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NAVARRE CORP /MN/ - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
(Edgar Glimpses Via Acquire Media NewsEdge) Overview
We are a distributor and provider of complete logistics solutions for
traditional and e-commerce retail channels. Our solutions support both
direct-to-consumer ("DTC") and business-to-business ("B2B") sales channels. We
are also a publisher of computer software.
Since our founding in 1983, we have established distribution relationships with
major retailers including Best Buy, Wal-Mart/Sam's Club, Apple, Amazon, Costco
Wholesale Corporation, Staples, Target, Office Depot and OfficeMax, and we
distribute to nearly 31,000 retail and distribution center locations throughout
the United States and Canada. We believe our established relationships
throughout the supply chain permit us to offer products to our internet-based
and retail customers and to provide our vendors with access to broad retail
channels. In order to participate in the growing revenue streams resulting from
e-commerce and fulfillment services, we are expanding the business services we
offer.
Our business operates through two business segments - Distribution and
Publishing.
Through our distribution business, we distribute computer software, consumer
electronics and accessories and video games, and provide fee-based logistical
services. Our distribution business focuses on providing a range of value-added
services, including electronic and internet-based ordering and gift card
fulfillment. Through our publishing business, we own or license various computer
software brands. Our publishing business packages, brands, markets and sells
directly to consumers, retailers, third-party distributors and our distribution
business. Our publishing business currently consists of Encore Software, Inc.
("Encore").
Encore publishes a variety of software products for the PC and Mac platforms.
These products fall mainly into the print, personal productivity, education,
family entertainment, and home and landscape architectural design software
categories. In addition to retail publishing, Encore also sells directly to
consumers through its e-commerce websites.
During October 2011, we implemented a series of initiatives, including a
reduction in workforce and simplification of business structures and processes
across the Company's operations. Substantially all restructuring activities were
complete by March 31, 2012. These actions were intended to increase operating
efficiencies and provide additional resources to invest in product lines and
service categories in order to execute our long-term growth strategy. In
conjunction with the initiatives described above, we reviewed our portfolio of
businesses to identify poor performing activities and areas where continued
business investments would not meet our requirements for financial returns
(collectively, "Restructuring Plan"). During the six months ended September 30,
2012, cash expenditures related to the Restructuring Plan were approximately
$1.9 million.
Recent events
On September 27, 2012, the Company and SpeedFC Inc., a Delaware corporation
("SpeedFC") entered into an Agreement and Plan of Merger (the "Merger
Agreement") by and among Navarre, SFC Acquisition Co., Inc., a Minnesota
corporation and wholly-owned subsidiary of Navarre, (the "Merger Subsidiary"),
SpeedFC, the existing stockholders and optionholders of SpeedFC (together
referred to herein as the "SFC Equityholders"), and Jeffrey B. Zisk, the current
President and Chief Executive Officer of SpeedFC (in the capacity as SFC
Equityholders' representative). The Company intends to acquire SpeedFC through a
merger of SpeedFC with and into Merger Subsidiary, which shall be the Surviving
Corporation (the "Merger"). On October 29, 2012, the parties entered into
Amendment No. 1 to the Merger Agreement (the "Amendment").
In exchange for all of the SFC Equityholders' equity interests in SpeedFC, the
Merger Agreement, as amended, states that the Company will provide initial
consideration of $50.0 million in cash and shares of Navarre common stock, with
additional contingent payments in cash and common stock available as described
below. The initial consideration is comprised of: (i) $25.0 million to be paid
in cash at closing (less certain escrow and holdback amounts, and subject to
certain net working capital and post-closing adjustments); and (ii) $25.0
million worth of shares of Navarre common stock, or 17,095,186 shares, to be
issued at closing. The contingent consideration is subject to the achievement of
certain financial performance metrics by SpeedFC (together with its subsidiary
and Merger Sub) in the 2012 calendar year, which, if met, would require: (i) the
payment of up to a maximum of $5.0 million in cash consideration, with up to a
maximum of $1.25 million payable in early 2013 and up to a maximum of $3.75
million (before interest of five percent per annum) payable in equal, quarterly
installments beginning in late 2013 and ending on February 29, 2016 (the
"Amended Contingent Cash Payment") and (ii) the issuance of up to 6,287,368
shares of our Common Stock to the SFC Equityholders, with up to 2,215,526
("Amended First Equity Amount") shares payable in early 2013, up to 738,509
shares ("Amended Second Equity Amount") payable in late 2013 (both such share
amounts being calculated based on the Average Parent Stock Price as of October
25, 2012 or $1.6926) and the original 3,333,333 shares payable at the same time
as the Amended Second Equity Amount (all equity amounts together, the "Amended
Contingent Equity Payment"). The Amended Contingent Cash Payment and Amended
Contingent Equity Payment amounts are subject to certain escrow conditions and
adjustments in connection with the measurement periods for evaluation of the
achievement of financial performance metrics. As a result of the Amendment, a
total of 23,382,554 shares of Navarre Common Stock could be issued in connection
with the SpeedFC Merger Agreement, if all contingent amounts are fully earned.
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Consummation of the transaction remains subject to customary conditions,
including the approval of the issuance of certain of the shares in connection
with the Merger by the shareholders of the Company, and the Company obtaining
satisfactory financing for the transaction. At its upcoming annual meeting, the
Company's shareholders will be asked to consider and vote upon, among other
things, the proposal to approve the issuance of certain of the shares of the
Company's common stock in connection with the Merger.
