UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

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

for the quarterly period ended September 30, 2011

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

for the transition period from                      to                     

Commission File Number 0-22982

NAVARRE CORPORATION

(Exact name of registrant as specified in its charter)

Minnesota		41-1704319
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

7400 49th Avenue North, Minneapolis, MN 55428
(Address of principal executive offices)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Class		Outstanding at November 3, 2011
Common Stock, No Par Value		36,951,043 shares

 

 

NAVARRE CORPORATION

Index

		Page
PART I. FINANCIAL INFORMATION			3
Item 1. Consolidated Financial Statements			3
Consolidated Balance Sheets — September 30, 2011 and March 31, 2011			3
Consolidated Statements of Operations — Three and Six Months ended September 30, 2011 and 2010			4
Consolidated Statements of Cash Flows — Six Months ended September 30, 2011 and 2010			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			25
Item 3. Quantitative and Qualitative Disclosures About Market Risk			38
Item 4. Controls and Procedures			38
PART II. OTHER INFORMATION			38
Item 1. Legal Proceedings			38
Item 1A. Risk Factors			39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			39
Item 3. Defaults Upon Senior Securities			39
Item 4. (Removed and Reserved)			39
Item 5. Other Information			39
Item 6. Exhibits			39
SIGNATURES			40
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

Item 1.		Consolidated Financial Statements.

NAVARRE CORPORATION

Consolidated Balance Sheets
(In thousands, except share amounts)

		September 30,
		2011				March 31,
		(Unaudited)				2011
Assets:
Current assets:
Cash and cash equivalents		$	5,403			$	—
Accounts receivable, net			59,088				57,833
Receivable from the sale of discontinued operations			—				24,000
Inventories			34,486				24,913
Prepaid expenses			3,794				3,957
Deferred tax assets — current, net			6,719				6,436
Other assets — current			52				—
Total current assets			109,542				117,139
Property and equipment, net			8,213				9,299
Software development costs, net			2,609				2,202
Other assets:
Intangible assets, net			2,112				2,375
Goodwill			5,690				5,709
Deferred tax assets — non-current, net			25,316				24,320
Non-current prepaid royalties			9,057				9,667
Other assets			2,863				3,155
Total assets		$	165,402			$	173,866
Liabilities and shareholders’ equity:
Current liabilities:
Accounts payable		$	83,407			$	80,379
Checks written in excess of cash balances			—				8,790
Accrued expenses			8,173				7,768
Contingent payment obligation short-term — acquisition (Note 3)			422				526
Note payable — acquisition (Note 3)			—				1,002
Other liabilities — short-term			68				103
Total current liabilities			92,070				98,568
Long-term liabilities:
Contingent payment obligation long-term — acquisition (Note 3)			—				422
Other liabilities — long-term			1,865				1,795
Total liabilities			93,935				100,785
Commitments and contingencies (Note 12)
Shareholders’ equity:
Common stock, no par value:
Authorized shares — 100,000,000; issued and outstanding shares — 36,874,435 at September 30, 2011 and 36,577,605 at March 31, 2011			163,526				162,997
Accumulated deficit			(91,947	)			(90,071	)
Accumulated other comprehensive (loss) income			(112	)			155
Total shareholders’ equity			71,467				73,081
Total liabilities and shareholders’ equity		$	165,402			$	173,866

See accompanying notes to consolidated financial statements.

NAVARRE CORPORATION

Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)

		Three Months Ended								Six Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Net sales		$	106,568			$	120,476			$	210,584			$	219,268
Cost of sales (exclusive of depreciation)			93,973				103,216				184,202				187,531
Gross profit			12,595				17,260				26,382				31,737
Operating expenses:
Selling and marketing			5,005				5,277				10,048				10,161
Distribution and warehousing			2,495				2,686				4,938				5,158
General and administrative			5,753				5,149				11,677				10,223
Depreciation and amortization			927				991				1,899				1,882
Total operating expenses			14,180				14,103				28,562				27,424
(Loss) income from operations			(1,585	)			3,157				(2,180	)			4,313
Other income (expense):
Interest (expense) income, net			(288	)			(456	)			(581	)			(851	)
Other income (expense), net			(255	)			(172	)			(330	)			(431	)
(Loss) income from continuing operations before income tax			(2,128	)			2,529				(3,091	)			3,031
Income tax benefit (expense)			879				(1,072	)			1,215				(1,371	)
Net (loss) income from continuing operations			(1,249	)			1,457				(1,876	)			1,660
Discontinued operations:
Income from discontinued operations, net of tax			—				1,680				—				2,575
Net (loss) income		$	(1,249	)		$	3,137			$	(1,876	)		$	4,235
Basic (loss) earnings per common share:
Continued operations		$	(0.03	)		$	0.04			$	(0.05	)		$	0.05
Discontinued operations			—				0.05				—				0.07
Net (loss) income		$	(0.03	)		$	0.09			$	(0.05	)		$	0.12
Diluted (loss) earnings per common share:
Continued operations		$	(0.03	)		$	0.04			$	(0.05	)		$	0.04
Discontinued operations			—				0.05				—				0.07
Net (loss) income		$	(0.03	)		$	0.09			$	(0.05	)		$	0.11
Weighted average shares outstanding:
Basic			36,831				36,376				36,719				36,371
Diluted			36,831				36,995				36,719				36,886

See accompanying notes to consolidated financial statements.

NAVARRE CORPORATION

Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

		Six Months Ended
		September 30,
		2011				2010
Operating activities:
Net (loss) income		$	(1,876	)		$	4,235
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Income from discontinued operations			—				(2,575	)
Contingent payment obligation — unearned			(526	)			—
Depreciation and amortization			1,899				1,882
Amortization of debt acquisition costs			298				298
Amortization of software development costs			442				219
Share-based compensation expense			424				468
Deferred income taxes			(1,279	)			2,234
Other			225				553
Changes in operating assets and liabilities:
Accounts receivable			(1,685	)			5,484
Inventories			(9,679	)			(5,658	)
Prepaid expenses			773				(194	)
Income taxes receivable			(52	)			94
Other assets			(108	)			(43	)
Accounts payable			4,452				(6,113	)
Income taxes payable			(37	)			57
Accrued expenses			692				(4,982	)
Net cash used in operating activities			(6,037	)			(4,041	)
Investing activities:
Proceeds from sale of discontinued operations			22,537				—
Repayment of note payable — acquisition			(1,009	)			—
Cash paid for acquisition			—				(8,090	)
Purchases of property and equipment			(575	)			(435	)
Investment in software development			(849	)			(460	)
Net cash provided by (used in) investing activities			20,104				(8,985	)
Financing activities:
Proceeds from revolving line of credit			28,162				99,685
Payments on revolving line of credit			(28,162	)			(91,891	)
Payment of deferred compensation			—				(1,333	)
Checks written in excess of cash balances			(8,790	)			3,991
Other			126				(5	)
Net cash (used in) provided by financing activities			(8,664	)			10,447
Net cash provided by (used in) continuing operations			5,403				(2,579	)
Discontinued operations:
Net cash provided by operating activities			—				2,776
Net cash used in investing activities			—				(191	)
Net cash used in financing activities			—				(6	)
Net increase (decrease) in cash			5,403				—
Cash and cash equivalents at beginning of period			—				—
Cash and cash equivalents at end of period		$	5,403			$	—
Supplemental cash flow information:
Cash and cash equivalents paid for (received from):
Interest		$	334			$	863
Income taxes, net of refunds			36				40
Supplemental schedule of non-cash investing and financing activities:
Contingent payment obligation — unearned			(526	)			—
Note payable and contingent payment obligation related to the Punch! purchase price allocation			—				(1,950	)
Other comprehensive income (loss) related to gain (loss) on foreign exchange translation			(267	)			129

See accompanying notes to consolidated financial statements.

