UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

Commission File Number 0-22982

NAVARRE CORPORATION

7400 49^th Avenue North, New Hope, MN 55428
(Address of principal executive offices)

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

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

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

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

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b of the Act). Yes (ü) No ( )

The aggregate market value of the voting stock held by non-affiliates of the Registrant at September 30, 2004 was $347,525,175 based on the closing sale price on such date of $14.49 per share.

The Registrant had 29,752,166 shares of Common Stock, no par value, outstanding at June 9, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K incorporate certain information by reference from the Registrant’s definitive Proxy Statement to be filed with the Securities and Exchange Commission not later than 120 days after the conclusion of the registrant’s last fiscal year, which ended March 31, 2005.

PART I

Item 1 — Business

Overview

     We are a distributor and publisher of a broad range of home entertainment and multimedia products, including PC software, CD audio, DVD and VHS video, video games and accessories. Since our founding in 1983, we have established distribution relationships with major retailers including Best Buy, Wal-Mart/Sam’s Club and CompUSA, and we currently distribute to over 18,000 retail and distribution center locations throughout the United States and Canada. We believe that our established relationships throughout the supply chain, our broad product offering and our state-of-the-art distribution facility permit us to offer industry-leading home entertainment and multimedia products to our retail customers and to provide access to attractive retail channels for the publishers of such products.

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

     Our business is divided into two segments—Distribution and Publishing.

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

     Publishing. Through our publishing business, which generally has higher gross margins than our distribution business, we own or license various PC software, CD audio and DVD and VHS video titles, and we package, brand, market and sell directly to retailers, third party distributors and our distribution business. Our publishing business currently consists of Encore Software, Inc. (“Encore”), BCI Eclipse Company, LLC (“BCI”), FUNimation Productions, Ltd. and The FUNimation Store, Ltd. (together, “FUNimation”). Encore, which we acquired in July 2002, licenses and publishes personal productivity, genealogy, education and interactive gaming PC products, including titles such as Print Shop, Mavis Beacon, Zone Alarm and Reader Rabbit. BCI, which we acquired in November 2003, is a provider of niche DVD and video products and in-house produced CDs and DVDs. FUNimation, acquired on May 11, 2005, is a leading anime and children’s entertainment content provider in the United States.

Strategy

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

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

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

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Distribute a Broader Range and Larger Volume of Products. We seek to distribute a broader range and larger volume of home entertainment and multimedia products to our retail customers by providing a broad selection of products and capitalizing on our customer relationships. We seek to capture additional business from new and existing retail customers by providing them with a lower “all-in” cost of procuring merchandise and getting product to retailers’ shelves through efficient distribution. We expect that providing additional products to retailers will enable us to gain category management opportunities and enhance our reputation for product distribution expertise. We believe our approximately 60 strategic account associates located throughout the United States and Canada will help position us to improve the retail penetration of our published products to new and existing retail customers.

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Integrating Our Technology and Systems with Retailers. We seek to enhance the link in the supply chain between us and our publishers and retail customers through the integration of our respective information and technology systems, including inventory management tools, replenishment systems and point-of-sale information. We believe this integration will lead to better in-stock levels of product, improved on-time arrivals of product to the customer, enhanced inventory management and lower return rates for our customers, thereby strengthening customer relationships.

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Providing Value-Added Services. We believe that due to increasing retailer logistic needs and demands, including demands for new technology standards such as GTIN® (global trade item number) and RFID (radio frequency identification devices), many publishers will be required to decide whether to spend additional resources to update their distribution capabilities or to select a distributor such as us that intends to offer such services. We believe that implementing and offering these and other technologies should position us well to capture additional business from existing and new publishers.

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

Competitive Strengths

     We believe that we possess the following competitive strengths:

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Value-Added Services. We offer a wide range of distribution services and procurement solutions intended to capitalize on our broad understanding of the products that we distribute, the procurement process and the supply chain, as well as our logistics expertise and systems capabilities. We believe that our advanced distribution infrastructure enables us to provide customized procurement programs for our retail customers at a lower overall cost than many of our competitors. In addition, we believe that our information technology systems provide cost-effective interfacing with our customers’ information technology systems, supporting integration of the procurement process. We believe that our focus on providing customer-specific and cost-effective solutions is a key benefit that we provide to our retail customers.

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Broad Product Offering. We provide our retail customers with a broad selection of home entertainment and multimedia products that we believe allows us to better serve their home entertainment and multimedia product requirements. In addition, we regularly survey the markets we serve for new products with significant retail potential, that come from publishers we currently have relationships with as well as those we have not distributed for in the past.