The Company and SpeedFC have made customary representations and warranties in
the Merger Agreement and agreed to certain customary covenants, including
covenants regarding operation of the businesses of the companies and their
subsidiaries prior to the closing.
Pursuant to the Merger Agreement, the SFC Equityholders have agreed to indemnify
Navarre for a number of items, including, among others, adverse consequences
resulting from breaches of representations, warranties and covenants and certain
identified liabilities. These indemnification obligations do not arise until the
losses exceed $250,000 and the parties indemnification obligations cannot exceed
a specified amount.
Additionally, the Merger Agreement provides that immediately after the closing
of the Merger the Company will increase the size of its board of directors by
two members and will appoint Jeffrey B. Zisk, the president and chief executive
officer and a director of SpeedFC, and M. David Bryant, also a director of
SpeedFC, to fill those vacancies.
The Merger Agreement contains certain termination rights for each of the Company
and SpeedFC and further provides that, upon termination of the Merger Agreement
in certain circumstances, either Navarre or SpeedFC may be required to pay an
expense reimbursement related to the legal, accounting and other reasonable
out-of-pocket costs associated with preparing, negotiating and performing the
obligations in connection with the Merger.
The Merger Agreement provides that, on the closing date of the Merger, the
Company will enter into a registration rights agreement (the "Registration
Rights Agreement") with the SFC Equityholders which will require Navarre to
provide the SFC Equityholders certain demand and piggyback registration rights
with respect to registered public offerings that the Company may effect for its
own account or for the benefit of other selling shareholders.
The Merger Agreement also provides that on the closing date of the Merger, the
Company will enter into an employment agreement with Jeffrey B. Zisk, who will
serve as president of the subsidiary Surviving Corporation.
Executive Summary
Consolidated net sales for the second quarter of fiscal 2013 decreased 2.3% to
$104.1 million compared to $106.6 million for the second quarter of fiscal 2012.
This $2.5 million decrease in net sales was primarily due to our transition out
of the home video product category which generated $6.1 million of net sales in
the second quarter of fiscal 2012. In addition, net sales increased $7.2 million
for our software and publishing products (before intercompany eliminations) due
to expanded distribution to existing and new customers, partially offset by a
decrease in net sales in the video game category of $3.4 million compared to the
second quarter of fiscal 2012.
Our gross profit decreased to $12.1 million, or 11.6% of net sales, in the
second quarter of fiscal 2013 compared to $12.6 million, or 11.8% of net sales,
for the same period in fiscal 2012. The $479,000 and 3.8% decrease in gross
profit was principally due to a higher volume of lower gross profit margin
products within the distribution segment and offset by higher gross profit
margin software titles in the publishing segment.
Total operating expenses for the second quarter of fiscal 2013 were $11.3
million, or 10.9% of net sales, compared to $14.2 million, or 13.3% of net
sales, in the same period for fiscal 2012. The $2.9 million decrease was
primarily due to operating efficiencies resulting from the Restructuring Plan.
Net income for the second quarter of fiscal 2013 was $488,000 or $0.01 per
diluted share compared to a net loss of $1.2 million or $0.03 per diluted share
for the same period last year.
Consolidated net sales for the six months ended September 30, 2012 decreased
7.2% to $195.4 million compared to $210.6 million for the first six months of
fiscal 2012. This $15.2 million decrease in net sales was primarily due to our
transition out of the home video product category which generated $16.4 million
of net sales in the first six months of fiscal 2012. In addition, net sales
increased $9.5 million (before intercompany eliminations) for our consumer
electronics and accessories products and due to the distribution of new products
to existing and new customers, partially offset by a decrease in net sales in
the software and video games categories of $8.1 million (before intercompany
eliminations) compared to the first six months of fiscal 2012.
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Our gross profit decreased to $22.2 million, or 11.3% of net sales, for the
first six months of fiscal 2013 compared to $26.4 million, or 12.5% of net
sales, for the same period in fiscal 2012. The $4.2 million and 16.0% decrease
in gross profit was principally due to a higher volume of lower gross profit
margin products within the distribution segment.
Total operating expenses for the first six months of fiscal 2013 were $21.9
million, or 11.2% of net sales, compared to $28.6 million, or 13.6% of net
sales, in the same period for fiscal 2012. The $6.7 million decrease was
primarily due to operating efficiencies resulting from the Restructuring Plan.
Net loss for the first six months of fiscal 2013 was $83,000 or zero per diluted
share compared to net loss of $1.9 million or $0.05 per diluted share for the
same period last year.
Working Capital and Debt
Our business is working capital intensive and requires significant levels of
working capital primarily to finance accounts receivable and inventories. We
finance our operations through cash and cash equivalents, funds generated
through operations, accounts payable and our revolving credit facility. The
timing of cash collections and payments to vendors may require usage of our
revolving credit facility in order to fund our working capital needs. "Checks
written in excess of cash balances" can occur from time to time, including
period ends, and represent payments made to vendors that have not yet been
presented by the vendor to our bank, and therefore a corresponding advance on
our revolving line of credit has not yet occurred. On a terms basis, we extend
varying levels of credit to our customers and receive varying levels of credit
from our vendors. During the last twelve months, we have not had any significant
changes in the terms extended to customers or provided by vendors which would
have a material impact to the reported financial statements.