NAVARRE CORPORATION

Notes to Consolidated Financial Statements
(Unaudited)

Note 1 — Organization and Basis of Presentation

Navarre Corporation (the “Company” or “Navarre”), a Minnesota corporation formed in 1983, is a distributor, provider of complete logistics solutions and publisher of computer software. The Company operates through two business segments — distribution and publishing.

Through the distribution business, the Company distributes computer software, consumer electronics and accessories, video games and home videos and also provides fee-based logistical services. The distribution business focuses on providing a range of value-added services, including vendor-managed inventory, electronic and internet-based ordering and gift card fulfillment. The Company has relationships with certain of its customers and vendors whereby the Company provides fee-based services, which are recognized on a net basis within sales.

Through the publishing business, the Company owns or licenses various widely-known computer software brands through Encore Software, Inc. (“Encore”). In addition to retail publishing, Encore also sells directly to consumers through its e-commerce websites.

The Company also formerly published and sold anime content through FUNimation Productions, Ltd. (“FUNimation”). The Company sold FUNimation on March 31, 2011 and accordingly, the results of operations, assets and liabilities of FUNimation for all periods presented are classified as discontinued operations (see further disclosure in Note 2).

The accompanying unaudited consolidated financial statements of Navarre Corporation have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements.

All significant inter-company accounts and transactions have been eliminated in consolidation. In the opinion of the Company, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

Because of the seasonal nature of the Company’s business, the operating results and cash flows for the three and six month periods ended September 30, 2011 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2012. For further information, refer to the consolidated financial statements and footnotes thereto included in Navarre Corporation’s Annual Report on Form 10-K for the year ended March 31, 2011.

Basis of Consolidation

The consolidated financial statements include the accounts of Navarre Corporation and its wholly-owned subsidiary, Encore (collectively referred to herein as the “Company”). The results of operations and assets and liabilities of FUNimation for all periods presented are classified as discontinued operations.

Reclassifications

Certain balance sheet classifications included in the consolidated financial statements have been reclassified from the prior years’ presentations to conform to the current year presentation.

Fair Value of Financial Instruments

The carrying value of the Company’s current financial assets and liabilities, because of their short-term nature, approximates fair value.

Revenue Recognition

Revenue on products shipped, including consigned products owned by the Company, is recognized when title and risk of loss transfers, delivery has occurred, the price to the buyer is determinable and collectability is reasonably assured. Service revenues are recognized upon delivery of the services and represented less than 10% of total net sales for three and six month periods ended September 30, 2011 and 2010. The Company provides fee-based services to certain of its customers and vendors, which are recognized on a net basis within sales. Under certain conditions, the Company permits its customers to return or destroy products. The Company records a reserve for sales returns, product destructions and allowances against amounts due to reduce the net recognized receivables to the amounts the Company reasonably believes will be collected. These reserves are based on the application of the Company’s historical or anticipated gross profit percent against average sales returns and product destructions, sales discounts percent against average gross sales and specific reserves for marketing programs.

The Company’s distribution customers, at times, qualify for certain price protection benefits from the Company’s vendors. The Company serves as an intermediary to settle these amounts between vendors and customers. The Company accounts for these amounts as reductions of revenue with corresponding reductions in cost of sales.

The Company’s publishing business, at times, provides certain price protection, promotional monies, volume rebates and other incentives to customers. The Company records these amounts as reductions in revenue.

Recently Issued Accounting Pronouncements

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) (“ASU 2011-04”). ASU 2011-04 includes updated accounting guidance to amend existing requirements for fair value measurements and disclosures. The guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value but whose fair value must be disclosed. It also clarifies and expands upon existing requirements for fair value measurements of financial assets and liabilities as well as instruments classified in shareholders’ equity. ASU 2011-04 is effective for the first interim or annual reporting period beginning after December 15, 2011. The Company does not expect the adoption of ASU 2011-04 to have material impact on its consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires that all non-owner changes in stockholder’s equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option for companies to present components of other comprehensive income as part of the statement of changes in stockholder’s equity. ASU 2011-05 also requires reclassification adjustments and the effect of those adjustments on net income and other comprehensive income to be presented on the face of the financial statement where the components of net income and other comprehensive income are presented. ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company does not believe this will have a material impact on its consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”), which amends the guidance in ASC 350-20, “Intangibles — Goodwill and Other — Goodwill”. Under ASU 2011-08, entities have the option of performing a qualitative assessment before calculating the fair value of the reporting unit when testing goodwill for impairment. If the fair value of the reporting unit is determined, based on qualitative factors, to be more likely than not less than the carrying amount of the reporting unit, then entities are required to perform the two-step goodwill impairment test. ASU 2011-08 is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of ASU 2011-08 is not expected to have a material impact on the Company’s financial position or results of operations.

Note 2 — Discontinued Operations

Sale Transaction

On March 31, 2011, the Company sold its wholly-owned subsidiary, FUNimation, for $24.0 million. The proceeds were received in full during fiscal 2012 and therefore recorded as a receivable on the Company’s Consolidated Balance Sheets at March 31, 2011. In connection with the sale, the Company entered into an agreement to act as FUNimation’s exclusive distributor in the United States on a continuing basis, and will also act as FUNimation’s logistics and fulfillment services provider (see further disclosure in Note 22).

The Company has presented all results of operations, assets and liabilities of FUNimation for all periods presented as discontinued operations, and the consolidated financial statements, including the notes, have been reclassified to reflect such segregation for all periods presented. Prior to reclassification, the discontinued operations were reported in the publishing operating segment. The Company elected to allocate a portion of the consolidated interest expense related to the revolving line of credit, based on a percentage of its assets, to the discontinued operations. The Company used the proceeds received upon the sale of FUNimation to reduce the Company’s borrowings and for general working capital needs.

The summary of operating results from discontinued operations for the three and six months ended September 30, 2010 was as follows (in thousands):

		Three Months Ended				Six Months Ended
		September 30,				September 30,
		2010				2010
Net sales		$	9,008			$	16,709
Interest expense			122				219
Net income from discontinued operations, before income taxes		$	2,637			$	4,059
Income tax expense			(957	)			(1,484	)
Net income from discontinued operations, net of taxes		$	1,680			$	2,575

Note 3 — Acquisition

Punch! Software, LLC

On May 17, 2010, the Company completed the acquisition of substantially all of the assets of Punch! Software, LLC, (“Punch!”) a leading provider of home and landscape architectural design software in the United States. Total consideration included; $8.1 million in cash at closing, a $1.1 million note payable on the first anniversary of the closing with interest at a rate of 0.67% per annum, plus up to two performance payments (contingent consideration) of up to $1.25 million each (undiscounted), based on the Company achieving minimum annual net sales of $8.0 million in connection with the acquired assets. If earned, these payments were and are payable on the first and second anniversary of the closing date. The combined fair value of the contingent consideration of $948,000 was estimated by applying the income approach. That measure is based on significant inputs that are not observable in the market. Key assumptions include (1) a discount rate range of 20%-25% and (2) a probability adjusted level of revenues between $7.7 million and $9.4 million. The Company did not achieve the minimum annual sales target of $8.0 million in the first year and therefore the first anniversary contingent payment of $526,000 was reversed during the first quarter of fiscal 2012.

The acquisition of Punch! expanded the Company’s content ownership. The goodwill of $5.7 million arising from the acquisition consists largely of the synergies and economies of scale expected from combining the operations of the Company and Punch!. All goodwill was assigned to the Company’s publishing business. All of the goodwill recognized is expected to be deductible for income tax purposes over a 15 year tax period. This transaction did not qualify as an acquisition of a significant business pursuant to Regulation S-X and financial statements for the acquired business were not filed. Operating results from the date of acquisition are included within the publishing business.

