation; the exercise of outstanding warrants and options adversely affecting stock price; the
Companys anti-takeover provisions, its ability to issue preferred stock and its staggered board
may discourage take-over attempts beneficial to shareholders; and the Companys directors may not
be personally liable for certain actions which may discourage shareholder suits against them.
A detailed statement of risks and uncertainties is contained in our reports to the SEC,
including, in particular, our Annual Report on Form 10-K for the year ended March 31, 2006, as
supplemented by subsequent Form 10-Q filings. Investors and shareholders are urged to read these
documents carefully.
Critical Accounting Policies
We consider our critical accounting policies to be those related to revenue recognition,
production costs and license fees, allowance for doubtful accounts, goodwill and intangible assets,
impairment of long-lived assets, inventory valuation, income taxes, and contingencies and
litigation. Except with respect to the changes in the manner in which we account for share-based
compensation which was originally discussed in Item 2 Managements Discussion and Analysis of
Financial Condition and Results of Operations of our Quarterly Report on Form 10-Q for the period
ended September 30, 2006, and as reported below, there have been no material changes to these
critical accounting policies as discussed in greater detail under this heading in Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations in our
Annual Report on Form 10-K for the year ended March 31, 2006.
Share-based Compensation
We have granted stock options, restricted stock units and restricted stock to certain
employees and non-employee directors. We recognize compensation expense for all share-based
payments granted after March 31, 2006 and all share-based payments granted prior to but not yet
vested as of March 31, 2006, in accordance with SFAS 123R. Under the fair value recognition
provisions of SFAS 123R, we recognize share-based compensation net of an estimated forfeiture rate
and only recognize compensation cost for those
26
shares expected to vest on a straight-line basis over the requisite service period of the
award (normally the vesting period) or when the performance condition has been met. Prior to the
adoption of SFAS 123R, we accounted for share-based payments under the APB 25 and accordingly, only
recognized compensation expense for stock options or restricted stock, which had a grant date
intrinsic value.
Determining the appropriate fair value model and calculating the fair value of share-based
payment awards require the input of highly subjective assumptions, including the expected life of
the share-based payment awards and stock price volatility. We use the Black-Scholes model to value
our stock option awards and a lattice model to value restricted stock unit awards. Management
believes that future volatility will not materially differ from the historical volatility. Thus,
the fair value of the share-based payment awards represents managements best estimates, but these
estimates involve inherent uncertainties and the application of management judgment. As a result,
if factors change and management uses different assumptions, share-based compensation expense could
be materially different in the future. In addition, we are required to estimate the expected
forfeiture rate and only recognize expense for those shares expected to vest. If the actual
forfeiture rate is materially different from the estimate, share-based compensation expense could
be significantly different from what has been recorded in the current period. See Note 4 to the
consolidated financial statements for a further discussion on the share-based compensation.
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 we use to produce non-GAAP results is not computed according to GAAP, is
likely to differ from the methods used by other companies and should not be regarded as a
replacement for corresponding GAAP measures. Net sales before inter-company eliminations has
limitations as a supplemental measure, and you should not consider it in isolation or as a
substitute for analysis of our results as reported under GAAP. The following table represents a
reconciliation of GAAP net sales to net sales before inter-company eliminations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
December 31, |
|
|
December 31, |
|
(In thousands) |
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net sales: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution |
|
$ |
198,914 |
|
|
$ |
198,940 |
|
|
$ |
488,558 |
|
|
$ |
468,002 |
|
Publishing |
|
|
35,045 |
|
|
|
35,940 |
|
|
|
95,789 |