On November 12, 2009, we entered into a three year, $65.0 million revolving
credit facility (the "Credit Facility") with Wells Fargo Foothill, LLC as agent
and lender, and a participating lender. On December 29, 2011, the Credit
Facility was amended to eliminate the participating lender, reduce the revolving
credit facility limit to $50.0 million, provide for an additional $20.0 million
under the Credit Facility under certain circumstances and extend the maturity
date to December 29, 2016. The Credit Facility is secured by a first priority
security interest in all of our assets, as well as the capital stock of our
companies. Additionally, the Credit Facility, as amended, calls for monthly
interest payments at the bank's base rate (as defined in the Credit Facility)
plus 1.25%, or LIBOR plus 2.25%, at our discretion.
At both September 30, 2012 and March 31, 2012 we had zero outstanding on the
Credit Facility. Amounts available under the Credit Facility are subject to a
borrowing base formula. Changes in the assets within the borrowing base formula
can impact the amount of availability. Based on the facility's borrowing base
and other requirements at such dates, we had excess availability of $29.4
million and $30.4 million at September 30, 2012 and March 31, 2012,
respectively. At September 30, 2012, we were in compliance with all covenants
under the Credit Facility and we currently believe that we will be in compliance
with all covenants during the next twelve months.
In association with, and per the terms of the Credit Facility, we also pay and
have paid certain facility and agent fees. Weighted-average interest on the
Credit Facility was 4.25% at both September 30, 2012 and March 31, 2012. Such
interest amounts have been, and continue to be, payable monthly.
Forward-Looking Statements / Risk Factors
We make written and oral statements from time to time regarding our business and
prospects, such as projections of future performance, statements of management's
plans and objectives, forecasts of market trends, and other matters that are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements
containing the words or phrases "will likely result," "are expected to," "will
continue," "is anticipated," "estimates," "projects," "believes," "expects,"
"anticipates," "intends," "target," "goal," "plans," "objective," "should" or
similar expressions identify forward-looking statements, which may appear in
documents, reports, filings with the SEC, including this Quarterly 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. 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.
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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 statement will be achieved. Any
forward-looking statement made by or on behalf of us speaks only as of the date
on which such statement is made. Our forward-looking statements are based on
assumptions that are sometimes based upon estimates, data, communications and
other information from suppliers, government agencies and other sources that may
be subject to revision. Except as required by law, we do not undertake any
obligation to update or keep current either (i) any forward-looking statement to
reflect events or circumstances arising after the date of such statement, or
(ii) the important factors that could cause our future results to differ
materially from historical results or trends, results anticipated or planned by
us, or which are reflected from time to time in any forward-looking statement
which may be made by or on behalf of us.
In addition to other matters identified or described by us from time to time in
filings with the SEC, there are several important factors that could cause our
future results to differ materially from historical results or trends, results
anticipated or planned by us, or results that are reflected from time to time in
any forward-looking statement that may be made by or on behalf of us. Some of
these important factors, but not necessarily all important factors, include the
following: our revenues being derived from a small group of customers; our
dependence on significant vendors and manufacturers and the popularity of their
products; technological developments, particularly software as a service
application, electronic transfer and downloading could adversely impact sales,
margins and results of operations; inability to adapt to evolving technological
standards; some revenues are dependent on consumer preferences and demand; our
restructuring efforts may have unpredictable outcomes, including the possibility
of us incurring additional restructuring charges; a deterioration in businesses
of significant customers could harm our business; the seasonality and
variability in our business and decreased sales could adversely affect our
results of operations; growth of non-U.S. sales and operations could
increasingly subject us to additional risks that could harm our business; the
extent to which our insurance does not mitigate the risks facing our business or
our insurers are unable to meet their obligations, our operating results may be
negatively impacted; increased counterfeiting or piracy may negatively affect
demand for our home entertainment products; we may not be able to protect our
intellectual property rights; the failure to diversify our business could harm
us; the loss of key personnel could affect the depth, quality and effectiveness
of the management team; our ability to meet our significant working capital
requirements or if working capital requirements change significantly; product
returns or inventory obsolescence could reduce sales and profitability or
negatively impact our liquidity; the potential for inventory values to decline;
impairment in the carrying value of our assets could negatively affect
consolidated results of operations; our credit exposure or negative product
demand trends or other factors could cause credit loss; our ability to
adequately and timely adjust cost structure for decreased demand; our ability to
compete effectively in distribution and publishing, which are highly competitive
industries; our dependence on third-party shipping and fulfillment for the
delivery of our product; our reliance on third-party subcontractors for certain
of our business services; developing software is complex, costly and uncertain
and operational errors or defects in such products could result in liabilities
and/or impair such products' marketability; our dependence on information
systems; future acquisitions or divestitures could disrupt business; future
acquisitions could result in potentially unsuccessful integration of acquired
companies; interruption of our business or catastrophic loss at any of our
facilities could curtail or shutdown our business; future terrorist or military
activities could disrupt our operations or harm assets; we may be subject to one
or more jurisdictions asserting that we should collect or should have collected
sales or other taxes; our ability to use net operating loss carryforwards to
reduce future tax payments may be limited; we may be unable to refinance our
debt facility; our debt agreement limits operating and financial flexibility; we
may incur additional debt; changes to financial standards could adversely affect
our reported results of operations; our e-Commerce business has inherent
cybersecurity risks that may disrupt our business; fluctuations in stock price
could adversely affect our ability to raise capital or make our securities
undesirable; the exercise of outstanding options could adversely affect our
stock price; our anti-takeover provisions, our ability to issue preferred stock
and our staggered board may discourage takeover attempts beneficial to
shareholders; we do not intend to pay dividends on common stock, thus
shareholders should not expect a return on investment through dividend payments;
and our 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, 2012 and other public filings and disclosures. Investors and
shareholders are urged to read these documents carefully.