The purchase price was allocated based on estimates of the fair value of assets acquired and liabilities assumed as follows (in thousands):

Consideration:
Cash		$	8,090
Note payable			1,002
Contingent payment obligation — short-term			422
Contingent payment obligation — unearned and unpaid			526
Fair value of total consideration transferred		$	10,040
The Punch! purchase price was allocated as follows:
Accounts receivable		$	1,114
Inventory			815
Prepaid expenses			94
Property and equipment			18
Purchased intangibles			2,787
Goodwill			5,690
Accounts payable			(469	)
Accrued expenses			(9	)
		$	10,040

Net sales of Punch!, included in the Consolidated Statements of Operations for the three and six months ended September 30, 2011 were $1.4 million and $2.8 million, respectively, compared to $2.4 million and $3.1 million for the three and six months ended September 30, 2010, respectively. Although the Company has made reasonable efforts to calculate the precise impact that the Punch! acquisition had on the Company’s net income (loss) for these periods, the Company has deemed it impracticable to determine such amounts.

Acquisition-related costs (included in selling, general, and administrative expenses in the Consolidated Statements of Operations) for the three and six months ended September 30, 2010 were zero and $185,000, respectively.

Note 4 — Accounts Receivable

Accounts receivable consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Trade receivables		$	57,255			$	60,151
Vendor receivables			6,893				2,039
Other receivables			31				344
			64,179				62,534
Less: allowance for doubtful accounts and sales discounts			2,828				2,674
Less: allowance for sales returns, net margin impact			2,263				2,027
Total		$	59,088			$	57,833

Note 5 — Inventories

Inventories, net of reserves, consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Finished products		$	31,420			$	22,144
Consigned inventory			2,395				1,992
Raw materials			1,657				1,596
			35,472				25,732
Less: inventory reserve			986				819
Total		$	34,486			$	24,913

Note 6 — Prepaid Expenses

Prepaid expenses consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Prepaid royalties		$	2,598			$	2,591
Other prepaid expenses			1,196				1,366
Current prepaid expenses			3,794				3,957
Non-current prepaid royalties			9,057				9,667
Total prepaid expenses		$	12,851			$	13,624

Note 7 — Property and Equipment

Property and equipment consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Furniture and fixtures		$	1,159			$	1,160
Computer and office equipment			18,395				18,173
Warehouse equipment			10,078				10,078
Leasehold improvements			2,243				1,944
Construction in progress			250				240
Total			32,125				31,595
Less: accumulated depreciation and amortization			23,912				22,296
Net property and equipment		$	8,213			$	9,299

Depreciation expense was $800,000 and $1.6 million for the three and six months ended September 30, 2011, respectively and $850,000 and $1.7 million for the three and six months ended September 30, 2010, respectively.

Note 8 — Capitalized Software Development Costs

The Company incurs software development costs for software to be sold, leased or marketed in the publishing business. Software development costs include third-party contractor fees and overhead costs. The Company capitalizes these costs once technological feasibility is achieved. Capitalization ceases and amortization of costs begins when the software product is available for general release to customers. The Company amortizes capitalized software development costs by the greater of the ratio of gross revenues of a product to the total current and anticipated future gross revenues of that product or the straight-line method over the remaining estimated economic life of the product. The Company tests for possible impairment whenever events or changes in circumstances, such as a reduction in expected cash flows, indicate that the carrying amount of the asset may not be recoverable. If indicators exist, the Company compares the undiscounted cash flows related to the asset to the carrying value of the asset. If the carrying value is greater than the undiscounted cash flow amount, an impairment charge is recorded in cost of goods sold in the Consolidated Statements of Operations for amounts necessary to reduce the carrying value of the asset to fair value. Software development costs consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Software development costs		$	3,874			$	3,025
Less: accumulated amortization			1,265				823
Software development costs, net		$	2,609			$	2,202

Amortization expense was $250,000 and $442,000 for the three and six months ended September 30, 2011, respectively and $118,000 and $219,000 for the three and six months ended September 30, 2010, respectively and is included in cost of goods sold in the Consolidated Statements of Operations.

Note 9 — Goodwill and Intangible Assets

Goodwill

The Company performs an impairment test of goodwill annually, or when events or a change in circumstances indicate that the carrying value might exceed the current fair value. Certain factors may result in the need to perform an impairment test other than annually, including significant underperformance of the Company’s business relative to expected operating results, significant adverse economic and industry trends, and a decision to divest an individual business within a reporting unit.

The Company’s reporting units are composed of either a discrete business or an aggregation of businesses with similar economic characteristics. For the purpose of performing the required goodwill impairment tests, the Company applies a present value (discounted cash flow) method to determine the fair value of the goodwill of the publishing business. The publishing business had a goodwill balance of $5.7 million at both September 30, 2011 and March 31, 2011. There is no goodwill associated with the distribution business.

Goodwill impairment is determined using a two-step process.

	•		The first step is to identify if a potential impairment exists by comparing the fair value of the business with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to have a potential impairment and the second step of the process is not necessary. However, if the carrying amount of a reporting unit exceeds its fair value, the second step is performed to determine if goodwill is impaired and to measure the amount of impairment loss to recognize, if any.
	•		The second step, if necessary, compares the implied fair value of goodwill with the carrying amount of goodwill. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. However, if the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess.

The Company estimates the fair value of the publishing business (its only reporting unit at this time with goodwill), using various valuation techniques, with the primary technique being a discounted cash flow analysis. A discounted cash flow analysis requires the Company to make various assumptions about sales, operating margins, growth rates and discount rates. Assumptions about discount rates are based on a weighted-average cost of capital derived from observable market inputs and comparable company data. Assumptions about sales, operating margins, and growth rates are based on management’s forecasts, business plans, economic projections, anticipated future cash flows and marketplace data. Assumptions are also made for varying perpetual growth rates for periods beyond the long-term business plan period.

There were no impairment charges recorded during the three and six month periods ended September 30, 2011 or 2010.

Indefinite Lived Intangible Assets

Indefinite lived intangible assets include the Punch! trademark, which is not amortized. The Company makes annual assessments, or as events or circumstances indicate that the asset might be impaired, to evaluate realizability of carrying values.

The fair value of the indefinite lived intangible assets is determined for the annual impairment test using the relief from royalty valuation technique, which is a variation of the income approach. There were no impairment charges recorded during the three and six month periods ended September 30, 2011 or 2010.

Definite Lived Intangible Assets

The Company evaluates its definite lived intangible amortizing assets for impairment when changes in events and circumstances indicate that the carrying value might exceed the current fair value. The Company determines fair value utilizing current market values and future market trends. There were no impairment charges recorded during the three and six month periods ended September 30, 2011 or 2010.

Intangible assets

Other identifiable intangible assets, with zero residual value, are being amortized (except for the trademarks which have an indefinite life) over useful lives of five years for developed technology, eight years for customer relationships, three years for customer list and seven years for the domain name and were valued as follows (in thousands):

		As of September 30, 2011
		Gross carrying				Accumulated
		amount				amortization				Net
Developed technology		$	1,940			$	595			$	1,345
Customer relationships			80				16				64
Customer list			167				81				86
Domain name			70				53				17
Trademarks (not amortized)			600				—				600
Total intangible assets		$	2,857			$	745			$	2,112

		As of March 31, 2011
		Gross carrying				Accumulated
		amount				amortization				Net
Developed technology		$	1,940			$	373			$	1,567
Customer relationships			80				10				70
Customer list			167				51				116
Domain name			70				48				22
Trademarks (not amortized)			600				—				600
Total intangible assets		$	2,857			$	482			$	2,375

Aggregate amortization expense for the three and six months ended September 30, 2011 was $132,000 and $263,000, respectively. Aggregate amortization expense for the three and six months ended September 30, 2010 was $132,000 and $178,000, respectively.

The following is a schedule of estimated future amortization expense (in thousands):

Remainder of fiscal 2012		$	263
2013			484
2014			386
2015			353
Thereafter			26
Total		$	1,512

Debt issuance costs

Debt issuance costs are included in “Other Assets” and are amortized over the life of the related debt. Debt issuance costs consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Debt issuance costs		$	1,790			$	1,790
Less: accumulated amortization			1,144				845
Net debt issuance costs		$	646			$	945

Amortization expense of $149,000 and $298,000 for the three and six months ended September 30, 2011, respectively and $149,000 and $298,000 for the three and six months ended September 30, 2010, respectively, was included in interest expense in the accompanying Consolidated Statements of Operations.