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Established Content in our Publishing Business. We currently license a number of well-known home entertainment and multimedia titles. Encore, whose published brands when combined, rank it as the sixth largest PC software publisher in North America by dollar sales (according to The NPD Group),

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publishes leading titles in the education, productivity, kids and games software categories, including Print Shop, Print Master, Mavis Beacon, Zone Alarm, Reader Rabbit and Hoyle Casino. According to The NPD Group, as of January 2005, Hoyle Casino held the #1 rank in the PC Games/Family Entertainment category and the Hoyle brand held a 14% share of this category based on dollar sales. According to The NPD Group, Mavis Beacon is the #1 ranking typing title with a 54% market share, as of January 2005. In addition, our BCI subsidiary currently publishes home video for the television shows Rides and Overhaulin’, both featured on The Learning Channel, and PRIDE Fighting Championships, featured on Pay-Per-View. Through our FUNimation business we also license and distribute a portfolio of established anime and children’s entertainment titles in the United States, including Dragon Ball Z, Fullmetal Alchemist, Yu-Gi-Oh!, Code Lyoko, Teenage Mutant Ninja Turtles, Arthur, Noddy, Case Closed, Yu Yu Hakusho, Beyblade, Fruits Basket and Cabbage Patch Kids.

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Established Relationships with Publishers and Retailers. Since our founding in 1983, we have established distribution relationships with major retailers including Best Buy, Wal-Mart/Sam’s Club and CompUSA, and we currently distribute to over 18,000 retail and distribution center locations throughout the United States and Canada. We believe our strong relationships throughout the supply chain, broad product offering and state-of-the-art distribution facility permit us to offer industry-leading home entertainment and multimedia products to our retail customers and provide access to attractive retail channels for publishers of these products. We believe our relationships with leading publishers and our efficient distribution of their products should provide opportunities for us to secure distribution rights to leading products in the future. We believe that these relationships give us a competitive advantage in the markets in which we operate and provide us with attractive channels to distribute current and future products offered by our publishing business.

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Efficient Operations and Operating Leverage. We believe that our competitive position is enhanced by our efficient operations, which are based on extensive use of automation and technology in our state-of-the-art distribution facility; centralization of functions such as purchasing, accounting and information systems; and economies of scale. We recently completed a state-of-the-art warehouse facility adjacent to our corporate headquarters. We believe that this facility provides us with an industry-leading fulfillment infrastructure, the ability to efficiently service our vendors and retail customers, and the capacity to increase the number of products that we distribute.

Distribution Markets

     PC Software

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

     We presently have relationships with PC software publishers such as Symantec Corporation, Roxio, Inc., Adobe Systems Inc., McAfee, Inc., Dreamcatcher Interactive, Inc., Sony Online Entertainment, Inc., Delorme and THQ. These relationships are important to our distribution business and during the fiscal year ended March 31, 2005 each of these publishers accounted for more than $5.0 million in revenues. In the case of Symantec, sales accounted for approximately $51.0 million in net sales in the fiscal year ended March 31, 2004 and approximately $91.0 in net sales for the fiscal year ended March 31, 2005. During the past fiscal year, we added several publishers to our distribution roster.

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

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     Video Games Software and Accessories

     According to The NPD Group, the video games software and accessories industry was $10.2 billion in 2004 compared to $10.0 billion in 2003. According to industry sources, the installed base of video game consoles in North America is expected to grow to approximately 58.2 million users in 2008 compared to 32.0 million users in June 2004.

     We continued to expand our distribution of console-based video games in fiscal 2005. Our relationships with video game vendors such as Square Enix USA, Inc., Midway, THQ and Vivendi are important to this category of our distribution business.

     Major Label Music

     According to the Recording Industry Association of America (“RIAA”), the dollar value of audio and music video product shipped to domestic markets was $11.4 billion in 2004 versus $11.0 billion in 2003. Industry sources indicate that approximately 83% of the unit shipments are derived from major recording labels which are controlled by four companies. Those companies are Warner Music Group, Sony/BMG Music Entertainment, EMI Music Marketing, and Universal Music & Video Distribution Corp. Generally, these companies control distribution of their products through major music retail chains and other channels.

     We have established a relationship with certain of these companies, which allows us to distribute certain major label music to wholesale clubs and mass merchant retailers on a non-exclusive basis through our distribution business.

     Independent Label Music

     The independent segment of the music industry currently represents approximately 17% of total music product for 2004 according to the RIAA.

     We are one of a limited number of large, independent distribution companies that represent independent labels exclusively on a regional or national basis. These companies provide products and services to the nation’s leading music specialty stores and wholesalers. We seek to increase our market share in the independent music distribution business by continuing to seek quality music labels and to provide greater service to our customers, in addition to providing content ownership and licensing opportunities. Relationships with independent music labels such as CMH Records, Inc., Studio Distribution, Inc. and Cleopatra Records, Inc. are also important to our independent music distribution business. We have exclusive distribution agreements in place with certain of these labels that allow us to retain a percentage of amounts received in connection with the sale of the products provided by these labels. Among other customary provisions, these agreements generally provide us with the ability to return products to our independent music labels, the right for us to retain a reserve against potential returns of products, and requirements that the label provide discounts, rebates and price protections.