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Critical Accounting Policies
We consider our critical accounting policies to be those related to revenue
recognition, allowance for doubtful accounts, goodwill and intangible assets,
impairment of long-lived assets, inventory valuation, share-based compensation,
income taxes, restructuring charges, and contingencies and litigation. There
have been no material changes to these critical accounting policies as discussed
in greater detail under this heading in Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations in our Annual Report
on Form 10-K for the year ended March 31, 2012.
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 evaluation 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 Six Months Ended
September 30, September 30,
(Unaudited) (Unaudited)
2012 2011 2012 2011
Net sales:
Distribution $ 101,671 $ 104,037 $ 190,721 $ 205,771
Publishing 7,081 6,315 12,499 13,522
Net sales before inter-company eliminations 108,752 110,352 203,220 219,293
Inter-company sales (4,620 ) (3,784 ) (7,816 ) (8,709 )
Net sales as reported $ 104,132 $ 106,568 $ 195,404 $ 210,584
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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 and Comprehensive Loss.
Three Months Ended Six Months Ended
September 30, September 30,
(Unaudited) (Unaudited)
2012 2011 2012 2011
Net sales:
Distribution 97.6 % 97.6 % 97.5 % 97.6 %
Publishing 6.8 5.9 6.5 6.4
Inter-company sales (4.4 ) (3.5 ) (4.0 ) (4.0 )
Total net sales 100.0 100.0 100.0 100.0
Cost of sales, exclusive of depreciation 88.4 88.2 88.7 87.5
Gross profit 11.6 11.8 11.3 12.5
Operating expenses
Selling and marketing 4.4 4.7 4.3 4.8
Distribution and warehousing 1.7 2.3 1.8 2.3
General and administrative 4.0 5.4 4.2 5.6
Depreciation and amortization 0.8 0.9 0.8 0.9
Total operating expenses 10.9 13.3 11.1 13.6
Income (loss) from operations 0.7 (1.5 ) 0.2 (1.1 )
Interest income (expense), net (0.2 ) (0.3 ) (0.1 ) (0.3 )
Other income (expense), net 0.1 (0.2 ) (0.1 ) (0.1 )
Income (loss)- before taxes 0.6 (2.0 ) - (1.5 )
Income tax benefit (0.3 ) 0.8 - 0.6
Net income (loss) 0.3 % (1.2 )% - % (0.9 )%
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Distribution Segment
The distribution segment distributes computer software, consumer electronics and
accessories and video games and provides fee-based distribution logistics
services.
Fiscal 2013 Second Quarter Results Compared To Fiscal 2012 Second Quarter
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the distribution segment
decreased $2.3 million, or 2.3%, to $101.7 million for the second quarter of
fiscal 2013 compared to $104.0 million for the second quarter of fiscal 2012.
Net sales in the software product group increased $6.4 million to $83.9 million
during the second quarter of fiscal 2013 from $77.5 million for the same period
last year due to increased demand for our software products. Consumer
electronics and accessories net sales increased with net sales of $15.7 million
during the second quarter of fiscal 2013 compared to $14.8 million for the same
period last year. Video games net sales decreased $3.4 million to $2.2 million
in the second quarter of fiscal 2013 from $5.6 million for the same period last
year, due to fewer video game releases. Home video net sales decreased to zero
in the second quarter of fiscal 2013 from $6.2 million in the second quarter of
fiscal 2012, due to our transition out of home video exclusive content. We
believe future net sales will be dependent upon our ability to continue to add
new, appealing content and upon the strength of the retail environment and
overall economic conditions.
Gross Profit
Gross profit for the distribution segment was $8.4 million, or 8.3% of net
sales, for the second quarter of fiscal 2013 compared to $9.6 million, or 9.2%
of net sales, for the second quarter of fiscal 2012. The $1.2 million or 11.6%
decrease in gross profit margin was primarily due to a increase in volume and a
mix of lower gross profit margin video game products. We expect gross profit
rates to fluctuate depending principally upon the make-up of products sold,
however, we anticipate experiencing similar margin blends going forward.
Operating Expenses
Total operating expenses for the distribution segment were $9.7 million, or 9.5%
of net sales, for the second quarter of fiscal 2013 compared to $11.2 million,
or 10.8% of net sales, for the second quarter of fiscal 2012. Overall expenses
decreased by $1.5 million primarily due to operating efficiencies as a result of
the Restructuring Plan.
Selling and marketing expenses for the distribution segment were consistent at
$3.5 million, or 3.4% of net sales, for the second quarter of fiscal 2013
compared to $3.6 million, or 3.5% of net sales, for the second quarter of fiscal
2012.
Distribution and warehousing expenses for the distribution segment were $1.8
million, or 1.8% of net sales, for the second quarter of fiscal 2013 compared to
$2.5 million, or 2.4% of net sales, for the second quarter of fiscal 2012. The
$694,000 decrease was primarily a result of a reduction in rent expense due to
vacating a warehouse facility during fiscal 2012, in addition to a reduction of
personnel and related costs.
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 $3.7 million, or 3.7% of net sales, for the second
quarter of fiscal 2013 compared to $4.4 million, or 4.2% of net sales, for the
second quarter of fiscal 2012. The $658,000 decrease in the first quarter of
fiscal 2013 was primarily a result of decreased compensation expense.
Depreciation and amortization expense for the distribution segment was $655,000
for the second quarter of fiscal 2013 compared to $763,000 for the second
quarter of fiscal 2012. The $108,000 decrease was primarily due to certain
assets becoming fully depreciated.