Note 10 — Accrued Expenses

Accrued expenses consisted of the following (in thousands):

		September 30,				March 31,
		2011				2011
Compensation and benefits		$	1,715			$	2,217
Legal disputes and contingencies			2,910				2,854
Former CEO severance			1,405				—
Royalties			301				303
Rebates			954				1,246
Interest			45				96
Other			843				1,052
Total		$	8,173			$	7,768

Note 11 — 401(k) Plan

The Company has a defined contribution 401(k) profit-sharing plan for eligible employees, which is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended. The plan covers substantially all full-time employees. Employees are entitled to make tax deferred contributions of up to 100% of their eligible compensation, subject to annual IRS limitations. The Company matches 50% of employee’s contributions up to the first 4% of their base pay, annually. The Company’s contributions charged to expense were $76,000 and $103,000 for the three and six months ended September 30, 2011, respectively and $95,000 and $172,000 for the three and six months ended September 30, 2010, respectively. The Company’s matching contributions vest over three years.

Note 12 — Commitments and Contingencies

Contingent payment — Punch! acquisition

At March 31, 2011, the Company accrued a $1.0 million note payable related to a deferred payment due on the first anniversary of the Punch! acquisition closing, plus interest at a rate of 0.67% per annum. The obligation was paid in full during the first quarter of fiscal 2012. Additionally, at March 31, 2011, the Company accrued $948,000 for two potential contingent performance payments of up to $1.25 million each (undiscounted), based on the Company achieving minimum annual net sales of $8.0 million in connection with the acquired assets. The two contingent payments were and are payable on the first and second anniversary of the closing date. The combined fair value of the contingent consideration of $948,000 was estimated by applying the income approach. That measure is based on significant inputs that are not observable in the market. Key assumptions include (1) a discount rate range of 20%-25% and (2) a probability adjusted level of revenues between $7.7 million and $9.4 million (see further disclosure in Note 3). The Company did not achieve the minimum annual sales target of $8.0 million required for the first anniversary contingent payment and therefore the initial contingent payment of $526,000 was reversed during the first quarter of fiscal 2012.

Changes in the carrying value of the contingent payment obligation are as follows (in thousands):

Balance, March 31, 2011		$	948
Reversal of unearned contingent payment			(526	)
Balance, September 30, 2011		$	422

Leases

The Company leases its facilities and a portion of its office and warehouse equipment. The terms of the lease agreements generally range from 3 to 15 years, with certain leases containing options to extend the lease up to an additional 10 years. The Company does not believe that exercise of the renewal options are reasonably assured at the inception of the lease agreements, and therefore, considers the initial base term to be the lease term. The leases require payment of real estate taxes and operating costs in addition to base rent. Total base rent expense was $613,000 and $1.2 million for the three and six months ended September 30, 2011, respectively and $613,000 and $1.2 million for the three and six months ended September 30, 2010, respectively. Lease terms vary, but generally provide for fixed and escalating rentals which range from an additional $0.06 per square foot to a 3% annual increase over the life of the lease.

The following is a schedule of future minimum rental payments required under non-cancelable operating leases as of September 30, 2011 (in thousands):

Remainder of fiscal 2012		$	1,232
2013			2,510
2014			2,161
2015			2,157
2016			2,023
Thereafter			4,853
Total		$	14,936

Guarantee

On May 29, 2007, FUNimation entered into an office lease in Flower Mound, Texas. In order to obtain the lease, the Company, as the parent of the FUNimation subsidiary at that time, guaranteed the full and prompt payment of the lease obligations and as of March 31, 2011, the Company continued to be the guarantor. On April 14, 2011, the Company entered into an agreement to be released from the office lease guarantee by providing a five-year, standby letter of credit for $1.5 million, which is reduced by $300,000 each subsequent year. The standby letter of credit can be drawn down, to the extent in default, if the full and prompt payment of the lease is not completed by FUNimation. There was no indication that FUNimation would not be able to pay the required future lease payments totaling $3.8 million and $4.1 million at September 30, 2011 and March 31, 2011, respectively. Therefore, at September 30, 2011 and March 31, 2011, the Company did not believe a future draw on the standby letter of credit was probable and an accrual related to any future obligation was not considered necessary at such times.

Litigation and Proceedings

In the normal course of business, the Company is involved in a number of litigation/arbitration and administrative/regulatory matters that, other than the matter described immediately below, are incidental to the operation of the Company’s business. These proceedings generally include, among other things, various matters with regard to products distributed by the Company and the collection of accounts receivable owed to the Company. The Company does not currently believe that the resolution of any of those pending matters will have a material adverse effect on the Company’s financial position or liquidity, but an adverse decision in more than one of these matters could be material to the Company’s consolidated results of operations.

Because of the preliminary status of many of these various legal proceedings, as well as the contingencies and uncertainties associated with these types of matters, it is difficult, if not impossible, to predict the exposure to the Company with respect to many of these proceedings. However, the Company is able to make an estimate of the probable costs for the resolution of certain legal claims and, as of both September 30, 2011 and March 31, 2011, approximately $2.9 million was accrued with respect to such claims. This estimate has been developed in consultation with internal and outside counsel handling the Company’s defense in these matters and is based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. There is a reasonable possibility that a change in the estimate may occur, and the Company will adjust the accrual at such future date, if necessary.

SEC Investigation

On February 17, 2006, the Company received an inquiry from the Division of Enforcement of the U.S. Securities and Exchange Commission (the “SEC”) requesting certain documents and information. This information request, and others received since that date, relate to information regarding the Company’s restatements of previously-issued financial statements, certain write-offs, reserve methodologies and revenue recognition practices. The Company has cooperated fully with the SEC’s requests in connection with this non-public investigation.

Note 13 — Capital Leases

The Company leases certain equipment under non-cancelable capital leases. At September 30, 2011 and March 31, 2011, leased capital assets included in property and equipment were as follows (in thousands):

		September 30, 2011				March 31, 2011
Computer and office equipment		$	332			$	332
Less: accumulated amortization			255				224
Property and equipment, net		$	77			$	108

Amortization expense for the three and six months ended September 30, 2011 was $15,000 and $31,000, respectively, and $13,000 and $25,000, respectively, for the three and six months ended September 30, 2010. Future minimum lease payments, excluding additional costs such as insurance and maintenance expense payable by the Company under these agreements, by year and in the aggregate are as follows (in thousands):

		Minimum Lease
		Commitments
Remainder of fiscal 2012		$	37
2013			44
2014			13
Total minimum lease payments		$	94
Less: amounts representing interest at rates ranging from 6.9% to 9.4%			6
Present value of minimum capital lease payments, reflected in the balance sheet as current and non-current capital lease obligations of $68 and $20, respectively		$	88

Note 14 — Bank Financing and Debt

On November 12, 2009, the Company entered into a three year, $65.0 million revolving credit facility (the “Credit Facility”) with Wells Fargo Foothill, LLC as agent and lender, and Capital One Leverage Financing Corp. as a participating lender. The Credit Facility is secured by a first priority security interest in all of the Company’s assets, as well as the capital stock of its subsidiary companies. Additionally, the Credit Facility calls for monthly interest payments at the bank’s base rate (as defined in the Credit Facility) plus 4.0%, or LIBOR plus 4.0%, at the Company’s discretion. The entire outstanding balance of principal and interest is due in full on November 12, 2012.

At both September 30, 2011 and March 31, 2011 the Company had zero outstanding on the Credit Facility. Amounts available under the Credit Facility are subject to a borrowing base formula. Changes in the assets within the borrowing base formula can impact the amount of availability. Based on the Credit Facility’s borrowing base and other requirements at such dates, the Company had excess availability of $37.3 million and $33.3 million at September 30, 2011 and March 31, 2011, respectively.