|
|
|
93,849 |
|
Other |
|
|
|
|
|
|
169 |
|
|
|
|
|
|
|
424 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales before inter-company eliminations |
|
|
233,959 |
|
|
|
235,049 |
|
|
|
584,347 |
|
|
|
562,275 |
|
Inter-company eliminations |
|
|
(23,711 |
) |
|
|
(20,208 |
) |
|
|
(54,611 |
) |
|
|
(48,016 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales as reported |
|
$ |
210,248 |
|
|
$ |
214,841 |
|
|
$ |
529,736 |
|
|
$ |
514,259 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Results of Operations
The following table sets forth for the periods indicated the percentage of net sales
represented by certain items included in our Consolidated Statements of Operations.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended December 31, |
|
Nine Months Ended December 31, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Net sales: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution |
|
|
94.6 |
% |
|
|
92.7 |
% |
|
|
92.2 |
% |
|
|
91.0 |
% |
Publishing |
|
|
16.7 |
|
|
|
16.7 |
|
|
|
18.1 |
|
|
|
18.2 |
|
Other |
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.1 |
|
Inter-company sales |
|
|
(11.3 |
) |
|
|
(9.4 |
) |
|
|
(10.3 |
) |
|
|
(9.3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales |
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
Cost of sales, exclusive of
amortization and
depreciation |
|
|
83.2 |
|
|
|
86.9 |
|
|
|
82.8 |
|
|
|
84.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
16.8 |
|
|
|
13.1 |
|
|
|
17.2 |
|
|
|
15.8 |
|
Selling and marketing |
|
|
3.9 |
|
|
|
3.6 |
|
|
|
4.3 |
|
|
|
4.3 |
|
Distribution and warehousing |
|
|
1.9 |
|
|
|
1.4 |
|
|
|
1.8 |
|
|
|
1.4 |
|
General and administrative |
|
|
5.5 |
|
|
|
5.3 |
|
|
|
6.0 |
|
|
|
6.4 |
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended December 31, |
|
Nine Months Ended December 31, |
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
Bad debt |
|
|
0.0 |
|
|
|
5.7 |
|
|
|
0.5 |
|
|
|
2.4 |
|
Depreciation and amortization |
|
|
1.3 |
|
|
|
1.4 |
|
|
|
1.5 |
|
|
|
1.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
12.6 |
|
|
|
17.4 |
|
|
|
14.1 |
|
|
|
16.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations |
|
|
4.2 |
|
|
|
(4.3 |
) |
|
|
3.1 |
|
|
|
(0.3 |
) |
Interest expense |
|
|
(1.0 |
) |
|
|
(1.4 |
) |
|
|
(1.1 |
) |
|
|
(1.6 |
) |
Interest income |
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.1 |
|
Warrant income (expense) |
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.0 |
|
Gain on deconsolidation of
variable interest entity |
|
|
0.0 |
|
|
|
0.9 |
|
|
|
0.0 |
|
|
|
0.4 |
|
Other income (expense), net |
|
|
(0.1 |
) |
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.1 |
|
Income tax (expense) benefit |
|
|
(1.2 |
) |
|
|
2.0 |
|
|
|
(0.8 |
) |
|
|
0.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) |
|
|
1.9 |
% |
|
|
(2.8 |
)% |
|
|
1.2 |
% |
|
|
(0.8 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution Segment
The distribution segment distributes PC software, video games, accessories, major label music
(through December 2005), and DVD video, as well as independent music.
Fiscal 2007 Third Quarter Results Compared With Fiscal 2006 Third Quarter
Net Sales
Net sales for the distribution segment were $198.9 million (before inter-company eliminations)
for the third quarter of fiscal 2007 compared to $198.9 million (before inter-company eliminations)
for fiscal 2006 third quarter. Although net sales were unchanged, there were increases in net sales
in the DVD video product group that were offset by a decrease in net sales of PC software and video
game product groups. Net sales decreased in the software product group to $134.5 million during
the third quarter of fiscal 2007 from $138.0 million for the same period last year. Software net
sales decreased primarily due to timing of releases and softness of the retail environment in
general. DVD video net sales grew to $28.6 million in the third quarter of fiscal 2007 from $21.0
million in third quarter of fiscal 2006 due to increased publisher and customer rosters and strong
releases throughout the quarter. Video games net sales decreased to $16.5 million in the third
quarter of fiscal 2007 from $20.0 million for the same period last year, primarily due the loss of
an exclusive video game distribution agreement due to the bankruptcy of a major retailer.
Independent music net sales decreased slightly to $19.3 million in the third quarter of fiscal 2007
from $19.9 million in the same period last year. We believe that future sales increases will be
dependent on our ability to continue to add new, appealing content and upon the strength of the
retail environment as a whole.