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Operating Income (Loss)
Net operating loss for the distribution segment was $1.2 million for the second
quarter of fiscal 2013 compared to net operating loss of $1.7 million for the
second quarter of fiscal 2012.
Fiscal 2013 Six Months Results from Continuing Operations Compared With Fiscal
2012 Six Months
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the distribution segment
decreased $15.1 million, or 7.3%, to $190.7 million for the first six months of
fiscal 2013 compared to $205.8 million for the first six months of fiscal 2012.
Consumer electronics and accessories net sales increased $9.5 million to $36.5
million during the first six months of fiscal 2013 from $27.0 million for the
same period last year due to the distribution of new products to existing
customers and obtaining new customers. The increase in consumer electronics and
accessories net sales substantially offset net sales decline in software
products. Net sales decreased $2.6 million in the software product group to
$149.3 million for the first six months of fiscal 2013 from $151.9 million for
the same period last year primarily due to decreased demand for our software
products. Video games net sales decreased $5.4 million to $4.9 million for the
first six months of fiscal 2013 from $10.4 million for the same period last
year, due to fewer video game releases. Home video net sales decreased to zero
for the first six months of fiscal 2013 from $16.4 million for the first six
months of fiscal 2012, due to our transition out of home video exclusive
content. We believe future net sales will be dependent upon our ability to
continue to add new, appealing content and upon the strength of the retail
environment and overall economic conditions.
Gross Profit
Gross profit for the distribution segment was $15.7 million, or 8.2% of net
sales, for the first six months of fiscal 2013 compared to $19.7 million, or
9.6% of net sales, for the first six months of fiscal 2012. The $4.0 million
decrease in gross profit and the 20.4% decrease in gross profit margin were both
primarily due to decreased software sales and a mix of lower gross profit margin
security and utility software products. We expect gross profit rates to
fluctuate depending principally upon the make-up of products sold.
Operating Expenses
Total operating expenses for the distribution segment were $18.3 million, or
9.6% of net sales, for the first six months of fiscal 2013 compared to $23.6
million, or 11.5% of net sales, for the same period of fiscal 2012. Overall
expenses decreased by $5.3 million primarily due to operating efficiencies as a
result of the Restructuring Plan.
Selling and marketing expenses for the distribution segment decreased $1.1
million to $6.2 million, or 3.3% of net sales, for the first six months of
fiscal 2013 compared to $7.4 million, or 3.6% of net sales, for the first six
months of fiscal 2012. This decrease was primarily due to a reduction in
variable freight costs due to decreased net sales and efficiencies in addition
to a reduction of personnel and related costs.
Distribution and warehousing expenses for the distribution segment were $3.5
million, or 1.8% of net sales, for the first six months of fiscal 2013 compared
to $4.9 million, or 2.4% of net sales, for the same period of fiscal 2012. The
$1.4 million decrease was primarily a result of a reduction in rent expense due
to vacating a warehouse facility during fiscal 2012 in addition to a reduction
of personnel and related costs.
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 $7.3 million, or 3.8% of net sales, for the first
six months of fiscal 2013 compared to $9.8 million, or 4.8% of net sales, for
the first six months of fiscal 2012. The $2.5 million decrease in the first six
months of fiscal 2013 was primarily a result of decreased compensation expense.
Depreciation and amortization for the distribution segment was $1.3 million for
the first six months of fiscal 2013 and $1.6 million the first six months of
fiscal 2012.
Operating (Loss) Income
Net operating loss for the distribution segment was $2.6 million for the first
six months of fiscal 2013 compared to net operating loss of $3.9 million for the
same period of fiscal 2012.
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Publishing Segment
The publishing segment owns or licenses various widely-known computer software
brands through Encore. In addition to sales to retailers, Encore also sells
directly to consumers through its websites.
Fiscal 2013 Second Quarter Results Compared To Fiscal 2012 Second Quarter
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the publishing segment were $7.1
million for the second quarter of fiscal 2013 compared to $6.3 million for the
second quarter of fiscal 2012. The $800,000, or 12.1% increase in net sales, was
primarily due to an increase in retail sales. We believe sales results in the
future will be dependent upon our ability to continue to add new, appealing
content, to develop digitally downloadable products and to access a variety of
sales channels.
Gross Profit
Gross profit for the publishing segment was $3.7 million, or 51.9% of net sales,
for the second quarter of fiscal 2013 compared to $3.0 million, or 48.2% of net
sales, for the second quarter of fiscal 2012. The increase in gross profit
margin percentage is a result of the mix of sales that included an amount of
higher gross profit margin software titles. We expect gross profit rates to
fluctuate depending principally upon the make-up of product sales.
Operating Expenses
Total operating expenses for the publishing segment decreased to $1.7 million,
or 23.7% of net sales, for the second quarter of fiscal 2013, compared to $3.0
million, or 46.9% of net sales, for the second quarter of fiscal 2012.
Selling and marketing expenses for the publishing segment were $1.1 million, or
15.0% of net sales, for the second quarter of fiscal 2013 compared to $1.4
million, or 22.3% of net sales, for the second quarter of fiscal 2012. The
$300,000 decrease was primarily due to personnel and related expense reductions
of $343,000 and advertising expenses of $113,000, offset by an increase in
professional fees of $131,000.
General and administrative expenses for the publishing segment consist
principally of executive, accounting and administrative personnel and related
expenses, including professional fees. General and administrative expenses for
the publishing segment were $458,000, or 6.5% of net sales, for the second
quarter of fiscal 2013, compared to $1.4 million, or 22.0% of net sales, for the
second quarter of fiscal 2012. The $900,000 decrease was primarily due to
personnel and related expense reductions of $531,000, professional fees of
$174,000 and rent related expenses of $101,000.
