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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 offer a vertically integrated, multi-channel platform of e-commerce services
and distribution solutions to retailers and manufacturers. We offer retail
distribution programs, website development and hosting, customer care,
e-commerce fulfillment, and third party logistics services.
Since our founding in 1983, we have established retail 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. In November 2012 we acquired
SpeedFC, Inc. ("SpeedFC"), a leading provider of end-to-end e-commerce services.
This acquisition allows us to provide a broad array of e-commerce services that
includes website development and integration, web hosting, cross-channel order
management and reporting, and fulfillment and customer care to online retailers
and manufacturers.
Beginning in the quarter ended December 31, 2012, we changed our reporting
segments in connection with the acquisition of SpeedFC, Inc. We previously
reported segment information under two reporting segments including distribution
and publishing. Effective the quarter ended December 31, 2012, our business
operates through two business segments: Distribution and E-Commerce and
Fulfillment Services.
Through our distribution business, we distribute computer software, consumer
electronics and accessories and video games, and sell proprietary software
products for the PC and Mac platforms.
Through our ecommerce and fulfillment services business, we provide web site
development and hosting, customer care, e-commerce fulfillment and third party
logistics services.
The distribution segment results as reported prior to the quarter ended December
31, 2012 included operating results of fee-based logistical services which is
now included in the e-commerce & fulfillment services segment. In addition, the
results of the previously reported publishing segment are included in the
distribution segment beginning the quarter ended December 31, 2012.
Recent events
On November 20, 2012, Navarre acquired all of the equity interests from all of
the stock and option holders (the "SFC Equityholders") of SpeedFC, Inc. (a
Delaware corporation), through a merger of that entity with and into a Navarre
wholly-owned subsidiary, now named SpeedFC, Inc., a Minnesota corporation
("SpeedFC")(the transaction, the "Acquisition") pursuant to the terms of that
certain Agreement and Plan of Merger dated September 27, 2012, as amended on
October 29, 2012 (the "Merger Agreement"). SpeedFC is a leading provider of
end-to-end e-commerce services to retailers and manufacturers and is part of the
Company's e-commerce and fulfillment segment.
The aggregate Acquisition consideration consisted of 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, both
payable to the SFC Equityholders proportionate to their prior ownership in
SpeedFC, as adjusted pursuant to the Merger Agreement. The initial consideration
paid at closing was comprised of: (i) $25.0 million in cash (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.
The contingent consideration payable to the SFC Equityholders is subject to the
achievement of certain financial performance metrics by SpeedFC in the 2012
calendar year related to an adjusted EBITDA target, 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 fiscal 2013 and
ending on February 29, 2016 (the "Contingent Cash Payment") and (ii) the
issuance of up to 6,287,368 shares of Navarre common stock to the SFC
Equityholders, with up to 2,215,526 ("First Equity Amount") shares payable in
early 2013, up to 738,509 shares ("Second Equity Amount") payable in late 2013,
and 3,333,333 shares payable at the same time as the Second Equity Amount (all
equity amounts together, the "Contingent Equity Payment"). The Contingent Cash
Payment and 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. If all
contingent equity amounts are fully earned, a total of 23,382,554 shares of
Navarre common stock could be issued in connection with the Acquisition.
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Consolidated net sales for the third quarter of fiscal 2013 increased 16.1% to
$178.3 million compared to $153.5 million for the third quarter of fiscal 2012.
The $24.8 million increase in net sales was primarily due to an increase in net
sales in the consumer electronics and accessories category of $14.7 million
compared to the third quarter of fiscal 2012, due to distribution of new
products to existing and new customers, and due to our recent acquisition of
SpeedFC, which generated $13.6 million of net sales in the third quarter of
fiscal 2013. In addition, net sales increased $3.3 million in our software
category due to expanded distribution to existing and new customers, partially
offset by a decrease in net sales in the video game category of $8.9 million
compared to the third quarter of fiscal 2012 and a decrease in net sales in the
home video category of $3.5 million compared to the third quarter of fiscal 2012
due to our transition out of the home video product category.