Gross Profit
Gross profit for the distribution segment was $21.4 million or 10.7% as a percent of net sales
for the third quarter fiscal 2007 compared to $15.2 million or 7.7% as a percent of net sales for
third quarter fiscal 2006. The increase in gross profit as a percent of net sales for third quarter
fiscal 2007 was due to a shift to higher gross margin products. Also, the third quarter of fiscal
2006 gross profit was negatively impacted by the write-off of balances of $4.1 million related to
an independent music label. We expect gross profit to fluctuate depending principally upon the
make-up of product sales each quarter.
Operating Expenses
Total operating expenses for the distribution segment were $17.6 million or 8.8% as a percent
of net sales for the third quarter of fiscal 2007 compared to $24.9 million or 12.5% as a percent
of net sales for the third quarter of fiscal 2006. Overall, operating expenses decreased in the
third quarter of fiscal 2007; particularly, bad debt expense, which was partially offset by an
increase in distribution and warehousing and general and administrative expenses.
Selling and marketing expenses for the distribution segment were $4.7 million or 2.4% as a
percent of net sales for the third quarter of fiscal 2007 compared to $4.8 million or 2.4% as a
percent of net sales for the third quarter of fiscal 2006. Freight costs as a percent of net sales
decreased to 1.6% for the third quarter of fiscal 2007 compared to 1.7% for the third quarter of
fiscal 2006.
Distribution and warehousing expenses for the distribution segment were $4.0 million or 2.0%
as a percent of net sales for the third quarter of fiscal 2007 compared to $3.1 million or 1.5% as
a percent of net sales for the third quarter of fiscal 2006. The increase in distribution and
warehousing expenses is primarily due to an increase in total units handled.
28
General and administrative expenses for the distribution segment consist principally of
executive, accounting and administrative personnel and related expenses, including professional
fees. General and administrative expenses for the distribution segment were $8.4 million or 4.2% as
a percent of net sales for the third quarter of fiscal 2007 compared to $7.5 million or 3.8% as a
percent of net sales for the third quarter of fiscal 2006. The total fluctuation between quarters
reflected higher expenses in the third quarter of fiscal 2007 for increased salary and bonus
expense, for increased information technology expenses due to the implementation of an enterprise
resource planning system, and share-based compensation expense. These increases were partially
offset by a decrease in professional fees.
Bad debt benefit for the distribution segment was $214,000 for the third quarter of fiscal
2007 compared to bad debt expense of $9.0 million in the same period last year, due to the
write-off of an accounts receivable of $9.0 million related to the bankruptcy of a retailer.
Depreciation and amortization for the distribution segment was $686,000 for the third quarter
of fiscal 2007 compared to $546,000 for the third quarter of fiscal 2006.
Net operating income for the distribution segment was $3.8 million for the third quarter of
fiscal 2007 compared to a net operating loss of $9.7 million for the third quarter of fiscal 2006.
Fiscal 2007 Nine Months Results Compared With Fiscal 2006 Nine Months
Net Sales
Net sales for the distribution segment were $488.6 million (before inter-company eliminations)
for the nine month period of fiscal 2007 compared to $468.0 million (before inter-company
eliminations) for the nine month period of fiscal 2006. The 4.4% increase in net sales for the nine
month period of fiscal 2007 was principally due to increases in sales in the PC software, DVD video
and video game product groups. Net sales increased in the software product group to $346.8 million
during the nine month period fiscal 2007 from $338.7 million for the same period last year.
Software continues to expand its market share presence. DVD video grew to $49.8 million in the
first nine months of fiscal 2007 from $41.1 million in first nine months of fiscal 2006 and video
games increased to $37.4 million in the first nine months of fiscal 2007 from $33.5 million for the
same period last year, due to increased publisher and customer rosters and strong releases
throughout the period. We believe that future sales increases will be dependent on our ability to
continue to add new, appealing content and upon the strength of the retail environment as a whole.