Depreciation and amortization expense for the publishing segment was $159,000
for the second quarter of fiscal 2013 compared to $164,000 for the second
quarter of fiscal 2012.
Operating Income
The publishing segment had a net operating income of $2.0 million for the second
quarter of fiscal 2013 compared to net operating income of $85,000 for the
second quarter of fiscal 2012.
Fiscal 2013 Six Months Results from Continuing Operations Compared With Fiscal
2012 Six Months
Net Sales (before inter-company eliminations)
Net sales before inter-company eliminations for the publishing segment were
$12.5 million for the first six months of fiscal 2013 compared to $13.5 million
for the same period of fiscal 2012. The $1.0 million, or 7.6% decrease in net
sales, over the prior year six months was primarily due to a decline in retail
sales of print productivity and gaming products, partially offset by an increase
in licensing revenue.
27--------------------------------------------------------------------------------
Gross Profit
Gross profit for the publishing segment was $6.4 million, or 51.6% of net sales,
for the first six months of fiscal 2013 compared to $6.6 million, or 49.1% of
net sales, for the first six months of fiscal 2012. We expect gross profit rates
to fluctuate depending principally upon the make-up of product sales.
Operating Expenses
Total operating expenses decreased $1.4 million for the publishing segment to
$3.5 million for the first six months of fiscal 2013 from $4.9 million for the
first six months of fiscal 2012.
Selling and marketing expenses for the publishing segment were $2.3 million, or
18.0% of net sales, for the first six months of fiscal 2013 compared to $2.7
million, or 19.9% of net sales, for the first six months of fiscal 2012. The
$400,000 decrease was primarily due to personnel and related expense reductions
of $800,000 offset by an increase in professional fees of $400,000.
General and administrative expenses for the publishing segment consist
principally of executive, accounting and administrative personnel and related
expenses, including professional fees. General and administrative expenses for
the publishing segment decreased to $957,000, or 7.7% of net sales, for the
first six months of fiscal 2013 compared to $1.9 million, or 14.0% of net sales,
for the first six months of fiscal 2012. The $950,000 decrease was primarily due
to the reversal of the $526,000 first anniversary Punch! contingent liability
accrual during the first six months of fiscal 2012 because it was unearned as
well as a reduction in personnel costs associated with a headcount reduction,
partially offset by an increase in legal fees.
Depreciation and amortization for the publishing segment was $318,000 for the
first six months of fiscal 2013 compared to $329,000 for the first six months of
fiscal 2012.
Operating Income
The publishing segment had net operating income of $2.9 million for the first
six months of fiscal 2013 compared to $1.7 million for the first six months of
fiscal 2012.
28--------------------------------------------------------------------------------Consolidated Other Income and Expense
Interest income (expense), net was expense of $166,000 for the second quarter of
fiscal 2013 compared to expense of $288,000 for the second quarter of fiscal
2012. Interest income (expense), net was expense of $261,000 for the first six
months of fiscal 2013 compared to expense of $581,000 for the same period of
fiscal 2012. The decrease in interest expense for both the second quarter and
first six months of fiscal 2013 was a result of a reduction in borrowings.
Other income (expense), net, which consists primarily of foreign exchange loss,
for the three and six months ended September 30, 2012 was income of $142,000 and
expense of $99,000, respectively. Other income (expense), net, which consists of
foreign exchange loss, for the three and six months ended September 30, 2011 was
expense of $255,000 and $330,000, respectively.
Consolidated Income Tax Benefit
We recorded income tax expense of $274,000 for the second quarter of fiscal 2013
or an effective tax rate of 36.0% compared to income tax benefit of $879,000 or
an effective tax rate of 42.4% for the second quarter of fiscal 2012. We
recorded income tax expense for the first six months of fiscal 2013 of $15,000
or an effective tax rate of negative 22.1% compared to income tax benefit of
$1.2 million or an effective tax rate of 39.3% for the first six months of
fiscal 2012. For the six months ended September 30, 2012, the effective tax rate
differs from the federal tax rate of 35% primarily due to state taxes and
unrecognized income tax benefits.
Deferred tax assets are evaluated by considering historical levels of income,
estimates of future taxable income streams and the impact of tax planning
strategies. A valuation allowance is recorded to reduce deferred tax assets when
it is determined that it is more likely than not, based on the weight of
available evidence, we would not be able to realize all or part of our deferred
tax assets. An assessment is required of all available evidence, both positive
and negative, to determine the amount of any required valuation allowance.
As a result of the current market conditions and their impact on our future
outlook, management has reviewed its deferred tax assets and concluded that the
uncertainties related to the realization of some of its assets, have become
unfavorable. As of both September 30, 2012 and March 31, 2012, we had a net
deferred tax asset position before valuation allowance of $38.9 million which is
composed of temporary differences, primarily related to net operating loss
carryforwards, which will begin to expire in fiscal 2029. The Company also has
foreign tax credit carryforwards which will begin to expire in 2016. We have
considered the positive and negative evidence for the potential utilization of
the net deferred tax asset and have concluded that it is more likely than not
that we will not realize the full amount of net deferred tax assets.
Accordingly, a valuation allowance of $18.9 million has been recorded as of
September 30, 2012 and March 31, 2012.