Our gross profit increased to $17.0 million, or 9.5% of net sales, in the third
quarter of fiscal 2013 compared to $7.5 million, or 4.9% of net sales, for the
same period in fiscal 2012. The $9.5 million increase in gross profit was
principally due to a higher volume of consumer electronics and accessories
products of $1.2 million and the contribution of gross profit of $2.3 million
from SpeedFC. Additionally, the third quarter of fiscal 2012 includes
restructure and impairment charges of $8.8 million.
Total operating expenses for the third quarter of fiscal 2013 were $14.5
million, or 8.2% of net sales, compared to $21.7 million, or 14.1% of net sales,
in the same period for fiscal 2012. The third quarter of fiscal 2012 includes
$8.2 million of restructure and impairment charges. The remaining $500,000
decrease is primarily due to operating efficiencies resulting from the
Restructuring Plan completed in fiscal 2012 offset by transaction and transition
costs related to the acquisition of SpeedFC of $1.5 million.
Net income for the third quarter of fiscal 2013 was $10,000 or zero per diluted
share compared to a net loss of $29.1 million or $0.79 per diluted share for the
same period last year.
Consolidated net sales for the nine months ended December 31, 2012 increased
2.6% to $373.7 million compared to $364.1 million for the first nine months of
fiscal 2012. This $9.6 million increase in net sales was primarily due to an
increase in net sales in the consumer and electronics category of $24.2 million
compared to the first nine months of fiscal 2012 and our recent acquisition of
SpeedFC which generated $13.6 million of net sales for the first nine months of
fiscal 2013. The increase was partially offset by a decrease in net sales in
the video game category of $14.4 million compared to the first nine months of
fiscal 2012, a decrease in net sales in the software category of $8.6 million
and a decrease in net sales in the home video category of $19.9 million compared
to the first nine months of fiscal 2012 due to our transition out of the home
video product category.
Our gross profit increased to $39.0 million, or 10.4% of net sales, for the
first nine months of fiscal 2013 compared to $33.5 million, or 9.2% of net
sales, for the same period in fiscal 2012. The $5.5 million increase in gross
profit was principally due to a higher volume of fulfillment services of $2.3
million and the contribution of gross profit of $2.3 million from SpeedFC. This
increase was partially offset by the sale of lower gross profit margin software
titles in the distribution segment. Additionally, fiscal 2012 includes
restructure and impairment charges of $8.8 million.
Total operating expenses for the first nine months of fiscal 2013 were $36.3
million, or 9.7% of net sales, compared to $49.9 million, or 13.7% of net sales,
in the same period for fiscal 2012. Fiscal 2012 includes restructuring and
impairment charges of $10.1 million. The remaining $3.5 million decrease was
primarily due to operating efficiencies resulting from the Restructuring Plan
completed in fiscal 2012 offset by $1.9 million of transaction and transition
costs and $854,000 of operating expenses related to the acquisition of SpeedFC.
Net loss for the first nine months of fiscal 2013 was $73,000 or zero per
diluted share compared to net loss of $31.0 million or $0.84 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.
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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. On November 20, 2012, 2012 the Credit Facility was
amended to provide for the acquisition of SpeedFC, eliminate the additional
$20.0 million available under the Credit Facility and extend the maturity date
to November 20, 2017.
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 1.75%, or LIBOR plus 2.75%,
at our discretion.
At December 31, 2012 and March 31, 2012 we had $17.4 million and zero
outstanding on the Credit Facility, respectively. 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 $26.4 million and $30.4 million at December 31, 2012 and
March 31, 2012, respectively. At December 31, 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 5.38% and 4.25% at both December 31, 2012 and March 31,
2012, respectively. 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.
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.
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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 e-commerce and fulfillment services,
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. We have
identified additional risks under Item 1A. Risk Factors to this Form 10-Q.
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, allowance for doubtful accounts, goodwill and intangible assets,
impairment of long-lived assets, inventory valuation, share-based compensation,
income taxes, restructuring charges, software development costs and
contingencies and litigation. Other than the addition of the accounting policy
related to software development costs and acquisitions and the addition to our
revenue recognition accounting policy below, 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.