Gross Profit
Gross profit for the distribution segment was $52.9 million or 10.8% as a percent of net sales
for the nine month period of fiscal 2007 compared to $45.6 million or 9.7% as a percent of net
sales for the same period of fiscal 2006. The increase in gross profit as a percent of net sales
for the nine month period of fiscal 2007 was due to a shift in sales mix to higher gross margin
products. Also, prior year gross profit was negatively impacted by the write-off of balances of
$4.1 million related to an independent music label. We expect gross profit to fluctuate depending
principally upon the make-up of product sales each quarter.
Operating Expenses
Total operating expenses for the distribution segment were $47.8 million or 9.8% as a percent
of net sales for the nine month period of fiscal 2007 compared to $52.9 million or 11.3% as a
percent of net sales for the same period of fiscal 2006. Overall, operating expenses decreased in
fiscal 2007; particularly, bad debt expense, which was partially offset by an increase in
distribution and warehousing and general and administrative expenses.
Selling and marketing expenses for the distribution segment were $12.4 million or 2.5% as a
percent of net sales for the nine month period of fiscal 2007 compared to $12.9 million or 2.8% as
a percent of net sales for the same period of fiscal 2006. The slight decrease for the nine month
period of fiscal 2007 resulted from decreased sales commissions. Freight costs were $8.4 million or
1.7% as a percent of sales in the nine month period of fiscal 2007 compared to $8.3 million or 1.8%
for the same period of fiscal 2006. Sales commissions decreased due to outside sales commissions
rate changes relating to merchandising services at a major mass merchandiser.
29
Distribution and warehousing expenses for the distribution segment were $9.4 million or 1.9%
as a percent of net sales for the nine month period of fiscal 2007 compared to $7.5 million or 1.6%
as a percent of net sales for the same period of fiscal 2006. The increase in distribution and
warehousing expenses is primarily due to an increase in total units handled.
General and administrative expenses for the distribution segment consist principally of
executive, accounting and administrative personnel and related expenses, including professional
fees. General and administrative expenses for the distribution segment were $22.6 million or 4.6%
as a percent of net sales for the nine months of fiscal 2007 compared to $21.9 million or 4.7% as a
percent of net sales for the same period of fiscal 2006. The total fluctuation between periods
reflected higher expenses for the nine month period of fiscal 2007 including increased salary and
bonus expense, increased information technology expenses due to the implementation of an enterprise
resource planning system, increased rent expense, and share-based compensation expense. These increases were partially offset by decreases in professional fees and
group health expense.
Bad debt expense for the distribution segment was $1.5 million for the nine month period of
fiscal 2007 compared to $9.0 million in the same period last year. The nine month period of fiscal
2007 and 2006 included the write-off of accounts receivable due to the bankruptcy of retailers of $1.5 million and $9.0 million, respectively.
Depreciation and amortization for the distribution segment was $1.9 million for the first nine
months of fiscal 2007 compared to $1.7 million for the same period of fiscal 2006.
Net operating income for the distribution segment was $5.1 million for the nine month period
of fiscal 2007 compared to a net operating loss of $7.3 million for same period of fiscal 2006.
Publishing Segment
The publishing segment includes Encore, BCI and FUNimation. We acquired FUNimation on May 11,
2005, and the results of FUNimation are included from the date of acquisition.
Fiscal 2007 Third Quarter Results Compared With Fiscal 2006 Third Quarter
Net Sales
Net sales for the publishing segment were $35.0 million (before inter-company eliminations)
for the third quarter fiscal 2007 compared to $35.9 million (before inter-company eliminations) for
the third quarter fiscal 2006. The 2.5% decrease in net sales was primarily due to a softness in
net sales due to a decline in certain PC software and DVD categories, offset by strong anime home
video net sales from releases which included BlackCat,
Basilisk, Fullmetal Panic, Trinity Blood and two Dragon Ball
Z movie 3-packs. We believe that future sales increases will be dependent on our ability to
continue to add new, appealing content and upon the strength of the retail environment as a whole.
Gross Profit
Gross profit for the publishing segment was $13.9 million or 39.7% as a percent of net sales
for third quarter of fiscal 2007 compared to $13.0 million or 36.0% as a percent of net sales for
third quarter of fiscal 2006. The increase in gross profit as a percent of net sales for the nine
month period of fiscal 2007 was due to a shift in sales mix to higher gross margin products.