In association with, and per the terms of the Credit Facility, the Company also pays and has paid certain facility and agent fees. Weighted-average interest on the Credit Facility was 7.5% at both September 30, 2011 and March 31, 2011. Such interest amounts have been, and continue to be, payable monthly.

Under the Credit Facility, the Company is required to meet certain financial and non-financial covenants. The financial covenants include a variety of financial metrics that are used to determine the Company’s overall financial stability as well as limitations on capital expenditures, a minimum ratio of EBITDA to fixed charges, limitations on prepaid royalties and a borrowing base availability requirement. At September 30, 2011, the Company was in compliance with all covenants under the Credit Facility. The Company currently believes it will be in compliance with all covenants in the Credit Facility over the next twelve months.

Letter of Credit

On April 14, 2011, the Company was released from the FUNimation office lease guaranty by providing a five-year, standby letter of credit for $1.5 million, which is reduced by $300,000 each subsequent year. The standby letter of credit can be drawn down, to the extent in default, if the full and prompt payment of the lease is not completed by FUNimation. No claims have been made against this financial instrument. There was no indication that FUNimation would not be able to pay the required future lease payments totaling $3.8 million and $4.1 million at September 30, 2011 and March 31, 2011, respectively. Therefore, at September 30, 2011 and March 31, 2011, the Company did not believe a future draw on the standby letter of credit was probable and an accrual related to any future obligation was not considered necessary at such times.

Note 15 — Shareholders’ Equity

The Company’s Articles of Incorporation authorize 10,000,000 shares of preferred stock, no par value. No preferred shares are issued or outstanding.

The Company did not repurchase any shares during either of the six months ended September 30, 2011 or 2010.

Note 16 — Private Placement Warrants

As of March 31, 2011, the Company had warrants to purchase 1,596,001 shares of common stock outstanding. The warrants had a term of five years and were exercisable at $5.00 per share. The Company had the right to require exercise of the warrants if, among other things, the volume weighted average price of the Company’s common stock exceeded $8.50 per share for each of 30 consecutive trading days. In addition, the warrants provided the investors the option to require the Company to repurchase the warrants for a purchase price, payable in cash within five (5) business days after such request, equal to the Black-Scholes value of any unexercised warrant shares, but only if, while the warrants were outstanding, the Company initiated a change in control transactions. The warrants expired on September 21, 2011 without any exercises.

Note 17 — Share-Based Compensation

The Company has two equity compensation plans: the Navarre Corporation 1992 Stock Option Plan and the Navarre Corporation 2004 Stock Plan (collectively, “the Plans”). The 1992 Plan expired on July 1, 2006, and no further grants are allowed under this Plan, however, there are outstanding options remaining under this Plan. The 2004 Plan provides for equity awards, including stock options, restricted stock and restricted stock units. Eligible participants under the Plans are all employees (including officers and directors), non-employee directors, consultants and independent contractors. These Plans are described in detail in the Company’s Annual Report filed on Form 10-K for the fiscal year ended March 31, 2011.

Stock Options

A summary of the Company’s stock option activity as of September 30, 2011 and changes during the six months ended September 30, 2011 are summarized as follows:

						Weighted
						average
		Number of				exercise
		options				price
Options outstanding, beginning of period:			3,789,834			$	3.24
Granted			589,500				1.78
Exercised			(232,335	)			0.69
Forfeited or expired			(1,539,001	)			4.39
Options outstanding, end of period			2,607,998			$	2.46
Options exercisable, end of period			1,155,839			$	3.19
Shares available for future grant, end of period			3,594,241

The weighted-average fair value of options granted during the six months ended September 30, 2011 was $594,000 and the total fair value of options exercisable was $2.2 million at September 30, 2011. The weighted-average remaining contractual term for options outstanding was 7.8 years and for options exercisable was 6.2 years at September 30, 2011.

The aggregate intrinsic value represents the total pretax intrinsic value, based on the Company’s closing stock price of $1.70 as of September 30, 2011, which theoretically could have been received by the option holders had all option holders exercised their options as of that date. The total intrinsic value of stock options exercised during the six months ended September 30, 2011 was $273,000. The aggregate intrinsic value for options outstanding was $240,000, and for options exercisable was $157,000 at September 30, 2011. The total number of in-the-money options exercisable as of September 30, 2011 was 256,000. There were 1.9 million in-the-money options exercisable as of September 30, 2010 when the closing stock price was $2.60.

As of September 30, 2011, total compensation cost related to non-vested stock options not yet recognized was $1.3 million, which is expected to be recognized over the next 1.6 years on a weighted-average basis.

During each of the six months ended September 30, 2011 and 2010, the Company received cash from the exercise of stock options totaling $159,000 and $20,000, respectively. There was no excess tax benefit recorded for the tax deductions related to stock options during either of the six months ended September 30, 2011 or 2010.

Restricted Stock

Restricted stock granted to employees typically has a vesting period of three years and expense is recognized on a straight-line basis over the vesting period, or when the performance criteria have been met. The value of the restricted stock is established by the market price on the date of grant or if based on performance criteria, on the date it is determined the performance criteria will be met. Restricted stock awards vesting is based on service criteria or achievement of performance targets. All restricted stock awards are settled in shares of the Company’s common stock.

A summary of the Company’s restricted stock activity as of September 30, 2011 and of changes during the six months ended September 30, 2011 is summarized as follows:

						Weighted
						average
						grant date
		Shares				fair value
Unvested, beginning of period:			584,335			$	1.96
Granted			135,000				1.78
Vested			(95,834	)			2.24
Forfeited			(225,250	)			1.68
Unvested, end of period			398,251			$	1.99

The weighted-average fair value of restricted stock awards granted during the six months ended September 30, 2011 was $240,000.

The total fair value of shares vested during the six months ended September 30, 2011 was $215,000. No shares vested during the six months ended September 30, 2010.

The weighted-average remaining vesting period for restricted stock awards outstanding at September 30, 2011 was 0.8 years.

As of September 30, 2011, total compensation cost related to non-vested restricted stock awards not yet recognized was $559,000, which amount is expected to be recognized over the next 1.1 years on a weighted-average basis. There was no excess tax benefit recorded for the tax deductions related to restricted stock during either of the six month periods ended September 30, 2011 or 2010.

Share-Based Compensation Valuation and Expense Information

The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of an option award. The fair value of options granted during the three and six months ended September 30, 2011 and 2010 was calculated using the following assumptions:

		Three Months Ended								Six Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Expected life (in years)			5.0				5.0				5.0				5.0
Expected volatility			68	%			73	%			68	%			73	%
Risk-free interest rate			0.95	%			1.46	%			0.95-2.24	%			1.46-2.60	%
Expected dividend yield			0.0	%			0.0	%			0.0	%			0.0	%

Expected life uses historical employee exercise and option expiration data to estimate the expected life assumption for the Black-Scholes grant-date valuation. The Company believes that this historical data is currently the best estimate of the expected term of a new option. The Company uses a weighted-average expected life for all awards and has identified one employee population. Expected volatility uses the Company stock’s historical volatility for the same period of time as the expected life. The Company has no reason to believe its future volatility will differ from the past. The risk-free interest rate is based on the U.S. Treasury rate in effect at the time of the grant for the same period of time as the expected life. Expected dividend yield is zero, as the Company historically has not paid dividends. The Company used a forfeiture rate of 4.63% during the three and six months ended September 30, 2011 and 2010.

Share-based compensation expense related to employee stock options, restricted stock and restricted stock units, net of estimated forfeitures, for the three and six months ended September 30, 2011 was $361,000 and $424,000, respectively, and $242,000 and $468,000, respectively, for the three and six months ended September 30, 2010. These amounts were included in general and administrative expenses in the Consolidated Statements of Operations. No amount of share-based compensation was capitalized.