Software development costs. Capitalization of software development costs begins
upon the establishment of technological feasibility. In the development of our
products and our enhancements to existing products, technological feasibility is
not established until substantially all product development is complete,
including the development of a working model. The establishment of technological
feasibility and the ongoing assessment of recoverability of capitalized software
development costs require considerable judgment by management with respect to
certain external factors, including, but not limited to, technological
feasibility, anticipated future gross revenues, estimated economic life, and
changes in software and hardware technologies. Such costs are amortized using
the straight-line method beginning when the product or enhancement is available
for general release over the estimated economic life of the product or
enhancement, generally three years.
Acquisition. Initial consideration is recognized at fair value as of the
acquisition date. Any contingent consideration is recognized as a liability at
fair value as of the acquisition date with subsequent fair value adjustments
recorded in operations. Acquisition costs are generally expensed as incurred.
We allocate the purchase price of acquired entities to the underlying tangible
and identifiable intangible assets acquired and liabilities based on their
estimated fair values, with any excess recorded as goodwill. Determining the
fair value of assets acquired and liabilities assumed requires management's
judgment and often involves the use of significant estimates and assumptions,
including assumptions with respect to future cash inflows and outflows, discount
rates, asset lives and market multiples, among other items. We determine the
fair values of such assets, principally intangible assets, generally in
consultation with third-party valuation advisors.
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Addition to revenue recognition accounting policy. A portion of the e-commerce
and fulfillment services business revenue arrangements include multiple service
elements, such as web implementation and migration, web site support, e-commerce
services and additional services. These deliverables are regarded as one unit of
accounting and the revenue recognition pattern is determined for the combined
unit. The contracted value of the revenue and related costs for elements not
quoted on a monthly basis, such as web site implementation and migration, are
deferred and recognized ratably over the term of the arrangement, approximately
three years, beginning when delivery has occurred. The revenues from the
remaining service elements are recorded on a monthly basis as the services are
provided. Costs associated with the web site implementation and migration are
deferred and recognized ratably over the term of the arrangement consistent with
the recognition of revenues.
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 Income (Loss).
Three Months Ended Nine Months Ended
December 31, December 31,
(Unaudited) (Unaudited)
2012 2011 2012 2011
Net sales:
Distribution 88.0 % 98.6 % 91.1 % 98.7 %
E-commerce and fulfillment services 12.0 1.4 8.9 1.3
Total net sales 100.0 100.0 100.0 100.0
Cost of sales:
Distribution 80.2 93.9 82.0 89.5
E-commerce and fulfillment services 10.3 1.2 7.6 1.3
Total cost of sales 90.5 95.1 89.6 90.8
Gross profit
Distribution 7.8 4.7 9.1 9.2
E-commerce and fulfillment services 1.7 0.2 1.3 -
Total gross profit 9.5 4.9 10.4 9.2
Operating expenses
Selling and marketing 3.0 3.7 3.6 4.4
Distribution and warehousing 1.3 1.7 1.6 2.1
General and administrative 2.5 3.3 2.9 3.9
Information technology 0.9 1.0 1.0 1.1
Depreciation and amortization 0.4 0.5 0.6 0.6
Goodwill and intangible impairment - 3.9 - 1.6
Total operating expenses 8.1 14.1 9.7 13.7
Income (loss) from operations 1.4 (9.2 ) 0.7 (4.5 )
Interest income (expense), net (0.2 ) (0.2 ) (0.1 ) (0.2 )
Other income (expense), net (0.3 ) (0.1 ) (0.2 ) (0.2 )
Income (loss)- before taxes 0.9 (9.5 ) 0.4 (4.9 )
Income tax benefit (0.9 ) (9.4 ) (0.4 ) (3.6 )
Net income (loss) - % (18.9 )% - % (8.5 )%
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Distribution SegmentThe distribution segment distributes computer software, consumer electronics and
accessories and video games.