Operating Expenses
Total operating expenses for the publishing segment were $9.0 million or 25.6% as a percent of
net sales for the third quarter of fiscal 2007 compared to $12.2 million or 33.8% as a percent of
net sales for the third quarter of fiscal 2006. The expense decrease in the third quarter of fiscal
2007 was primarily due to a decrease in bad debt expense of $3.0 million. The third quarter of
fiscal 2006 included the bankruptcy of a retailer.
The publishing segment had net operating income of $4.9 million for the third quarter of
fiscal 2007 compared to net operating income of $799,000 for the third quarter of fiscal 2006.
30
Fiscal 2007 Nine Months Results Compared With Fiscal 2006 Nine Months
Net Sales
Net sales for the publishing segment were $95.8 million (before inter-company eliminations)
for the nine month period of fiscal 2007 compared to $93.8 million (before inter-company
eliminations) for the same period of fiscal 2006. FUNimation contributed $42.0 million of net sales
during the nine month period of fiscal 2007. The 2.1% increase in net sales for the publishing
segment is primarily due to a strong performance of our new releases, the Dragon Ball Z Movie 13,
Wrath of the Dragon and the Fullmetal Alchemist movie, Conqueror of Shamballa, during the nine
month period of fiscal 2007. The publishing segment also realized a softness in net sales due to a
decline in certain PC software and DVD categories. We believe that future sales increases will be
dependent on our ability to continue to add new, appealing content and upon the strength of the
retail environment as a whole.
Gross Profit
Gross profit for the publishing segment was $38.4 million or 40.0% as a percent of net sales
for the nine month period of fiscal 2007 compared to $35.8 million or 38.2% as a percent of net
sales for the nine month period of fiscal 2006. The gross margin rate increase was due to a shift
to higher margin products for the nine month period of fiscal 2007.
Operating Expenses
Operating expenses for the publishing segment were $27.0 million or 28.2% as a percent of net
sales for the nine month period of fiscal 2007 compared to $28.4 million or 30.2% as a percent of
net sales for the same period of fiscal 2006. The expense decrease in the nine month period of
fiscal 2007 was primarily due to the decrease in bad debt expense,
partially offset by the full contribution of FUNimation in the nine
month period of fiscal 2007. The nine months of fiscal year 2006 included bad debt expense related
to the bankruptcy of a retailer.
The publishing segment had net operating income of $11.3 million for the nine month period of
fiscal 2007 compared to net operating income of $7.5 million for the same period of fiscal 2006.
Other Segment
The other segment included the operations of Mix & Burn, a consolidated VIE. The VIE was
deconsolidated as of December 1, 2005 due to our determination that it was no longer primary
beneficiary as defined by FIN 46(R).
Fiscal 2007 Third Quarter Results Compared With Fiscal 2006 Third Quarter
There were no sales for the other segment in the third quarter of fiscal 2007 due to the
deconsolidation in December 2005 compared to net sales of $169,000 (before inter-company
eliminations) for the third quarter of fiscal 2006. Gross profit was $36,000 or 21.3% as a percent
of net sales for the third quarter of fiscal 2006. Total operating expenses were $523,000 for the
third quarter of fiscal 2006. The other segment had a net operating loss of $487,000 for the third
quarter of fiscal 2006.
Fiscal 2007 Nine Months Results Compared With Fiscal 2006 Nine Months
There were no sales for the other segment in the nine months ended December 31, 2006 due to
the deconsolidation in December 2005 compared to net sales of $424,000 (before inter-company
eliminations) for the nine months ended December 31, 2005. Gross profit was $81,000 or 19.1% as a
percent of net sales for the nine months ended December 31, 2005. Total operating expenses were
$1.7 million for the nine months ended December 31, 2005. The other segment had a net operating
loss of $1.6 million for the nine months ended December 31, 2005.