We recognize interest accrued related to unrecognized income tax benefits
("UTB's") in the provision for income taxes. At March 31, 2012, interest accrued
was approximately $190,000, which was net of federal and state tax benefits, and
total UTB's net of federal and state income tax benefits that would impact the
effective tax rate if recognized, were $518,000. During the six months ended
September 30, 2012, $184,000 of UTB's were reversed, which was net of $165,000
of deferred federal and state income tax benefits. At September 30, 2012,
interest accrued was $298,000 and total UTB's, net of deferred federal and state
income tax benefits that would impact the effective tax rate if recognized, were
$525,000.
Consolidated Net Income (Loss)
For the second quarter of fiscal 2013, we recorded net income of $488,000
compared to a net loss of $1.2 million for the same period last year. For the
first six months of fiscal 2013, we recorded a net loss of $83,000, compared to
net loss from continuing operations of $1.9 million for the same period last
year.
Market Risk
At September 30, 2012, we had no outstanding indebtedness subject to interest
rate fluctuations. As such, a 100-basis point change in the current LIBOR rate
would have no impact on our annual interest expense.
29
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Our sales to customers in Canada are increasing. The majority of the sales and
purchasing activity related to these customers results in receivables and
accounts payables denominated in Canadian dollars. When these transactions are
translated into U.S. dollars at the exchange rate in effect at the time of each
transaction, gain or loss is recognized. These gains and/or losses are reported
as a separate component within other income and expense. During the three and
six months ended September 30, 2012 we had foreign exchange transaction gain of
$137,000 and loss of $105,000, respectively and foreign exchange transaction
loss of $255,000 and $329,000, respectively, for the three and six months ended
September 30, 2011.
Additionally, our balance sheet pertaining to these foreign operations is
translated into U.S. dollars at the exchange rate in effect on the last day of
each month. The net unrealized balance sheet translation gains and/or losses are
excluded from income and are reported as accumulated other comprehensive income
or loss. At September 30, 2012 we had accumulated other comprehensive gain
related to foreign translation of $73,000 compared to a loss of $9,000 at March
31, 2012.
Though changes in the exchange rate are out of our control, we periodically
monitor our Canadian activities and attempt to reduce exposure from exchange
rate fluctuations by limiting these activities or taking other actions, such as
exchange rate hedging. At this time, we do not engage in any hedging
transactions to mitigate foreign currency effects, but we continually monitor
our activities and evaluate such opportunities periodically.
Seasonality and Inflation
Quarterly operating results are affected by the seasonality of our business.
Specifically, our third quarter (October 1-December 31) typically accounts for
our largest quarterly revenue figures and a substantial portion of our earnings.
As a supplier 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. Poor economic or weather
conditions during this period could negatively affect our operating results.
Inflation is not expected to have a significant impact on our business,
financial condition or results of operations since we can generally offset the
impact of inflation through a combination of productivity gains and price
increases.
Liquidity and Capital Resources
Cash Flow Analysis
Operating Activities
Cash used in operating activities for the first six months of fiscal 2013 was
$15.7 million compared to $6.0 million for the same period last year.
The net cash used in operating activities for the first six months of fiscal
2013 mainly reflected our net loss, combined with various non-cash charges,
including depreciation and amortization of $1.6 million, amortization of
software development costs of $496,000, share-based compensation of $459,000, a
decrease in deferred income taxes of $10,000, offset by our working capital
demands. The following are changes in the operating assets and liabilities
during the first six months of fiscal 2013: accounts receivable increased $18.3
million, resulting from the timing of sales, net of decreased sales during the
quarter; inventories increased $5.9 million, primarily reflecting additional
inventory related to our growing consumer electronics and accessories product
line; prepaid expenses decreased $1.0 million, primarily resulting from the
timing of payments; accounts payable increased $6.8 million, primarily as a
result of timing of payments and purchases; and accrued expenses decreased $1.7
million, net of various accrual payments and a decrease in accrued wages.
The net cash used in operating activities for the first six months of fiscal
2012 mainly reflected our net loss, combined with various non-cash charges,
including the reversal of the first anniversary Punch! contingent payment
accrual of $526,000 which was unearned, depreciation and amortization of $1.9
million, amortization of debt acquisition costs of $298,000, amortization of
software development costs of $442,000, share-based compensation of $424,000, an
increase in deferred income taxes of $1.3 million, offset by our working capital
demands. The following are changes in the operating assets and liabilities
during the first six months of fiscal 2012: accounts receivable increased $1.7
million, resulting from the timing of sales, net of decreased sales during the
quarter; inventories increased $9.7 million, primarily reflecting additional
inventory related to our growing consumer electronics and accessories product
line; prepaid expenses decreased $773,000, primarily resulting from amortization
of prepaid expenses and recoupments of prepaid royalties; income taxes
receivable increased $52,000, primarily due to the timing of required tax
payments and tax refunds; accounts payable increased $4.5 million, primarily as
a result of timing of payments and purchases; income taxes payable decreased
$37,000 primarily due to the timing of required tax payments and tax refunds;
and accrued expenses increased $692,000, primarily as a result of a $1.4 million
severance accrual related to the departure of our former CEO, net of various
accrual payments and a decrease in accrued wages due to timing of pay periods.
30--------------------------------------------------------------------------------
Investing Activities
Cash flows used in investing activities totaled $813,000 for the first six
months of fiscal 2013 and cash flows provided by investing activities totaled
$20.1 million for the same period last year.
The Company made investments in software development of $26,000 and $849,000 for
the first six months of fiscal 2013 and 2012, respectively.
The purchases of property and equipment totaled $787,000 and $575,000 in the
first three months of fiscal 2013 and 2012, respectively. Purchases of property
and equipment in fiscal 2013 and 2012 consisted primarily of computer equipment.