Fiscal 2013 Third Quarter Results Compared To Fiscal 2012 Third Quarter
Net Sales
Net sales for the distribution segment increased $5.6 million, or 3.7%, to
$156.9 million for the third quarter of fiscal 2013 compared to $151.3 million
for the third quarter of fiscal 2012. Net sales in the software product group
increased $3.3 million to $107.6 million during the third quarter of fiscal 2013
from $104.4 million for the same period last year due to increased demand for
our software products. Consumer electronics and accessories net sales increased
$14.7 million to $47.4 million during the third quarter of fiscal 2013 compared
to $32.6 million for the same period last year due to distribution of new
products to existing and new customers. Video games net sales decreased $8.9
million to $1.9 million in the third quarter of fiscal 2013 from $10.8 million
for the same period last year, due to fewer video game releases. Home video net
sales decreased to zero in the third quarter of fiscal 2013 from $3.5 million in
the third 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 $13.8 million, or 8.8% of net
sales, for the third quarter of fiscal 2013 compared to $7.2 million, or 4.7% of
net sales, for the third quarter of fiscal 2012. Fiscal 2012 includes
restructure and impairment charges of $8.8 million. Excluding the restructure
and impairment charges, the $2.2 million decrease in gross profit was primarily
due to an increase in sales of lower margin software products and the decline in
volume of video games. 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 $13.3 million, or
8.5% of net sales, for the third quarter of fiscal 2013 compared to $21.1
million, or 14.0% of net sales, for the third quarter of fiscal 2012. The third
quarter of fiscal 2012 includes $8.3 million of restructure and impairment
charges. Excluding restructure and impairment charges, the $500,000 increase is
the result of $1.5 million of transaction and transition costs related to the
acquisition of SpeedFC partially offset by a reduction in personnel and related
costs resulting from the Restructuring Plan completed in fiscal 2012.
Selling and marketing expenses for the distribution segment were $4.9 million,
or 3.1% of net sales, for the third quarter of fiscal 2013 compared to $5.4
million, or 3.6% of net sales, for the third quarter of fiscal 2012. The third
quarter of fiscal 2012 includes $300,000 of restructure and impairment
charges. The remaining decrease is primarily a result of a reduction in
personnel and related costs and advertising resulting from the Restructuring
Plan completed in fiscal 2012.
Distribution and warehousing expenses for the distribution segment were $2.4
million, or 1.5% of net sales, for the third quarter of fiscal 2013 compared to
$2.7 million, or 1.8% of net sales, for the third quarter of fiscal 2012. The
$291,000 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 $4.3 million, or 2.7% of net sales, for the third
quarter of fiscal 2013 compared to $4.8 million, or 3.1% of net sales, for the
third quarter of fiscal 2012. The third quarter of fiscal 2012 includes $1.8
million of restructure and impairment charges. The remaining decrease in the
third quarter of fiscal 2013 was primarily a result of decreased personnel and
related costs and professional fees offset by $1.5 million in transaction and
transition costs related to the acquisition of SpeedFC.
Information technology expenses for the distribution segment were $968,000, or
0.6% of net sales, for the third quarter of fiscal 2013 compared to $1.5
million, or 1.0% of net sales, for the third quarter of fiscal 2012. The
decrease is primarily a due to a reduction in personnel and related costs
resulting from the Restructuring Plan completed in fiscal 2012.
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Depreciation and amortization expense for the distribution segment was $760,000
for the third quarter of fiscal 2013 compared to $771,000 for the second quarter
of fiscal 2012.
Operating Income (Loss)
Net operating income for the distribution segment was $499,000 for the third
quarter of fiscal 2013 compared to net operating loss of $14.0 million for the
third quarter of fiscal 2012.