     Major Studio Home Video

     According to industry sources, U.S. home video industry sales totaled $24.5 billion in 2004 compared to $22.5 billion in 2003.

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

Customers

     Since our founding in 1983, we have established relationships with retailers across mass merchant, specialty and wholesale club channels, including Best Buy, Wal-Mart/Sam’s Club, CompUSA and Costco. We currently sell and distribute products to over 18,000 retail and distribution center locations throughout the United States and Canada. While a major portion of our revenues are generated from these major retailers, we also supply products to smaller independent retailers through telephone sales and our business-to-business site located at

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www.navarre.com. See our discussion of “E-Commerce” below. Through these sales channels, we seek to ensure a broad reach of product throughout the country in a cost-efficient manner.

     In each of the past several years, we have had one or more customers that accounted for 10% or more of our net sales. During the fiscal year ended March 31, 2005, sales to two customers, Wal-Mart/Sam’s Club and Best Buy accounted for approximately 20%, and 19%, respectively, of our total net sales. During the fiscal year ended March 31, 2004, sales to three customers, Best Buy, CompUSA and Sam’s Club, represented approximately 18%, 13% and 11%, respectively, of our total net sales.

Navarre’s Distribution Business Model

     Vendor Relationships

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

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

     Retail Services

     Along with the value added sales functions that we provide to vendors, we also have the ability to customize shipments to each individual customer. In the case of the warehouse club channel, we may “pre-sticker” multiple different labels, based on the vendor/customer preference. We assemble creative marketing programs, which include pallet programs, product bundles and specialized packaging. We also create multi-vendor assortments for the club channel, providing the retailer with a broad assortment of products. Our marketing and creative services department designs and produces a variety of advertising vehicles including in-store flyers, direct mail pieces and magazine/newspaper ads, as well as free standing displayers for retail.

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

     Warehouse Systems

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

     E-Commerce

     During fiscal year 2005, we continued to expand the number of electronic commerce (“e-commerce”) customers for whom we perform fulfillment and distribution. These services include sales of PC software, prerecorded music and DVD/VHS videos and video games. Our business-to-business web-site www.navarre.com integrates on-line ordering and deployment of text and visual product information, and has been enhanced to allow for easier user navigation and ordering.

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Publishing Markets

     In July 2002 and November 2003, we acquired Encore and BCI, respectively. Encore is a publisher of entertainment and education PC products and BCI is a provider of niche DVD/video products. Both of these businesses exclusively own or license and produce PC/DVD/video products. In April 2004, we entered into an exclusive co-publishing agreement with Riverdeep, Inc. for the sales and marketing of Riverdeep’s interactive products in the educational and productivity markets, which includes products published under the Broderbund and The Learning Company labels. In December 2004, we entered into exclusive licensing agreements with Vivendi and The United States Playing Card Company, Inc. for the sales and marketing of the Hoyle brand of family entertainment software products. FUNimation, acquired on May 11, 2005, is a leading anime and children’s entertainment content provider in the United States.

     Encore

     Encore, whose published brands when combined, rank it as the sixth largest PC software publisher in North America by dollar sales (according to The NPD Group), publishes leading titles in the education, productivity, kids and games software categories, including Print Shop, Print Master, Mavis Beacon, Zone Alarm, Reader Rabbit and Hoyle Casino. According to The NPD Group, as of January 2005, the Hoyle brand held a 14% share of the PC Games/Family Entertainment category based on dollar sales, and Hoyle Casino held the #1 rank in this category. According to The NPD Group, Mavis Beacon was the #1 ranked typing title with a 54% market share, as of January 2005.

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

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

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

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

     BCI

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

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     BCI’s portfolio of titles represents both licensed titles, in-house produced CDs and DVDs from production groups, and specialty television programming on Discovery, A&E, HBO, Fox and Pay-Per-View. BCI’s home video titles include Rides and Overhaulin’, featured on The Learning Channel, and PRIDE Fighting Championships, featured on Pay-Per-View.