Consolidated Other Income and Expense
Interest expense was $2.1 million for third quarter of fiscal 2007 compared to $3.0 million
for third quarter of fiscal 2006. Interest expense was $6.0 million for the nine month period of
fiscal 2007 compared to $8.2 million for the same period of fiscal 2006. The
31
decrease in interest expense for third quarter and nine months of fiscal 2007 is a result of a
reduction of debt. Other income (expense) items for the three months ended December 31, 2006 of
$(121,000) consisted primarily of interest income of $42,000 and a foreign currency exchange loss
of $242,000. Other income (expense) items for the three months ended December 31, 2005 of $1.9
million consisted primarily of the deconsolidation of a variable interest entity. Other income
(expense) items for the nine months ended December 31, 2006 of $(107,000) consisted primarily of
interest income of $251,000 on available cash balances, warrant expense of $251,000, other income
of $123,000 and a foreign currency exchange loss of $244,000. Other income (expense) items for the
nine months ended December 31, 2005 of $2.9 million consisted primarily of the gain on
deconsolidation of a variable interest entity of $1.9 million, a vendor contract buy-out of
$375,000 and interest income of $601,000 on available cash balances.
Consolidated Income Tax Expense
Our effective tax rate was 38.3% for the three months ended December 31, 2006 and 41.8% for
the three months ended December 31, 2005. Our effective tax rate for the third quarter of fiscal
2007 was lower than third quarter of fiscal 2006 due to the inclusion of the net operating loss of
the VIE in fiscal 2006, which did not have a tax benefit to the consolidated financial statements.
The Companys effective tax rate was 38.9% for the nine months ended December 31, 2006 and 37.3%
for the same period last year.
Market Risk
Our exposure to changes in interest rates results from borrowings used primarily to fund the
FUNimation acquisition. We use derivative financial instruments to manage the interest rate risks
associated with a portion of its variable interest rate indebtedness. As of December 31, 2006 we
had $76.4 million of indebtedness, of which approximately $24.6 million was subject to interest
rate fluctuations. Based on these borrowings subject to interest rate fluctuations outstanding on
December 31, 2006, a 100-basis point change in LIBOR would cause our annual interest expense to
change by $246,000.
Seasonality and Inflation
Quarterly operating results are affected by the seasonality of our business. Specifically, our
third quarter (October 1December 31) typically accounts for our largest quarterly revenue figures
and a substantial portion of our earnings. Our trends in fiscal 2006 were negatively impacted by
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 material 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
Operating Activities
Cash provided by operating activities for the nine months of fiscal 2007 was $5.7 million and
cash used in operating activities for the nine months of fiscal 2006 was $16.9 million. The net
cash provided by operating activities for the nine months of fiscal 2007 mainly reflected our net
income, combined with various non-cash charges, including depreciation and amortization of $15.7
million, a change in the fair market value of warrants of $251,000, deferred compensation expense
of $811,000, a change in deferred revenue of $610,000, and share-based compensation expense of
$520,000, offset by a change in deferred income taxes of $1.5 million and by our working capital
demands. The following are changes in the operating assets and liabilities during the nine months
ended December 31, 2006: accounts receivable increased by $48.2 million, reflecting the increase in
and timing of sales and seasonality; inventories increased by $5.4 million, primarily reflecting higher inventories
required by increased sales activities; prepaid expenses increased by $5.4 million, primarily
reflecting royalty advances in the publishing segment; production costs and license fees increased
$2.8 million and $7.5 million, respectively, due primarily to new content acquisitions; income
taxes receivable decreased $4.4 million primarily due to timing of required tax payments and tax
refunds; other assets decreased $1.3 million due primarily to amortization and recoupments;
accounts payable increased $48.3 million, primarily as a result
of timing of disbursements, seasonality and
increased inventories; income taxes payable increased by $1.6 million due to required tax payments;
and accrued expenses decreased $3.5 million primarily as a result of decreased interest expense
accrual and royalty payments.
The net cash used in operating activities in the nine months of fiscal 2006 of $16.9 million
was primarily the result of a net loss combined with various non-cash charges, including
depreciation and amortization of $14.2 million, offset by a change in deferred taxes of $1.5
million, a gain on deconsolidation of a variable interest entity of $1.9 million and by our working
capital demands.