Fiscal 2013 Nine Months Results Compared With Fiscal 2012 Nine Months
Net Sales
Net sales for the distribution segment decreased $18.7 million, or 5.2%, to
$340.5 million for the first nine months of fiscal 2013 compared to $359.2
million for the first nine months of fiscal 2012. Consumer electronics and
accessories net sales increased $24.2 million to $83.9 million during the first
nine months of fiscal 2013 from $59.7 million for the same period last year due
to the distribution of new products to existing and new customers. Net sales
decreased $8.6 million in the software product group to $249.8 million for the
first nine months of fiscal 2013 from $258.4 million for the same period last
year primarily due to decreased demand for our software products. Video games
net sales decreased $14.4 million to $6.8 million for the first nine months of
fiscal 2013 from $21.1 million for the same period last year, due to fewer video
game releases. Home video net sales decreased to zero for the first nine months
of fiscal 2013 from $19.9 million for the first nine 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 $34.2 million, or 10.0% of net
sales, for the first nine months of fiscal 2013 compared to $33.3 million, or
9.3% of net sales, for the first nine months of fiscal 2012. Fiscal 2012
includes restructure and impairment charges of $8.8 million. The decrease in
gross profit is due to the decrease in sales volume and an increased 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 $34.2 million, or
10.0% of net sales, for the first nine months of fiscal 2013 compared to $48.3
million, or 13.5% of net sales, for the same period of fiscal 2012. Fiscal 2012
includes $10.1 million of restructure and impairment charges. The remaining $4.0
million decrease is primarily due to operating efficiencies as a result of the
Restructuring Plan completed in fiscal 2012 offset by $1.9 million of
transaction and transition costs related to the acquisition of SpeedFC.
Selling and marketing expenses for the distribution segment decreased $2.2
million to $12.9 million, or 3.8% of net sales, for the first nine months of
fiscal 2013 compared to $15.1 million, or 4.2% of net sales, for the first nine
months of fiscal 2012. Fiscal 2012 includes $300,000 of restructure and
impairment charges. The remaining 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 $5.9
million, or 1.7% of net sales, for the first nine months of fiscal 2013 compared
to $7.6 million, or 2.1% of net sales, for the same period of fiscal 2012. The
$1.7 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 $10.1 million, or 3.0% of net sales, for the first
nine months of fiscal 2013 compared to $13.3 million, or 3.7% of net sales, for
the first nine months of fiscal 2012. Fiscal 2012 includes $3.3 million of
restructure and impairment charges. Further, expenses decreased in the first
nine months of fiscal 2013 due to decreased compensation expense, offset by $1.9
million of transaction and transition costs related to the acquisition of
SpeedFC.
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Information technology expenses for the distribution segment were $3.1 million,
or 0.9% of net sales, for the first nine months of fiscal 2013 compared to $4.0
million, or 1.1% of net sales, for the first nine months of fiscal 2012,
primarily a result of decreased personnel costs.
Depreciation and amortization for the distribution segment was $2.2 million for
the first nine months of fiscal 2013 and $2.3 million the first nine months of
fiscal 2012.
Operating (Loss) Income
Net operating income for the distribution segment was $21,000 for the first nine
months of fiscal 2013 compared to net operating loss of $15.0 million for the
same period of fiscal 2012.
E-commerce and Fulfillment Services SegmentThe e-commerce and fulfillment business provides web site development and
hosting, customer care, e-commerce fulfillment and third party logistics
services.
Fiscal 2013 Third Quarter Results Compared To Fiscal 2012 Third Quarter
Net Sales
Net sales for the e-commerce and fulfillment services segment were $21.4 million
for the third quarter of fiscal 2013 compared to $2.2 million for the third
quarter of fiscal 2012. The $19.2 million, or 874.4% increase in net sales, was
primarily due to organic growth of the existing e-commerce and fulfillment
services business of $5.6 million and the acquisition of SpeedFC effective
November 20, 2012, which generated net sales of $13.6 million during the third
quarter of fiscal 2013. We believe sales results in the future will be dependent
upon our ability to continue to win new client relationships and generate new
opportunities in our client pipeline.
Gross Profit
Gross profit for the e-commerce and fulfillment services segment was $3.2
million, or 14.9% of net sales, for the third quarter of fiscal 2013 compared to
$367,000, or 16.7% of net sales, for the third quarter of fiscal 2012. The
increase in gross profit is a result of growth of service revenue volume and the
contribution of SpeedFC for the quarter of $2.3 million. We expect gross profit
rates to fluctuate depending principally upon the make-up of service revenue
mix.
Operating Expenses
Total operating expenses for the e-commerce and fulfillment services segment
increased to $1.2 million, or 5.7% of net sales, for the third quarter of fiscal
2013, compared to $544,000, or 41.4% of net sales, for the third quarter of
fiscal 2012, all primarily related to the addition of SpeedFC in the quarter.