Proceeds from the sale of discontinued operations totaled $22.5 million and
payment of a note payable totaled $1.0 million, both in the first six months of
fiscal 2012.
Financing Activities
Cash flows provided financing activities totaled $10.9 million for the first six
months of fiscal 2013 and cash flows provided by financing activities totaled
$8.7 million for the first six months of fiscal 2012.
For the first six months of fiscal 2013, we had proceeds from and repayments of
the revolving line of credit of $77.3 million and an increase in checks written
in excess of cash balances of $10.9 million.
For the first six months of fiscal 2012, we had proceeds from and repayments of
the revolving line of credit of $28.2 million and a decrease in checks written
in excess of cash balances of $8.8 million.
Capital Resources
On November 12, 2009, we entered into a three year, $65.0 million revolving
credit facility (the "Credit Facility") with Wells Fargo Foothill, LLC as agent
and lender, and a participating lender. On December 29, 2011, the Credit
Facility was amended to eliminate the participating lender, reduce the revolving
credit facility limit to $50.0 million, provide for an additional $20.0 million
under the Credit Facility under certain circumstances and extend the maturity
date to December 29, 2016. The Credit Facility is secured by a first priority
security interest in all of our assets, as well as the capital stock of our
companies. Additionally, the Credit Facility, as amended, calls for monthly
interest payments at the bank's base rate (as defined in the Credit Facility)
plus 1.25%, or LIBOR plus 2.25%, at our discretion.
Amounts available under the Credit Facility are subject to a borrowing base
formula. Changes in the assets within the borrowing base formula can impact the
amount of availability. At September 30, 2012, we had zero outstanding on the
Credit Facility and based on the facility's borrowing base and other
requirements, we had excess availability of $29.4 million.
In association with, and per the terms of the Credit Facility, we also pay and
have paid certain facility and agent fees. Weighted-average interest on the
Credit Facility was 4.25% at September 30, 2012 and March 31, 2012. Such
interest amounts have been and continue to be payable monthly.
Under the Credit Facility we are required to meet certain financial and
non-financial covenants. The financial covenants include a variety of financial
metrics that are used to determine our overall financial stability and include
limitations on our capital expenditures, a minimum ratio of adjusted EBITDA to
fixed charges, limitations on prepaid royalties and a minimum borrowing base
availability requirement. At September 30, 2012, we were in compliance with all
covenants under the Credit Facility. We currently believe we will be in
compliance with the Credit Facility covenants over the next twelve months.
31
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Liquidity
We finance our operations through cash and cash equivalents, funds generated
through operations, accounts payable and our revolving credit facility. The
timing of cash collections and payments to vendors can require the usage of our
revolving credit facility in order to fund our working capital needs. "Checks
written in excess of cash balances" may occur from time to time, including
period ends, and represent payments made to vendors that have not yet been
presented by the vendor to our bank, and therefore a corresponding advance on
our revolving line of credit has not yet occurred. On a terms basis, we extend
varying levels of credit to our customers and receive varying levels of credit
from our vendors. During the last twelve months, we have not had any significant
changes in the terms extended to customers or provided by vendors which would
have a material impact on the reported financial statements.
We continually monitor our actual and forecasted cash flows, our liquidity and
our capital resources. We plan for potential fluctuations in accounts
receivable, inventory and payment of obligations to creditors and 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 among other things: (1) investments in inventory related to
consumer electronics and accessories and other growth product lines; (2)
investments to license content and develop software for established products;
(3) legal disputes and contingencies (4) payments related to restructuring
activities (5) investments to sign exclusive distribution agreements; (6)
equipment needs for our operations; and (7) asset or company acquisitions.
During the first six months of fiscal 2013, we invested approximately $590,000,
before recoveries, in connection with the acquisition of licensed and
exclusively distributed product in our publishing and distribution segments.
During the six months ended September 30, 2012, we had approximately $1.9
million of cash expenditures related to the Restructuring Plan. We expect
approximately $800,000 will be cash expenditures over the remainder of fiscal
2013.
At September 30, 2012, we had zero outstanding on our $50.0 million Credit
Facility. Our Credit Facility includes an accordion feature allowing the Company
to increase borrowing availability up to $70.0 million under certain
circumstances. Our Credit Facility is available for working capital and general
corporate needs and amounts available are subject to a borrowing base formula.
Changes in the assets within the borrowing base formula can impact the amount of
availability. At September 30, 2012, based on the facility's borrowing base and
other requirements at such dates, we had excess availability of $29.4 million.
At September 30, 2012, we were in compliance with all covenants under the Credit
Facility and currently believe we will be in compliance with all covenants
throughout the next twelve months.
We currently believe cash and cash equivalents, funds generated from the
expected results of operations, funds available under our Credit Facility and
vendor terms will be sufficient to satisfy our working capital requirements,
other cash needs, costs of restructuring and to finance expansion plans and
strategic initiatives for at least the next twelve months, apart from our
proposed acquisition of SpeedFC, Inc. As previously discussed, the proposed
Merger with SpeedFC, Inc. will require that we issue additional shares of common
stock and obtain financing of up to $35.0 million. Please refer to Note 15 in
the consolidated unaudited financial statements. Additionally, with respect to
long-term liquidity, we filed a Registration Statement on Form S-3 on October
22, 2012, which was amended on November 5, 2012, to renew our shelf registration
statement covering the offer and sale of up to $20.0 million of common and/or
preferred shares, which registration statement has not yet been declared
effective. Any further growth through acquisitions would likely require the use
of additional equity or debt capital, some combination thereof, or other
financing.
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