FUNimation Business

     On May 11, 2005, we completed the acquisition of 100% of the general and limited partnership interests of FUNimation Productions, Ltd. and The FUNimation Store, Ltd., which are based in Fort Worth, Texas (together, “FUNimation”). We operate FUNimation as a part of our Publishing business. FUNimation is a leading content provider in the United States market for anime which it licenses from Japanese rights holders and translates and adopts the content for television programming and home videos, primarily targeting audiences between the ages of 6 and 17. In addition, FUNimation licenses other children’s entertainment content. FUNimation leverages its licensed content into various revenue streams, including television broadcast, VHS and DVD home video distribution, and licensing of merchandising rights for toys, video games and trading cards. FUNimation’s licensed titles include Dragon Ball Z, Fullmetal Alchemist, Yu-Gi-Oh!, Code Lyoko, Teenage Mutant Ninja Turtles, Noddy, Arthur, Case Closed, Yu Yu Hakusho, Beyblade, Fruits Basket and Cabbage Patch Kids. A number of these titles are currently airing on various television networks including The Cartoon Network, ABC Family and Fox.

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

     Broadcast

     For television programming, FUNimation translates and adapts its licensed anime titles to conform to U.S. television programming standards. FUNimation performs most of its production work in-house at its production facility in Fort Worth, Texas. As of June 8, 2005, the primary television broadcast outlets for FUNimation’s licensed properties were as follows:

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     Home Video Distribution

     FUNimation seeks to increase the revenue derived from its licensed properties through home video distribution. FUNimation also currently provides home video distribution services for other children’s content providers, including 4Kids Entertainment, Nelvana and Alliance Atlantis. A majority of its home videos are sold directly to major retail chains. According to Nielsen VideoScan, in 2004, FUNimation was ranked as one of the leading distributors of anime home video in the United States.

     Licensing and Merchandising

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

     Retail Sales and Web Sites

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

Competition

     All aspects of our business are highly competitive. Our competitors include other national and regional businesses, as well as some suppliers that sell directly to retailers. Some of these competitors have substantially greater financial and other resources than we do. Our ability to effectively compete in the future depends upon a number of factors, including our ability to:

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

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obtain proprietary publishing rights with various rights holders and brand owners;

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maintain our margins and volume;

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

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anticipate changes in the marketplace including technological developments and consumer interest in our proprietary products; and

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maintain operating expenses at an appropriate level.

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     In the PC software industry, we face competition from a number of distributors including Ingram Micro, Inc., Tech Data Corporation and Atari, Inc., as well as from manufacturers and publishers that sell directly to retailers. In the pre-recorded music industry, we face competition from the five major label distribution companies, as well as other national independent distributors, such as Koch Entertainment, RED Music Distribution, Alternative Distribution Alliance, Ryko Distribution, and Caroline Distribution, as well as from other entities that sell directly to retailers. FUNimation’s competitors include: 4Kids, ADV Films, Geneon Entertainment, Bandai, Ventura, Anchor Bay, Media Blasters and Buena Vista.

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

Backlog

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

Environmental Matters

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

Employees

     As of March 31, 2005, we had 618 employees, including 179 in administration, finance and merchandising, 97 in sales and marketing and 342 in distribution. As of March 31, 2005, FUNimation had 112 employees, including 29 in administration, finance and licensing, and 83 in sales, marketing, production and distribution. These employees are not subject to collective bargaining agreements and are not represented by unions. We consider our relations with our employees to be good.

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RECENT DEVELOPMENTS

Restatements

     In June 2005, our management, after consultation with the Audit Committee of the Board of Directors, determined that our consolidated financial statements for the third fiscal quarter ended December 31, 2003, year ended March 31, 2004, first fiscal quarter ended June 30, 2004, second fiscal quarter ended September 30, 2004, and third fiscal quarter ended December 31, 2004 should no longer be relied upon. As a result of the fiscal year 2005 audit, it was determined that expenses related to the incentive-based deferred compensation of our Chief Executive Officer should have been recorded in the third fiscal quarter of 2004 and first fiscal quarter of 2005. As a result, additional expenses and accrued liabilities of $1.5 million and $2.2 million have been recorded in these quarters, respectively. These expenses were determined in accordance with the provisions of the Chief Executive Officer’s 2001 employment agreement.

     It was also determined that our deferred tax benefit recorded in the third fiscal quarter of 2005 was improperly included in income and should have increased common stock. Consequently, the tax benefit of $2.4 million recognized during the third fiscal quarter of 2005 was reduced and common stock increased by the same amount.

     The consolidated financial statements for our third fiscal quarter ended December 31, 2003, year ended March 31, 2004, first fiscal quarter ended June 30, 2004, second fiscal quarter ended September 30, 2004, and third fiscal quarter ended December 31, 2004 and notes thereto included in this annual report on Form 10-K have been restated to include the effects of the expenses related to the incentive-based deferred compensation of our Chief Executive Officer and the deferred tax benefit recorded in income that should have been applied to common stock.