Note 18 — (Loss) Earnings Per Share

The following table sets forth the computation of basic and diluted (loss) earnings per share (in thousands, except per share data):

		Three Months Ended								Six Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Numerator:
Net (loss) income from continuing operations		$	(1,249	)		$	1,457			$	(1,876	)		$	1,660
Income from discontinued operations, net			—				1,680				—				2,575
Net (loss) income		$	(1,249	)		$	3,137			$	(1,876	)		$	4,235
Denominator:
Denominator for basic (loss) earnings per share—weighted-average shares			36,831				36,376				36,719				36,371
Dilutive securities: Employee stock options, restricted stock and warrants			—				619				—				515
Denominator for diluted (loss) earnings per share—adjusted weighted-average shares			36,831				36,995				36,719				36,886
Basic (loss) earnings per common share:
Continuing operations		$	(0.03	)		$	0.04			$	(0.05	)		$	0.05
Discontinued operations			—				0.05				—				0.07
Net (loss) income		$	(0.03	)		$	0.09			$	(0.05	)		$	0.12
Diluted (loss) earnings per common share:
Continuing operations		$	(0.03	)		$	0.04			$	(0.05	)		$	0.04
Discontinued operations			—				0.05				—				0.07
Net (loss) income		$	(0.03	)		$	0.09			$	(0.05	)		$	0.11

Approximately 2.4 million and 2.9 million of the Company’s stock options and non-vested restricted stock were excluded from the calculation of diluted earnings per share for the three and six months ended September 30, 2011, respectively, and 2.3 million and 2.6 million stock options and non-vested restricted stock were excluded from the calculation of diluted earnings per share for the three and six months ended September 30, 2010, respectively, because the exercise prices of such stock options and the grant-date fair value of such restricted stock were greater than the average price of the Company’s common stock and therefore their inclusion would have been anti-dilutive.

Approximately 1.6 million warrants were also excluded from the calculation of diluted earnings per share for both the three and six months ended September 30, 2010 because the exercise prices of such warrants was greater than the average price of the Company’s common stock and therefore their inclusion would have been anti-dilutive. The warrants expired on September 21, 2011 without any exercises.

Note 19 — Comprehensive (Loss) Income

Other comprehensive (loss) income pertains to net unrealized gains and losses on foreign exchange rate translation of the Company’s balance sheet pertaining to foreign operations. These net unrealized gains and losses are not included in net (loss) income but rather are recorded in accumulated other comprehensive (loss) income within shareholders’ equity.

Comprehensive (loss) income consisted of the following (in thousands):

		Three Months Ended								Six Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Net (loss) income		$	(1,249	)		$	3,137			$	(1,876	)		$	4,235
Net unrealized (loss) gain on foreign exchange rate translation, net of tax			(279	)			189				(267	)			129
Comprehensive (loss) income		$	(1,528	)		$	3,326			$	(2,143	)		$	4,364

The changes in other comprehensive (loss) income are non-cash items.

Accumulated other comprehensive (loss) income balances, net of tax effects, were other comprehensive loss of $112,000 and other comprehensive income of $155,000 at September 30, 2011 and March 31, 2011, respectively.

Note 20 — Income Taxes

For the three months ended September 30, 2011, the Company recorded income tax benefit from continuing operations of $879,000, compared to income tax expense from continuing operations of $1.1 million for the three months ended September 30, 2010. The effective income tax rate applied to continuing operations for the three months ended September 30, 2011 was 41.3%, compared to 42.4% for the three months ended September 30, 2010. For the six months ended September 30, 2011, the Company recorded income tax benefit from continuing operations of $1.2 million, compared to income tax expense from continuing operations of $1.4 million for the six months ended September 30, 2010. The effective income tax rate applied to continuing operations for the six months ended September 30, 2011 was 39.3%, compared to 45.2% for the six months ended September 30, 2010.

For the three months ended September 30, 2010, the Company recorded income tax expense from discontinued operations of $957,000 at an effective tax rate of 36.3%. For the six months ended September 30, 2010, the Company recorded income tax expense from discontinued operations of $1.5 million at an effective tax rate of 36.6%.

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, the Company would not be able to realize all or part of its deferred tax assets. An assessment is required of all available evidence, both positive and negative, to determine the amount of any required valuation allowance.

At September 30, 2011 and March 31, 2011, management evaluated the need for a valuation allowance. Based on the history of pretax earnings, future taxable income projections and future reversals of existing taxable temporary differences, it was concluded that the Company would more likely than not be able to realize the entire $32.0 million of deferred tax assets recorded at September 30, 2011 and $30.8 million at March 31, 2011. Therefore no valuation allowance was recorded at either September 30, 2011 or March 31, 2011. The deferred tax assets at September 30, 2011 are composed of temporary differences primarily related to the book write-off of certain intangibles and net operating loss carryforwards which will begin to expire in fiscal 2029. The Company also had foreign tax credit carryforwards at September 30, 2011 which will begin to expire in 2016.

The Company recognizes interest accrued related to unrecognized income tax benefits (“UTB’s”) in the provision for income taxes. At March 31, 2011, interest accrued was approximately $168,000, which was net of federal and state tax benefits and total UTB’s net of deferred federal and state tax benefits that would impact the effective tax rate if recognized were $612,000. During the six months ended September 30, 2011 an additional $111,000 of UTB’s were accrued, which was net of $23,000 of deferred federal and state income tax benefits. At September 30, 2011, interest accrued was $198,000 and total UTB’s, net of deferred federal and state income tax benefits that would impact the effective tax rate if recognized, were $723,000.

The Company’s federal income tax returns for tax years ending in 2007 through 2010 remain subject to examination by tax authorities. The Company files in numerous state jurisdictions with varying statutes of limitations. The Company does not anticipate that the total unrecognized tax benefits will significantly change prior to March 31, 2012.

Note 21 — Related Party Transactions

On April 6, 2011, the Board of Directors of the Company terminated the employment of the President and Chief Executive Officer, Cary L. Deacon. The Company recognized approximately $1.4 million in expense during the first six months of fiscal 2012 related to severance costs arising out of the termination of Mr. Deacon’s employment.

Note 22 — Variable Interest Entity

On March 31, 2011, the Company sold its wholly-owned subsidiary, FUNimation. At both September 30, 2011 and March 31, 2011, the Company assessed its variable interest in FUNimation including the terms of the exclusive distribution and logistics and fulfillment services agreements, employment matter indemnification (maximum exposure of $250,000), and the office lease guarantee (released and replaced with a $1.5 million standby letter of credit) to determine if FUNimation met the definition of a variable interest entity (“VIE”). Based on the Company’s evaluation it was determined that FUNimation was a VIE. Consolidating any VIEs within the Company’s financial results is required if the Company is found to be the primary beneficiary. However, because the Company did not have the power to direct the activities of the VIE that most significantly impacted their economic performance, nor did the Company have the obligation to absorb the significant losses or the right to receive significant benefits from the VIE, it was determined that the Company was not the primary beneficiary. Therefore, the results of FUNimation were not consolidated into the Company’s financial results (see further disclosure regarding the letter of credit in Note 12).

Note 23 — Business Segments

The Company identifies its segments based on its organizational structure, which is primarily by business activity. Operating profit represents earnings before interest expense, interest income, income taxes and allocations of corporate costs to the respective divisions. Inter-company sales are made at market prices. The Company’s corporate office maintains a majority of the Company’s cash and revolving line of credit under its cash management policy.

Navarre operates two business segments: distribution and publishing.

Through the distribution business, the Company distributes computer software, consumer electronics and accessories, video games and home video and also provides complete logistics solutions. The distribution business focuses on providing vendors and retailers with a range of value-added services, including vendor-managed inventory, electronic and internet-based ordering, and gift card fulfillment.

Through the publishing business the Company owns or licenses various widely-known computer software brands through Encore. In addition to retail publishing, Encore also sells directly to consumers through its websites. The publishing business packages, brands, markets and sells published software directly to retailers, third party distributors, and to the Company’s distribution business.

The Company also formerly published and sold anime content through FUNimation Productions, Ltd. (“FUNimation”). The Company sold FUNimation on March 31, 2011 and accordingly, the results of operations of FUNimation for all periods presented are classified as discontinued operations (see further disclosure in Note 2).