32
Investing Activities
Cash flows used in investing activities totaled $5.7 million for the nine months of fiscal
2007 and $100.3 million for the same period last year. Acquisition of property and equipment and
acquisition of intangible assets totaled $4.2 million and $1.1 million, respectively, for the nine
months of fiscal 2007. Acquisition of property and equipment for the nine months of fiscal 2006
were $1.4 million. Acquisition of businesses totaled $98.1 million for the nine months of fiscal
2006 consisting of the acquisition of FUNimation. Payments of earn-outs related to the BCI
acquisition totaled $350,000 for each nine month period in fiscal 2007 and 2006, respectively.
Financing Activities
Cash flows used in financing activities totaled $3.6 million for the nine months of fiscal
2007 and cash flows provided by financing activities totaled $116.1 million for the nine months of
fiscal 2006. We had repayments of notes payable of $3.8 million in the nine months of fiscal 2007
and net proceeds from notes payable of $118.6 million and debt issuance costs of $2.9 million for
the nine months of fiscal 2006. We recorded proceeds from the exercise of common stock options and
warrants of $421,000 and $484,000 for the nine months of fiscal 2007 and 2006, respectively. During
the nine months ended December 31, 2006, the maximum amount borrowed on the revolving line of
credit was approximately $9.0 million. At December 31, 2006 there were no amounts borrowed on the
revolving line of credit. We anticipate that we may borrow amounts under this revolving credit
facility from time to time during fiscal 2007 to meet seasonal working capital needs.
We continually monitor our actual and forecasted cash flows, our liquidity and our capital
resources, enabling us to plan for our present needs to fund projected increases in accounts
receivable, inventory and payment of obligations to creditors and fund unbudgeted business
activities that may arise during the year as a result of changing business conditions or new
opportunities. In addition to working capital needs for the general and administrative costs of our
ongoing operations, we have cash requirements for: (1) investments in our publishing segment in
order to license content; (2) investments in our distribution segment in order to sign exclusive
distribution agreements; (3) equipment needs for our operations; (4) amounts payable to our Chief
Executive Officer upon retirement; and (5) amounts payable in connection with the licensing and
implementation of an enterprise resource planning system that we have undertaken. During the nine
months of fiscal 2007, we invested approximately $24.7 million, before recoveries, in connection
with the acquisition of licensed and exclusively distributed product in our publishing and
distribution segments. Additionally, we had cash outlays of $3.1 million in connection with the
licensing and implementation of our enterprise resource planning system during the nine months
ended December 31, 2006.
Our credit agreement currently provides a six-year $115.0 million Term Loan B sub-facility and
a five-year revolving sub-facility for up to $25.0 million. The revolving sub-facility of up to
$25.0 million is available for working capital and general corporate needs. During the nine months
of fiscal 2007, we made payments of $3.8 million to reduce the amounts outstanding of the Term Loan
B sub-facility. As of December 31, 2006, we had $76.4 million outstanding on the Term B
sub-facility and no borrowings on the revolving sub-facility, respectively. 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 we may lend to our
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 as of December 31,
2006.
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, other cash needs, and to finance expansion plans and strategic
initiatives for the remainder of this fiscal year and otherwise in the foreseeable future, absent
significant acquisitions. 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 as of December 31,
2006 by fiscal year (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less |
|
|
|
|
|
|
|
|
|
|
More |
|
|
|
|
|
|
|
than 1 |
|
|
2 3 |
|
|
4 5 |
|
|
than 5 |
|
|
|
Total |
|
|
Year |
|
|
Years |
|
|
Years |
|
|
Years |
|
Operating leases |
|
$ |
25,975 |
|
|
$ |
743 |
|
|
$ |
6,003 |
|
|
$ |
4,481 |
|
|
$ |
14,748 |
|
Capital leases |
|
|
315 |
|
|
|
38 |
|
|
|
209 |
|
|
|
68 |
|
|
|
|
|
Note payable |
|
|
76,380 |
|
|
|
1,250 |
|
|
|
10,000 |
|
|
|
10,000 |
|
|
|
55,130 |
|
License and distribution agreement |
|
|
23,580 |
|
|
|
4,875 |
|
|
|
18,580 |
|
|
|
125 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
126,250 |
|
|
$ |
6,906 |
|
|
$ |
34,792 |
|
|
$ |
14,674 |
|
|
$ |
69,878 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
33
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Information with respect to disclosures about market risk is contained in the section entitled
Managements Discussion and Analysis of Financial Condition and Results of Operations Market
Risk in this Form 10-Q.