Capital Resources — Financing

     Our credit agreement with GE Commercial Finance was amended and restated in its entirety on May 11, 2005 in order to provide us with the funds necessary to complete funding for the FUNimation acquisition and was again amended and restated in its entirety on June 1, 2005. The credit agreement currently provides a six-year $115.0 million Term Loan B sub-facility, a $25.0 million five and one-half year Term Loan C sub-facility, and a five-year revolving sub-facility for up to $25.0 million. The entire $115.0 million of the Term Loan B sub-facility has been drawn since May 11, 2005 and the entire $25.0 million of the Term Loan C sub-facility was drawn at June 1, 2005. The revolving sub-facility of up to $25.0 million is available to us for our working capital and general corporate needs.

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

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

FUNimation Acquisition

     On May 11, 2005 we acquired 100% of the general and limited partnership interests of FUNimation Productions, Ltd. and The FUNimation Store, Ltd. As consideration for the acquisition of FUNimation, the sellers of FUNimation received $100.4 million in cash, subject to post-closing adjustments not to exceed $5.0 million and excess cash as defined in the purchase agreement, and 1,827,486 shares of Navarre common stock. In addition, during the five-year period following the closing of the transaction, we may pay up to an additional $17.0 million in cash to the FUNimation sellers if they achieve certain agreed-upon financial targets relating to the FUNimation business. The FUNimation business is described in more detail at “Business-FUNimation Business.”

AVAILABLE INFORMATION

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

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FORWARD-LOOKING STATEMENTS / IMPORTANT RISK FACTORS

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

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

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

Risks Relating To Our Business And Industry

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

     For the fiscal year ended March 31, 2005, net sales to two customers, Wal-Mart/Sam’s Club and Best Buy accounted for approximately 20% and 19%, respectively, of our total net sales, and, in the aggregate, approximately 39% of our total net sales. For the fiscal year ended March 31, 2004, net sales to three customers, Best Buy, CompUSA and Sam’s Club, represented approximately 18%, 13% and 11%, respectively, of our total net sales, and, in the aggregate, approximately 42% of our total net sales. For the fiscal year ended March 31, 2003, these three customers accounted for approximately 19%, 15% and 15%, respectively, of our total net sales, and, in the aggregate, approximately 49% of our total net sales. We believe that sales to a small group of customers will continue to represent a significant percentage of our total sales. Substantially all of the products we distribute to these customers are supplied on a non-exclusive basis under arrangements that may be cancelled without cause and upon short notice, and our retail customers generally are not required to make minimum purchases. If we are unable to continue to sell our products to all or any of these customers or are unable to maintain our sales to these customers at current levels and cannot find other customers to replace these sales, there would be an adverse impact on our revenues and profitability. There can be no assurance that we will continue to recognize a significant amount of revenue from sales to any specific customer.

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

     A significant portion of our increase in net sales over the past two fiscal years has been due to increased sales of PC software provided by software publishers such as Symantec Corporation, Roxio, Inc., Adobe Systems Inc., McAfee, Inc., Dreamcatcher Interactive, Inc. and Sony Online Entertainment, Inc. During the fiscal year ended

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March 31, 2005 and for the fiscal year ended March 31, 2004, each of these publishers accounted for more than $5.0 million in net sales. Sales under our agreement with Symantec accounted for approximately $91.0 million in net sales for the fiscal year ended March 31, 2005 and approximately $51.0 million in net sales for the fiscal year ended March 31, 2004. While we have agreements in place with each of these parties, such agreements generally are short-term agreements that may be cancelled without cause and upon short notice; they generally cover the right to distribute in the United States and Canada; they do not restrict the publishers from distributing their products through other distributors or directly to retailers; and they do not guarantee product availability to us for distribution. These agreements allow us to purchase the publishers’ products at a reduced wholesale price and to provide various distribution and fulfillment services in connection with the publishers’ products. If we were to lose our right to distribute products of any of the above PC software publishers, our net sales and profitability would be adversely impacted.

     Our relationships with independent music labels, such as CMH Records, Inc., Studio Distribution, Inc. and Cleopatra Records, Inc., also are important to our distribution business. Our future growth and success depends partly upon our ability to procure and renew PC software and music distribution agreements and to sell the underlying products. There can be no assurance that we will enter into new distribution agreements or that we will be able to sell products under existing distribution agreements. Further, our current distribution agreements may be terminated on short notice. The loss of a software developer, manufacturer or independent music label could negatively affect our product offerings and, accordingly, our net sales. Similarly, a decrease in customer demand for such products could negatively affect our net sales.

The continued growth and breadth of our exclusive distribution business could be negatively affected if we fail to sign or renew distribution agreements with independent music labels.