Financial information by reportable segment is included in the following summary for the three and six months ended September 30, 2011 and 2010 (in thousands):

		Distribution				Publishing				Eliminations				Consolidated
Three months ended September 30, 2011
Net sales		$	104,037			$	6,315			$	(3,784	)		$	106,568
(Loss) income from operations			(1,670	)			85				—				(1,585	)
(Loss) income from continuing operations, before income tax			(2,389	)			261				—				(2,128	)
Depreciation and amortization expense			763				164				—				927
Capital expenditures			273				50				—				323
Total assets			138,424				28,875				(1,897	)			165,402

		Distribution				Publishing				Eliminations				Consolidated
Three months ended September 30, 2010
Net sales (1)		$	118,761			$	8,656			$	(6,941	)		$	120,476
Income from operations			1,699				1,458				—				3,157
Income (loss) from continuing operations, before income tax (2)			1,712				1,583				(766	)			2,529
Depreciation and amortization expense			828				163				—				991
Capital expenditures			79				22				—				101
Total assets (3)			117,413				32,122				(7,733	)			141,802

		Distribution				Publishing				Eliminations				Consolidated
Six months ended September 30, 2011
Net sales		$	205,771			$	13,522			$	(8,709	)		$	210,584
(Loss) income from operations			(3,909	)			1,729				—				(2,180	)
(Loss) income from continuing operations, before income tax			(5,172	)			2,081				—				(3,091	)
Depreciation and amortization expense			1,570				329				—				1,899
Capital expenditures			514				61				—				575
Total assets			138,424				28,875				(1,897	)			165,402

		Distribution				Publishing				Eliminations				Consolidated
Six months ended September 30, 2010
Net sales (1)		$	214,714			$	15,710			$	(11,156	)		$	219,268
Income from operations			1,708				2,605				—				4,313
Income from continuing operations, before income tax (2)			1,711				2,876				(1,556	)			3,031
Depreciation and amortization expense			1,637				245				—				1,882
Capital expenditures			378				57				—				435
Total assets (3)			117,413				32,122				(7,733	)			141,802

Product Line Data

The following table provides net sales by product line for each business segment for the three and six months ended September 30, 2011 and 2010 (in thousands):

		Distribution				Publishing				Eliminations				Consolidated
Three months ended September 30, 2011
Software		$	77,528			$	6,315			$	(3,784	)		$	80,059
Consumer electronics and accessories			14,816				—				—				14,816
Video games			5,556				—				—				5,556
Home video			6,137				—				—				6,137
Consolidated		$	104,037			$	6,315			$	(3,784	)		$	106,568

		Distribution				Publishing				Eliminations				Consolidated
Three months ended September 30, 2010
Software		$	94,372			$	8,656			$	(6,941	)		$	96,087
Consumer electronics and accessories			6,468				—				—				6,468
Video games			7,924				—				—				7,924
Home video			9,997				—				—				9,997
Consolidated		$	118,761			$	8,656			$	(6,941	)		$	120,476

		Distribution				Publishing				Eliminations				Consolidated
Six months ended September 30, 2011
Software		$	151,956			$	13,522			$	(8,709	)		$	156,769
Consumer electronics and accessories			27,042				—				—				27,042
Video games			10,352				—				—				10,352
Home video			16,421				—				—				16,421
Consolidated		$	205,771			$	13,522			$	(8,709	)		$	210,584

		Distribution				Publishing				Eliminations				Consolidated
Six months ended September 30, 2010
Software		$	172,797			$	15,710			$	(11,156	)		$	177,351
Consumer electronics and accessories			11,257				—				—				11,257
Video games			11,594				—				—				11,594
Home video			19,066				—				—				19,066
Consolidated		$	214,714			$	15,710			$	(11,156	)		$	219,268

Geographic Data

The following table provides net sales by geographic region for the three and six months ended September 30, 2011 and 2010 and property, plant and equipment, net of accumulated depreciation by geographic region at September 30, 2011 and March 31, 2011 (in thousands):

		Three Months Ended								Six Months Ended
		September 30,								September 30,
Net Sales		2011				2010				2011				2010
United States		$	95,995			$	110,090			$	191,208			$	201,055
International			10,573				10,386				19,376				18,213
Total net sales		$	106,568			$	120,476			$	210,584			$	219,268

Property, Plant and Equipment, Net		September 30, 2011				March 31,2011
United States		$	7,869			$	8,829
International			344				470
Total property, plant and equipment, net		$	8,213			$	9,299

Sales Channel Data

The following table provides net sales by sales channel for the three and six months ended September 30, 2011 and 2010 (in thousands):

		Three Months Ended								Six Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Retail		$	91,869			$	111,091			$	182,390			$	202,286
E-commerce			14,699				9,385				28,194				16,982
Total net sales		$	106,568			$	120,476			$	210,584			$	219,268

Note 24 — Subsequent Events

During October 2011, the Company implemented a series of initiatives, including a reduction in workforce and simplification of business structures and processes across the Company’s operations (“Restructuring Plan”). These actions are intended to increase operating efficiencies and provide additional resources to invest in product lines and service categories in order to execute the Company’s long-term growth strategy plan.

J. Reid Porter, the Company’s Chief Operating Officer and Chief Financial Officer, retired effective October 28, 2011. Mr. Porter’s retirement resulted in the acceleration of vesting of all his unvested restricted stock units and stock options as of October 28, 2011.

The Company expects to record pre-tax restructuring charges and other non-recurring expenses related to the subsequent events discussed above of approximately $8.5 million to $9.5 million during the third and fourth quarters of fiscal year 2012.

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We are a distributor and provider of complete logistics solutions to traditional and internet-based retailers. Our solutions support both direct-to-consumer (“DTC”) and business-to-business (“B2B”) sales channels. Additionally, we are a publisher of computer software.

Since our founding in 1983, we have established distribution relationships with major retailers including Best Buy, Wal-Mart/Sam’s Club, Costco Wholesale Corporation, Staples, Office Depot, OfficeMax, Target, Apple, Amazon and RadioShack, and we distribute to nearly 17,000 retail and distribution center locations throughout the United States and Canada. We believe our established relationships throughout the supply chain permit us to offer products to our internet-based and retail customers and to provide our vendors with access to broad retail channels. In order to participate in the growing revenue streams resulting from e-commerce and fulfillment services, we are expanding the business services we offer.

Our business is operates through two business segments — Distribution and Publishing.

Through our distribution business, we distribute computer software, consumer electronics and accessories, video games and home video, and provide fee-based logistical services. The distribution business focuses on providing a range of value-added services, including vendor-managed inventory, electronic and internet-based ordering and gift card fulfillment.

Through our publishing business, we own or license various computer software brands. Our publishing business packages, brands, markets and sells directly to consumers, retailers, third-party distributors and our distribution business. Our publishing business currently consists of Encore Software, Inc. (“Encore”).

Encore, which we acquired in July 2002, publishes a variety of software products for the PC and Mac platforms. These products fall mainly into the print, personal productivity, education, family entertainment, and home and landscape architectural design software categories. In addition to retail publishing, Encore also sells directly to consumers through its e-commerce websites.

On May 17, 2010, Encore completed the acquisition of substantially all of the assets of Punch!, a leading provider of home and landscape architectural design software in the United States. The acquisition of Punch! expanded our content ownership and our strategy to enhance gross margins.

On March 31, 2011, we sold FUNimation Productions, Ltd. (“FUNimation”), a leading anime content provider which was previously part of our publishing segment. All results of operations, assets and liabilities of FUNimation are classified as discontinued operations for all periods presented, and the consolidated financial statements, including the notes, have been reclassified to reflect such segregation for all periods presented (see further disclosure in Note 2 to our consolidated financial statements).