Item 4. Controls and Procedures
(a) Controls and Procedures
As of the end of the period covered by this report, the Company conducted an evaluation, under
the supervision and with the participation of the Companys Chief Executive Officer and Chief
Financial Officer, of the Companys disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on this
evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of December
31, 2006, the Companys disclosure controls and procedures were effective to ensure that
information required to be disclosed by the Company in reports that it files or submits under the
Securities Exchange Act is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commissions rules and forms.
(b) Change in Internal Controls over Financial Reporting
There were no changes in the Companys internal controls over financial reporting during its
most recently completed quarter that have materially affected or are reasonably likely to
materially affect its internal control over financial reporting, as defined in Rule 13a-15(f) under
the Exchange Act.
34
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Litigation discussion in Note 21 to the Companys consolidated financial statements
included herein.
Item 1A. Risk Factors
Information regarding risk factors appears in Managements Discussion and Analysis of
Financial Condition and Results of Operations Forward-Looking Statements / Important Risk
Factors in Part 1 Item 2 of this Form 10-Q and in Part 1 Item 1A of our Annual Report on Form
10-K for the fiscal year ended March 31, 2006. Except for the following, which was originally filed
in Item 1A of our Quarterly Report on Form 10-Q for the period ended June 30, 2006, there have
been no material changes from the risk factors previously disclosed in our Annual Report of Form
10-K:
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 managements evaluation as well as evaluate our internal
control structure and procedures. As we disclosed in our Managements Report on Internal Control
over Financial Reporting set forth in Part II, Item 9A Controls and Procedures of our Annual
Report on Form 10-K for the period ended March 31, 2005 and our discussion of Internal Control
over Financial Reporting set forth in Part I, Item 4 Controls and Procedures of our quarterly
filings on Form 10-Q and 10-Q/A for the periods ended June 30, 2005 and September 30, 2005, we
concluded that our internal controls over financial reporting were not effective based on
applicable evaluation criteria as of the end of these periods as a result of our identification of
material weaknesses (as defined by the Public Company Accounting Oversight Board in its Auditing
Standard No. 2, An Audit of Internal Control over Financial Reporting Performed in Conjunction
with an Audit of Financial Statements). These material weaknesses related to the Company not
maintaining effective controls over the accounting for certain compensation and severance
arrangements, not maintaining effective controls over the accounting for income taxes and not
maintaining effective controls over the identification and determination of appropriate accounting
treatment for certain business relationships it had with entities that were variable interest
entities under Financial Accounting Standards Board Interpretation Number 46 (revised December
2003), Consolidation of Variable Interest Entities (FIN 46(R)). Although the Company believes it
has remediated the stated material weaknesses in internal controls over financial reporting and
strengthened its controls and procedures, if any of these efforts prove ineffective or if any
additional material weaknesses are identified in the future, we may not be able to address these
issues in a timely or efficient manner and our ability to report our financial results on a timely
and accurate basis may be adversely affected.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities
None.
35
Item 4. Submission of Matters to a Vote of Securities Holders
None
Item 5. Other Information
None
Item 6. Exhibits
|
(a) |
|
The following exhibits are included herein: |
|
|
|
31.1
|
|
Certification of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the
Exchange Act) |
|
|
|
31.2
|
|
Certification of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the
Exchange Act) |
|
|
|
32.1
|
|
Certification of the Chief Executive Officer pursuant Section 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) |
|
|
|
32.2
|
|
Certification of the Chief Financial Officer pursuant Section 906 of
the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350) |
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
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Navarre Corporation |
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|
|
(Registrant) |
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|
|
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|
|
|
Date: February 9, 2007
|
|
/s/ Cary L. Deacon
Cary L. Deacon
|
|
|
|
|
Chief Executive Officer |
|
|
|
|
(Principal Executive Officer) |
|
|
|
|
|
|
|
Date: February 9, 2007
|
|
/s/ J. Reid Porter
|
|
|
|
|
J. Reid Porter |
|
|
|
|
Chief Financial Officer (Principal Financial and |
|
|
|
|
Accounting Officer) |
|
|
37