     Our distribution business derives a portion of its sales from exclusive distribution agreements with independent music labels. Our future growth and success depend partly upon our ability to procure and renew these agreements and to sell the underlying recordings. In addition, we depend upon artists and labels to generate additional quality recordings. In order to procure future distribution agreements, we regularly evaluate new distribution opportunities with music labels. There can be no assurance that we will sign such music labels to distribution agreements or that we will be able to sell recordings under existing distribution agreements. Further, there can be no assurance that any current distribution agreements will be renewed. Similarly, a decrease in customer demand for such recordings could negatively affect our sales.

The loss of our founder could affect the depth, quality and effectiveness of our management team. In addition, if we fail to attract and retain qualified personnel, the depth, quality and effectiveness of our management team and employees could be negatively affected.

     Eric H. Paulson, our President, Chief Executive Officer and founder, has been with us since our inception in 1983. Mr. Paulson’s employment agreement extends through March 31, 2007, and the loss of or change in Mr. Paulson’s services to us could affect management’s ability to continue to effectively operate our business.

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

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

     Our publishing business has grown significantly over the past three fiscal years. Our discussions of changes in financial position and results of operations of this business may not be indicative of future performance, and this segment’s financial results may significantly vary in future quarters as we integrate these new lines of business. As these new lines of business represent new opportunities and challenges, we may encounter difficulties in the operation of this segment that could negatively affect its financial condition and results of operation. Accordingly, there is no assurance that we will be able to continue to grow this segment of our business. Investors should not rely on the past performance of our publishing segment as an indicator of our future growth, and there can be no assurance that we will be able to successfully implement our publishing growth strategy.

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

     One of our growth strategies is the acquisition of complementary businesses. We may not be able to identify suitable acquisition candidates or, if we do, we may not be able to make such acquisitions on commercially acceptable terms or at all. If we make acquisitions, a significant amount of our management’s time and financial resources may be required to complete the acquisition and integrate the acquired business, such as FUNimation, into our existing operations. Even with this investment of management time and financial resources, an acquisition may not produce the revenue, earnings or business synergies that we anticipated. Acquisitions involve numerous other risks, including assumption of unanticipated operating problems or legal liabilities, problems integrating the purchased operations, technologies or products, diversion of management’s attention from our core businesses, adverse effects on existing business relationships with suppliers and customers, incorrect estimates made in the accounting for acquisitions and amortization of acquired intangible assets that would reduce future reported earnings (goodwill impairments), ensuring acquired companies’ compliance with the requirements of the Sarbanes-Oxley Act of 2002 and potential loss of customers or key employees of acquired businesses. We cannot assure you that if we make any future acquisitions, investments, strategic alliances or joint ventures they will be completed in a timely manner or achieve anticipated synergies, that they will be structured or financed in a way that will enhance our creditworthiness or that they will meet our strategic objectives or otherwise be successful. In addition, we may not be able to secure the financing necessary to consummate future acquisitions, and future acquisitions and investments could involve the issuance of additional equity securities or the incurrence of additional debt, which could harm our financial condition or creditworthiness.

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

     Traditionally, our third quarter (October 1-December 31) has accounted for our largest quarterly revenue figures and a substantial portion of our earnings. Our third quarter accounted for approximately 30.6%, 32.1% and 32.5% of our net sales for the fiscal years ended March 31, 2005, 2004 and 2003, respectively, and approximately 63.5%, 28.7% and 69.5% of our net income for the fiscal years ended March 31, 2005, 2004 (as Restated) and 2003, respectively. As a distributor of products ultimately sold to consumers, our business is affected by the pattern of seasonality common to other suppliers of retailers, particularly during the holiday season. Because of this seasonality, if we or our customers experience a weak holiday season or if we provide extended payment terms for sales during the holiday season or determine to increase our inventory levels to meet anticipated retail customer demand, our financial results and liquidity or could be negatively affected. In addition, our borrowing levels and inventory levels can increase substantially during this time. For example, during the 2004 holiday season, we increased our inventory of certain PC software products to satisfy potential retail customer demand for such products, which temporarily caused our inventory and borrowing levels to be higher than usual for us. In addition to seasonality issues, other factors contribute to the variability of our revenues and cash flows in both of our business segments on a quarterly basis. These factors include:

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the popularity of the pre-recorded music, DVD and PC software titles released during the quarter;

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product marketing and promotional activities;

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the opening and closing of retail stores by our major customers;

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payment terms offered to certain of our retail customers during the holiday season;

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fluctuations of inventory levels;

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the extension, termination or non-renewal of existing distribution agreements and licenses; and

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general economic changes affecting the buying pattern of retailers, particularly those changes affecting consumer demand for home entertainment products and PC software.

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

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

     We rely upon bank borrowings to fund our general working capital needs and it may be necessary for us to secure additional financing in the future depending upon the growth of our business and the possible financing of additional acquisitions. If we were unable to borrow under our credit facility or otherwise unable to secure sufficient financing on acceptable terms or at all, our future growth and profitability could be adversely affected.