Selling and marketing expenses for the e-commerce and fulfillment services
segment were $395,000, or 1.8% of net sales, for the third quarter of fiscal
2013 compared to $290,000, or 22.1% of net sales, for the third quarter of
fiscal 2012.
General and administrative expenses for the e-commerce and fulfillment services
segment consist principally of executive, accounting and administrative
personnel and related expenses, including professional fees. General and
administrative expenses for the e-commerce and fulfillment services segment were
$271,000, or 1.3% of net sales, for the third quarter of fiscal 2013, compared
to $254,000, or 19.3% of net sales, for the third quarter of fiscal 2012.
28
--------------------------------------------------------------------------------Information technology expenses for the e-commerce and fulfillment services
segment were $565,000, or 2.6% of net sales, for the third quarter of fiscal
2013 compared to zero for the third quarter of fiscal 2012.
Operating Income
The e-commerce and fulfillment services segment had a net operating income of
$2.0 million for the third quarter of fiscal 2013 compared to net operating loss
of $177,000 for the third quarter of fiscal 2012.
Fiscal 2013 Nine Months Results Compared With Fiscal 2012 Nine Months
Net Sales
Net sales for the e-commerce and fulfillment services segment were $33.2 million
for the first nine months of fiscal 2013 compared to $4.9 million for the same
period of fiscal 2012. The $28.3 million, or 576% increase in net sales, over
the prior year nine months was primarily due to organic growth of the existing
e-commerce and fulfillment services business of $14.7 million in addition to the
acquisition of SpeedFC as of November 20, 2012 which contributed $13.6 million
in net sales for the first nine months of fiscal 2013. We believe sales results
in the future will be dependent upon our ability to continue to win new client
relationships and generate new opportunities in our client pipeline.
Gross Profit
Gross profit for the e-commerce and fulfillment services segment was $4.8
million, or 14.5% of net sales, for the first nine months of fiscal 2013
compared to $256,000, or 5.2% of net sales, for the first nine months of fiscal
2012. We expect gross profit rates to fluctuate depending principally upon the
make-up of services provided to the e-commerce and fulfillment services
customers.
Operating Expenses
Total operating expenses increased $551,000 for the e-commerce and fulfillment
services segment to $2.1 million for the first nine months of fiscal 2013 from
$1.5 million for the first nine months of fiscal 2012, primarily as a result of
the acquisition of SpeedFC.
Selling and marketing expenses for the e-commerce and fulfillment services
segment were $932,000, or 2.8% of net sales, for the first nine months of fiscal
2013 compared to $683,000, or 13.9% of net sales, for the first nine months of
fiscal 2012.
General and administrative expenses for the e-commerce and fulfillment services
segment consist principally of executive, accounting and administrative
personnel and related expenses, including professional fees. General and
administrative expenses for the e-commerce and fulfillment services segment
decreased to $602,000, or 1.8% of net sales, for the first nine months of fiscal
2013 compared to $863,000, or 17.6% of net sales, for the first nine months of
fiscal 2012. The $261,000 decrease was primarily due to a decrease in personnel
costs as a result of operating efficiencies offset by additional expenses
incurred for the SpeedFC acquisition.
Information technology expenses for the e-commerce and fulfillment services
segment were $565,000, or 1.7% of net sales, for the first nine months of fiscal
2013 compared to zero for the first nine months of fiscal 2012.
Operating Income
The e-commerce and fulfillment services segment had net operating income of $2.7
million for the first nine months of fiscal 2013 compared to net operating loss
of $1.3 million for the first nine months of fiscal 2012.
Consolidated Other Income and Expense
Interest income (expense), net was expense of $325,000 for the third quarter of
fiscal 2013 compared to expense of $292,000 for the third quarter of fiscal
2012. Interest income (expense), net was expense of $586,000 for the first nine
months of fiscal 2013 compared to expense of $873,000 for the same period of
fiscal 2012. The decrease in interest expense for the first nine months of
fiscal 2013 was a result of a reduction in borrowings.