During October 2011, we implemented a series of initiatives, including a reduction in workforce and simplification of business structures and processes across the Company’s operations (“Restructuring Plan”). These actions are intended to increase operating efficiencies and provide additional resources to invest in product lines and service categories in order to execute the our long-term growth strategy. We expect to record pre-tax restructuring charges and other non-recurring expenses of approximately $8.5 million to $9.5 million during the third and fourth quarters of fiscal year 2012.

Executive Summary

Continuing Operations

Consolidated net sales from continuing operations for the second quarter of fiscal 2012 decreased 11.5% to $106.6 million compared to $120.5 million for the second quarter of fiscal 2011. This $13.9 million decrease in net sales was due to reduced demand in software, video game and home video products, partially offset by an increase in net sales of consumer electronics and accessories, which was driven by the expansion of new products with existing and new customers.

Our gross profit from continuing operations decreased to $12.6 million, or 11.8% of net sales, in the second quarter of fiscal 2012 compared to $17.3 million, or 14.4% of net sales, for the same period in fiscal 2011. The $4.7 million decrease in gross profit and 2.6% decrease in gross profit margin percentage was principally due to decreased sales volume, with a mix of sales that included a higher amount of lower gross profit margin security and utilities software products within the distribution segment and lower gross profit margin value-priced software titles in the publishing segment.

Total operating expenses from continuing operations for the second quarter of fiscal 2012 were $14.2 million, or 13.3% of net sales, compared to $14.1 million, or 11.7% of net sales, in the same period for fiscal 2011. The $77,000 increase was primarily a result of a $330,000 increase in bad debt expense due to increased higher risk receivable balances, and a $119,000 increase in general and administrative expenses for the second quarter fiscal 2012 attributed to increased share-based compensation, partially offset by decreased selling and marketing expenses during the second quarter of fiscal 2012.

Net loss from continuing operations for the second quarter of fiscal 2012 was $1.2 million or $0.03 per diluted share compared to net income from continuing operations of $1.5 million or $0.04 per diluted share for the same period last year.

Consolidated net sales from continuing operations for the six months ended September 30, 2011 were $210.6 million compared to $219.3 million for the first six months of fiscal 2011, a decrease of 4.0%. The $8.7 million decrease in net sales was principally due to reduced demand in software, video games, and home video products as well as a reduction in publishing software sales into retail. These decreases in net sales were partially offset by the increase in net sales of consumer electronics and accessories, which was driven by the expansion of new products with existing and new customers.

Our gross profit from continuing operations was $26.4 million, or 12.5% of net sales, for the first six months of fiscal 2012, compared with $31.7 million, or 14.5% of net sales, for the same period in fiscal 2011. Both the $5.3 million decrease in gross profit and 2.0% decrease in gross profit margin were due to decreased sales volume, with a mix of lower gross profit margin security and utility software products within the distribution segment and lower gross profit margin value-priced software titles in the publishing segment.

Total operating expenses from continuing operations for the six months ended September 30, 2011 were $28.6 million, or 13.6% of net sales, compared to $27.4 million, or 12.5% of net sales, in the same period for fiscal 2011. The increase in operating expenses of 1.1% of net sales was primarily due to CEO transition costs of $1.7 million, partially offset by reduced personnel costs.

Net loss from continuing operations for the six months ended September 30, 2011 was $1.9 million or $0.05 per diluted share compared to net income from continuing operations of $1.7 million or $0.04 per diluted share for the same period last year.

Discontinued Operations

On March 31, 2011, we sold our wholly-owned subsidiary, FUNimation. Accordingly, all results of operations, assets and liabilities of FUNimation for all periods presented are classified as discontinued operations, and our consolidated financial statements, including the notes, have been reclassified to reflect such segregation for all periods presented.

There were no net sales from discontinued operations for the six months ended September 30, 2011. Net sales from discontinued operations for the three and six months ended September 30, 2010 were $9.0 million and $16.7 million, respectively. FUNimation benefitted from a strong release schedule of Dragonball Z titles and the receipt of agency fees related to a licensing agreement.

Net income from discontinued operations for the three and six month ended September 30, 2010 was $1.7 million or $0.05 per diluted share and $2.6 million or $0.07 per diluted share, respectively.

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 requires usage of our revolving credit facility in order to fund our working capital needs. We have a cash sweep arrangement with our lender, whereby, daily, all cash receipts from our customers reduce borrowings outstanding under the credit facility. Additionally, all payments to our vendors that are presented by the vendor to our bank for payment increase borrowings outstanding under the credit facility. “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 to the reported financial statements.

On November 12, 2009, we entered into a three year, $65.0 million revolving credit facility (the “Credit Facility”) with Wells Fargo Foothill, LLC as agent and lender, and Capital One Leverage Financing Corp. as a participating lender. The Credit Facility is secured by a first priority security interest in all of our assets, as well as the capital stock of our subsidiary companies. Additionally, the Credit Facility calls for monthly interest payments at the bank’s base rate, as defined in the Credit Facility, plus 4.0% or LIBOR plus 4.0%, at our discretion. The entire outstanding balance of principal and interest is due in full on November 12, 2012.

At both September 30, 2011 and March 31, 2011 we had zero outstanding on the Credit Facility. Amounts available under the Credit Facility are subject to a borrowing base formula. Changes in the assets within the borrowing base formula can impact the amount of availability. Based on the facility’s borrowing base and other requirements at such dates, we had excess availability of $37.3 million and $33.3 million at September 30, 2011 and March 31, 2011, respectively. At September 30, 2011, we were in compliance with all covenants under the Credit Facility and currently believe we will be in compliance with all covenants over 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 7.5% at both September 30, 2011 and March 31, 2011. 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.

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; 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; pending SEC investigation or litigation could subject us to significant costs, judgments or penalties and could divert management’s attention; the extent to which our insurance does not mitigate the risks facing our business or our insurers are unable to meet their obligations, our operating results may be negatively impacted; increased counterfeiting or piracy may negatively affect demand for our home entertainment products; we may not be able to protect our intellectual property rights; the failure to diversify our business could harm us; the loss of key personnel could affect the depth, quality and effectiveness of the management team; our ability to meet our significant working capital requirements or if working capital requirements change significantly; product returns or inventory obsolescence could reduce sales and profitability or negatively impact our liquidity; the potential for inventory values to decline; impairment in the carrying value of our assets could negatively affect consolidated results of operations; our credit exposure or negative product demand trends or other factors could cause credit loss; our ability to adequately and timely adjust cost structure for decreased demand; our ability to compete effectively in distribution and publishing, which are highly competitive industries; our dependence on third-party shipping and fulfillment for the delivery of our product; our reliance on third-party subcontractors for certain of our business services; developing software is complex, costly and uncertain and operational errors or defects in such products could result in liabilities and/or impair such products’ marketability; our dependence on information systems; future acquisitions or divestitures could disrupt business; future acquisitions could result in potentially unsuccessful integration of acquired companies; interruption of our business or catastrophic loss at any of our facilities could curtail or shutdown our business; future terrorist or military activities could disrupt our operations or harm assets; we may be subject to one or more jurisdictions asserting that we should collect or should have collected sales or other taxes; our ability to use net operating loss carryforwards to reduce future tax payments may be limited; we may be unable to refinance our debt facility; our debt agreement limits operating and financial flexibility; we may incur additional debt, which could exacerbate the risks associated with current debt levels; 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, 2011 and other public filings and disclosures. 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, and contingencies and litigation. There have been no material changes to these critical accounting policies as discussed in greater detail under this heading in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended March 31, 2011.

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

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

The following table represents a reconciliation of GAAP net sales to net sales before inter-company eliminations:

		Three Months Ended								Six Months Ended
		September 30,								September 30,
		(Unaudited)								(Unaudited)
		2011				2010				2011				2010
Net sales:
Distribution		$	104,037			$	118,761			$	205,771			$	214,714
Publishing			6,315				8,656				13,522				15,710
Net sales before inter-company eliminations			110,352				127,417				219,293				230,424
Inter-company sales			(3,784	)			(6,941	)			(8,709	)			(11,156	)
Net sales as reported		$	106,568			$	120,476			$	210,584			$	219,268