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

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

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

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

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

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

     We provide credit to our customers for a significant portion of our net sales. During the holiday season, certain of our retail customers may request and we may grant extended payment terms, which may require us to borrow additional amounts under our credit facilities. We are subject to the risk that our customers will not pay for the products they have purchased. This risk may increase if our customers experience decreases in demand for their

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products and services or become less financially stable due to adverse economic conditions or otherwise. If there is a substantial deterioration in the collectibility of our receivables, our earnings and cash flows could be adversely affected.

     In addition, from time to time, we may make loans to or invest in complementary businesses, such as our $2.5 million loan commitment to Mix & Burn, Inc., a start-up company developing a music listening and CD burning station. These business or investment opportunities may not be successful, which could result in the loss of our invested capital.

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

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

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

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

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

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obtain proprietary publishing rights with various rights holders and brand owners;

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maintain our margins and volume;

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

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anticipate changes in the marketplace including technological developments and consumer interest in our proprietary products; and

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maintain operating expenses at an appropriate level.

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

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

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

     We rely almost entirely on arrangements with third party shipping and fulfillment companies, principally UPS and Federal Express, for the delivery of our products. The termination of our arrangements with one or more of these third party shipping companies, or the failure or inability of one or more of these third party shipping companies to deliver products on a timely basis from suppliers to us, or products from us to our reseller customers or their end-user customers, could disrupt our business and harm our reputation and net sales. Furthermore, an increase in amounts charged by these shipping companies could negatively affect our gross margins and earnings.

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

     We depend on a variety of systems for our operations. These systems support our operating functions, including inventory management, order processing, shipping, receiving and accounting. Our recently implemented, new picking and shipping system, currently supports a portion of our business and we anticipate that all other product lines will be moved to this system. Any failures or significant downtime in our systems could prevent us from taking customer orders, printing product pick-lists, and/or shipping product. It could also prevent customers from accessing our price and product availability information.

     From time to time we may acquire other businesses having information systems and records, which may be converted and integrated into our information systems. This can be a lengthy and expensive process that results in a material diversion of resources from other operations. In addition, because our information systems are comprised of a number of legacy, internally-developed applications, they can be harder to upgrade and may not be adaptable to commercially available software. As our needs for technology evolve, we may experience difficulty or significant cost in upgrading or significant replacing our systems.

     We also rely on the Internet for a portion of our orders and information exchanges with our customers. The Internet and individual websites can experience disruptions and slowdowns. In addition, some websites have experienced security breakdowns. Our website could experience material breakdowns, disruptions or breaches in security. If we were to experience a security breakdown, disruption or breach that compromised sensitive information, this could harm our relationship with our customers or suppliers. Disruption of our website or the Internet in general could impair our order processing or more generally prevent our customers and suppliers from accessing information. This could cause us to lose business.

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

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

     Home entertainment products have traditionally been marketed and delivered on a physical delivery basis. If, in the future, these products are increasingly marketed and delivered through technology transfers, such as “electronic downloading” through the Internet or similar delivery methods, then our retail and wholesale distribution business could be negatively impacted. As electronic downloading grows through Internet retailers, competition between suppliers to electronic retailers in traditional ways will intensify and likely negatively impact our net sales and margins. Furthermore, we may be required to spend significant capital to enter or participate in this delivery channel. If we are unable to develop necessary supplier relationships with electronic retailers or are unable to develop relationships to facilitate electronic downloading of home entertainment products, our business may be materially harmed.

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

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

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

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

Interruption of our business or catastrophic loss at any of our facilities could lead to a curtailment or shutdown of our business, which would reduce our net sales and earnings.

     We receive, manage and distribute our inventory from a centralized warehouse and distribution facility that is located adjacent to our corporate headquarters. An interruption in the operation of or in the service capabilities at this facility or our separate returns processing center as a result of equipment failure or other reasons could result in our inability to distribute products, which would reduce our net sales and earnings for the affected period. In the event of a stoppage at such facilities, even if only temporary, or if we experience delays as a result of events that are beyond our control, delivery times to our customers and our relationship with such customers could be severely affected. Any significant delay in deliveries to our customers could lead to increased returns or cancellations and cause us to lose future sales. Our facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions, violent weather conditions or other natural disasters. We may experience a shutdown of our facilities or periods of reduced production as a result of equipment failure, delays in deliveries or catastrophic loss, which could have a material adverse effect on our business, results of operations or financial condition.

Future terrorist or military actions could result in disruption to our operations or loss of assets, in certain markets or globally.