29
--------------------------------------------------------------------------------
Other income (expense), net, which consists primarily of foreign exchange loss,
for the three and nine months ended December 31, 2012 was expense of $503,000
and $602,000, respectively. Other income (expense), net, which consists of
foreign exchange loss, for the three and nine months ended December 31, 2011 was
expense of $171,000 and $501,000, respectively.
Consolidated Income Tax Benefit
We recorded income tax expense of $1.6 million for the third quarter of fiscal
2013 or an effective tax rate of 99.4% compared to income tax expense of $14.5
million or an effective tax rate of negative 98.9% for the third quarter of
fiscal 2012. We recorded income tax expense for the first nine months of fiscal
2013 of $1.6 million or an effective tax rate of 104.7% compared to income tax
expense of $13.2 million or an effective tax rate of negative 74.8% for the
first nine months of fiscal 2012. We did not record a provision for or benefit
from income taxes for our Canadian subsidiary because we have available net
operating losses to offset future taxable income. For the nine months ended
December 31, 2012, the effective tax rate differs from the federal tax rate of
34% primarily due to state taxes, unrecognized income tax benefits and costs
related to the acquisition of SpeedFC, Inc.
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 December 31, 2012 and March 31, 2012, we had a net
deferred tax asset position before valuation allowance of $29.8 million and
$38.9 million, respectively, 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 $19.4
million and $18.9 million has been recorded as of December 31, 2012 and March
31, 2012, respectively, including a full valuation allowance against our Canada
net operating losses.
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 nine months ended
December 31, 2012, $89,000 of UTB's were reversed due to statute lapses, which
was net of $51,000 of deferred federal and state income tax benefits. At
December 31, 2012, interest accrued was $219,000 and total UTB's, net of
deferred federal and state income tax benefits that would impact the effective
tax rate if recognized, were $819,000.
Consolidated Net Income (Loss)
For the third quarter of fiscal 2013, we recorded net income of $10,000 compared
to a net loss of $29.1 million for the same period last year. For the first nine
months of fiscal 2013, we recorded a net loss of $73,000, compared to net loss
of $31.0 million for the same period last year.
Market Risk
At December 31, 2012, we had $17.4 million outstanding indebtedness subject to
interest rate fluctuations. A 100-basis point change in the current LIBOR rate
would cause our projected annual interest expense, based on current borrowed
amounts, to change by approximately $174,000. The fluctuation in our debt
service requirements, in addition to interest rate changes, may be impacted by
future borrowings under our credit facility or other alternative financing
arrangements.
30
--------------------------------------------------------------------------------
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
nine months ended December 31, 2012 we had foreign exchange transaction loss of
$388,000 and $493,000, respectively and foreign exchange transaction loss of
$172,000 and $501,000, respectively, for the three and nine months ended
December 31, 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 December 31, 2012 we had accumulated other comprehensive gain
related to foreign translation of $150,000 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 nine months of fiscal 2013 was
$6.8 million compared to $9.3 million for the same period last year.
The net cash used in operating activities for the first nine months of fiscal
2013 mainly reflected our various non-cash charges, including depreciation and
amortization of $3.7 million, share-based compensation of $705,000, a decrease
in deferred income taxes of $412,000, offset by our working capital demands. The
following are changes in the operating assets and liabilities during the first
nine months of fiscal 2013: accounts receivable increased $63.9 million,
resulting from the timing of sales and the addition of SpeedFC receivables;
inventories increased $10.1 million, primarily reflecting additional inventory
related to our growing consumer electronics and accessories product line;
prepaid expenses decreased $795,000, primarily resulting from the timing of
payments; accounts payable increased $61.9 million, primarily as a result of
timing of payments and purchases and the addition of SpeedFC payables; and
accrued expenses increased $896,000, net of various accrual payments.
The net cash used in operating activities for the first nine 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 $2.8
million, amortization of debt acquisition costs of $448,000, amortization of
software development costs of $1.9 million, share-based compensation of
$933,000, goodwill and intangibles impairment of $6.0 million, a decrease in
deferred income taxes of $13.4 million, offset by our working capital demands.