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

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

     In order to comply with the Sarbanes-Oxley Act of 2002, as well as changes to the NASDAQ listing standards and rules adopted by the Securities and Exchange Commission, we have been required to strengthen our internal controls, hire additional personnel and retain additional legal, accounting and advisory services, all of which have caused and will continue to cause our general and administrative costs to increase. Although we have not experienced any claims, insurers have increased and are likely to continue to increase premiums as a result of the high claims rates they have incurred with other companies over the past year, and so our premiums for our directors’ and officers’ insurance policies are likely to increase. Changes in the accounting rules and auditing standards, including legislative and other proposals to account for employee stock options as a compensation expense among others, could materially increase the expenses that we incur and report under generally accepted accounting principles and adversely affect our operating results.

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

          Section 404 of the Sarbanes-Oxley Act of 2002 requires that companies evaluate and report on their internal control structure and procedures over financial reporting. In addition, our independent accountants must report on management’s evaluation as well as evaluate our internal control structure and procedures. As a result of this process we have identified certain material weaknesses in our internal controls over financial reporting and we have taken steps to address these material weaknesses.

           However, if we are unable to successfully address these material weaknesses, or if any other material weaknesses are identified in the future which we are unable to successfully address, our ability to report our financial results on a timely and accurate basis may be adversely affected.

Risks Relating to the FUNimation Business

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

          FUNimation derives a substantial portion of its revenues from a small number of properties and such properties usually generate revenues only for a limited period of time. Additionally, FUNimation’s content is concentrated in the anime sector and its revenues are highly subject to the changing trends in the toy, game and entertainment businesses. In particular, the Dragon Ball properties accounted for $57.3 million, $61.9 million and $47.1 million, or 90%, 76%, and 65%, of FUNimation’s net sales for the years ended December 31, 2002, 2003 and 2004, respectively. FUNimation’s revenues may fluctuate significantly from year to year due to, among other reasons, the popularity of its licensed properties and the timing of entering into new licensing contracts.

          During the years ended December 31, 2002, 2003 and 2004, 95%, 92% and 82% of FUNimation’s revenues, respectively, were derived from sales of products under multiple licensing arrangements with two licensors. The loss of any of these licensing relationships could have a material negative effect on FUNimation’s revenues.

FUNimation’s success depends upon retaining the services of key FUNimation personnel.

          For the foreseeable future, we will place substantial reliance upon the personal efforts and abilities of Gen Fukunaga, the President and one of the founders of FUNimation. Mr. Fukunaga has entered into a five-year

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employment agreement with FUNimation Productions, Ltd. However, the loss of his services could materially and adversely affect FUNimation’s business, and could affect our financial condition and operating results. We cannot assure you that we would be able to find an appropriate replacement for Mr. Fukunaga if the need should arise.

     FUNimation’s ability to enhance and develop its markets for its current products and to introduce new products to the marketplace also depends on its ability to attract and retain qualified management personnel. FUNimation competes for such personnel with other companies and organizations, some of which have substantially greater capital resources and name recognition than FUNimation. If FUNimation is not successful in recruiting or retaining such personnel, it could have a material adverse effect on its business.

FUNimation’s business is dependent on a few customers, and a loss of any of these customers could have a material adverse effect on its revenues and profitability.

     During the year ended December 31, 2004, sales to four customers, Anderson Merchandisers, The Musicland Group, Goldhil Home Media International and Best Buy, represented approximately 28%, 16%, 16% and 12% of FUNimation’s gross wholesale and retail sales, respectively, and in the aggregate, approximately 72% of FUNimation’s gross wholesale and retail sales. In addition, one licensor made up approximately 80% of FUNimation’s license and royalty revenue for such year. Revenue from this licensor included $10.0 million relating to a contract effective as of December 2004 and that is reflected in accounts and royalties receivable at December 31, 2004 in accordance with SOP 00-2 American Institute of Certified Public Accountants Statement of Position (“SOP”) 00-2, Accounting by Producers or Distributors of Films. During the year ended December 31, 2003, sales to three customers, Anderson Merchandisers, The Musicland Group and Goldhil Home Media International, accounted for approximately 28%, 23% and 21% of FUNimation’s gross wholesale and retail sales, respectively, and, in the aggregate, approximately 72% of FUNimation’s gross wholesale and retail sales. If FUNimation is unable to continue to sell its products to all or any of these customers or is unable to maintain its sales to these customers at current levels and cannot find other customers to replace these sales, there would be an adverse impact on its revenues and profitability.

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

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

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any of FUNimation’s current properties, product concepts or programming will continue to be popular for any significant period of time;

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any new properties, product concepts or programming FUNimation represents or produces will achieve an adequate degree of popularity; or

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any property’s life cycle will be sufficient to permit FUNimation to profitably recover advance payments, guarantees, development, marketing, royalties and other costs.

     FUNimation’s failure to successfully anticipate, identify and react to consumer preferences could have a material adverse effect on FUNimation’s revenues, profitability and result