The following are changes in the operating assets and liabilities during the
first nine months of fiscal 2012: accounts receivable increased $34.4 million,
resulting from the timing of sales, net of decreased sales during the quarter;
inventories increased $8.0 million, primarily reflecting additional inventory
related to our growing consumer electronics and accessories product line;
prepaid expenses decreased $5.9 million, primarily resulting from the write-down
of prepaid expenses and recoupment of prepaid royalties; income taxes receivable
increased $20,000, primarily due to the timing of required tax payments and tax
refunds; accounts payable increased $33.8 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 decreased $661,000, net of various accrual payments and a
decrease in accrued wages due to timing of pay periods.
31
--------------------------------------------------------------------------------Investing Activities
Cash flows used in investing activities totaled $26.2 million for the first nine
months of fiscal 2013 and cash flows provided by investing activities totaled
$20.0 million for the same period last year.
The Company used $24.5 million in cash for the acquisition of SpeedFC in the
first nine months of fiscal 2013.
The Company made investments in software development of $102,000 and $905,000
for the first nine months of fiscal 2013 and 2012, respectively.
The purchases of property and equipment totaled $1.6 million and $593,000 in the
first nine 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 the note payable - acquisition totaled $1.0 million, both in the
first nine months of fiscal 2012.
Financing Activities
Cash flows provided financing activities totaled $27.4 million for the first
nine months of fiscal 2013 and cash flows used in financing activities totaled
$8.8 million for the first nine months of fiscal 2012.
For the first nine months of fiscal 2013, we had proceeds from and repayments of
the revolving line of credit of $133.1 million and $115.7 million,
respectively. Checks written in excess of cash balances increased $10.8 million
for the first nine months of fiscal 2013.
Proceeds from the sale of discontinued operations totaled $22.5 million and
payment of the note payable - acquisition totaled $1.0 million, both in the
first nine months of fiscal 2012.
For the first nine months of fiscal 2012, we had proceeds from and repayments of
the revolving line of credit of $34.9 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. On November 20, 2012, the Credit Facility was amended
to provide for the acquisition of SpeedFC, eliminate the additional $20.0
million available under the Credit Facility and extend the maturity date to
November 20, 2017.
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 1.75%, or LIBOR plus 2.75%,
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 December 31, 2012, we had $17.4 million outstanding
on the Credit Facility and based on the facility's borrowing base and other
requirements, we had excess availability of $26.4 million.
32
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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 5.38% and 4.25% at December 31, 2012 and March 31, 2012,
respectively. 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 and a minimum borrowing base availability requirement. At December
31, 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.
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) equipment and facility needs for our operations; and (6) asset or
company acquisitions.
During the first nine months of fiscal 2013, we invested approximately $1.9
million, before recoveries, in connection with the acquisition of licensed and
exclusively distributed product in our publishing and distribution segments.
At December 31, 2012, we had $17.3 million outstanding on our $50.0 million
Credit Facility. 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 December 31, 2012, based on the facility's borrowing
base and other requirements at such dates, we had excess availability of $26.4
million. At December 31, 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. Additionally, with
respect to long-term liquidity, we filed a Registration Statement on Form S-3 on
October 22, 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 was declared effective on February 4, 2013. Any further
growth through acquisitions would likely require the use of additional equity or
debt capital, some combination thereof, or other financing.
33
--------------------------------------------------------------------------------Contractual Obligations
The following table presents information regarding contractual obligations that
exist as of December 31, 2012 by fiscal year (in thousands):
Less than 1 1-3 3-5 More than 5
Total Year Years Years Years
Operating leases $ 44,143 $ 3,634 $ 8,077 $ 8,940 $ 23,492
Capital leases 129 53 64 12 -
License and distribution agreements 2,407 2,047 360 - -
Total $ 46,679 $ 5,734 $ 8,501 $ 8,952 $ 23,492
________
We have excluded liabilities resulting from uncertain tax positions of $1.5
million from the table above because we are unable to make a reasonably reliable
estimate of the period of cash settlement with the respective taxing
authorities. Additionally, interest payments related to the Credit Facility have
been excluded as future interest rates are uncertain.
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