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Navarre Corp. (NASDAQ:NAVR)

F1Q09 (Qtr End 6/30/08) Earnings Call

August 4, 2008 11:00 pm ET

Executives

Ryan Urness - General Counsel and Secretary

Cary Deacon - President and CEO

Reid Porter - EVP and CFO

Analysts

Bob Evans - Craig-Hallum Capital

Ernie Andberg - Feltl & Company

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2009 Navarre earnings conference call. (Operator Instructions).

I would now like to turn the presentation over to your host for today's conference, Mr. Ryan Urness, General Counsel and Corporate Secretary. Please proceed.

Ryan Urness

Thank you, operator, and good morning, everyone. Before we begin, I'd like to remind everyone that a replay of the webcast can be found on our website, at www.navarre.com, in the Investor Section. Shortly after the call, we'll post a replay of this conference call on the website.

The following constitutes a safe harbor statement under the Private Securities Litigation Reform Act of 1995. Except for historical information contained herein, these remarks contain forward-looking statements that involve risks and uncertainties which could cause our actual results to differ materially from those described in the forward-looking statements. These risks include but are not limited to general business conditions and the risks detailed in our public filings. The company does not undertake any obligation to update forward-looking statements.

As to any non-GAAP financial measures discussed, we refer listeners to the discussion and financial tables, including a reconciliation between GAAP and non-GAAP financial measures that are included in our press release dated August 1, 2008.

With that, I'd now like to introduce Cary L. Deacon, Chief Executive Officer of Navarre Corporation.

Cary Deacon

Thank you, Ryan. Good morning, ladies and gentlemen. Also joining me this morning is Reid Porter, our Executive Vice President and Chief Financial Officer; and Brian Burke, our Chief Operating Officer.

During the call, we will be providing a review of our fiscal year 2009 first quarter financial results. We will start off with Reid providing a detailed overview of these results, then I will follow-up with a business review of our performance during the quarter. After our prepared remarks, we will open up the call for any analyst questions.

Reid, over to you.

Reid Porter

Thanks, Cary. First quarter net sales were $142 million, an increase of 3.7% from last year's sales of $137 million. Distribution segment net sales before inter-company eliminations for the first quarter increased by 7.4% to $133 million. Most of the sales increase was at video games, where market conditions were relatively buoyant despite the soft retail environment. While software sales overall were flat year-to-year, the productivity and utility categories in software played an increasing role in our overall sales mix.

Publishing segment net sales decreased in the quarter by approximately $2.2 million to $27.4 million. FUNimation net sales were below last year due to a tough prior year comparison but exceeded our expectations for the quarter. FUNimation sales success in the quarter was in both new release and catalog products, as we continued to gain anime DVD market share.

Encore's net sales declined from the first quarter of the prior year, primarily due to a lack of new releases during the quarter. BCI, while being the smallest of our three publishing divisions, showed significant year-over-year improvement during the quarter.

Gross profit for the quarter was $22.1 million versus $24 million in the same period of the prior fiscal year. Gross profit margin percentage was 15.6% versus 17.5% during the first fiscal quarter of last year. The lower gross profit margin was the result of a lower sales mix of publishing business, as well as a lower gross profit margin in our distribution and software business.

The distribution segment's gross margin decline resulted in large part from a greater mix of lower margin productivity and utility software products.

Operating expenses of $19.4 million were essentially flat when compared to the same quarter last year. ERP implementation expenses, including the cost of running duplicate systems, increased year-to-year and unfavorably impacted distribution. Publishing expense reductions offset these increases. BCI expenses were lower due to the restructuring initiatives taken last year, and promotional expenses, particularly advertising expenses at FUNimation, were also lower year-to-year.

Interest expense was $1.6 million, which was similar to last year, but included a write-off of $490,000 of deferred debt costs associated with the June 2008 pay down of the company's Term B debt facility. In June, the company paid off the remaining $9.7 million balance of its Term B loan facility. This repayment was funded by our $95 million revolver credit facility, which had $48.7 million outstanding as of June 30.

Net income from continuing operations for the first quarter was $627,000 or $0.02 per diluted share during the quarter as compared to net income from continuing operations during the first quarter of the prior year of $1.9 million or $0.05 per share.

EBITDA from continuing operations for the quarter was $5.3 million as compared to EBITDA from continuing operations of $7.3 million for the same quarter last year.

Turning to the balance sheet, debt net of cash was $48.7 million, a decrease of $5.1 million versus prior year. Inventories were flat versus the prior year quarter. However, receivables were up $18 million year-to-year. About one half of the increase was volume-related, with the remainder due to an increase in days outstanding. We believe this increase in days related to quarter end timing issues and doesn't reflect a long-term trend.

Capital expenditures were $2.4 million. We expect capital spending to be significantly reduced in the coming quarters as ERP spending is winding down.

I'd now like to turn the discussion back to Cary for more color. Cary?

Cary Deacon

Thank you, Reid. We're very pleased with our first quarter results given the current economic situation and believe that we're on track to meet our targets for the full fiscal year. However, we anticipate that macroeconomic conditions will continue to be difficult during the foreseeable future.

I'm very excited about FUNimation's prospects with their strong content additions that will solidify not only this fiscal year but provide strong growth impetus for next year. I am also particularly pleased with BCI's year-over-year improvements for the quarter.

The final implementation phase of our new ERP system went live at the end of July as scheduled. The final phase included our transportation and distribution modules. This system implementation has been a massive undertaking for our company, and we are pleased to have it in place. We anticipate that it will deliver future efficiencies as well as additional opportunities to provide value-added services to our customers and vendors alike. As well, the company will no longer be running parallel systems, and as a result, the company will save approximately $1.3 million in the last half of this year as planned.

I would now like to take a moment to discuss the performance of each of our business segments. As Reid mentioned, the publishing segment experienced a net sales decrease compared to last year, due primarily to significant differences in product releases at both FUNimation and Encore compared to the same quarter of the prior year. FUNimation had a solid quarter and it exceeded our sales and profit expectations.

You may recall that during the first quarter last year, FUNimation released Afro Samurai, the top-selling DVD anime release of calendar 2007. Although this was a comparison that could not be matched this fiscal year, significant headway was gained during the quarter as FUNimation continued to gain market share in the anime space and has clearly cemented itself as the leading publisher of anime content in North America.

During the quarter, FUNimation acquired a significant amount of high-quality content, including the recently announced sequel to Afro Samurai, entitled Afro Samurai: Resurrection. In addition to the voice talent of Samuel L. Jackson, who was in the original series, the sequel will also include Mark Hamill of Star Wars and Lucy Liu, who starred in Charlie's Angels and Kill Bill films. We anticipate at a minimum a repeat of the success of the first series from this property scheduled to be available in early 2009.

Other FUNimation content acquisitions that were closed during the quarter included the distribution rights to the Geneon Entertainment catalog, and over 30 titles whose rights were previously held by AD Vision. We anticipate that this influx of strong new content will help FUNimation to gain market share and meet or exceed our expectations for this fiscal year.

Growth in net sales and solid expense management of BCI led the way to much improved financial results. Our efforts to restructure and position BCI for future growth and profitability appear to have taken root during the first quarter. As a result, BCI's net sales for the quarter increased significantly compared to the same period last year. And during the quarter, BCI largely eliminated its operating loss as compared to the prior year, which resulted in year-over-year improvements to the publishing segment's operating income.

Encore's operating metrics were solid, but its sales did not match the first quarter from last year. While the first quarter of 2008 fiscal year was heavy with new product releases, that was not the case in this first quarter. Encore's product release plan is more heavily weighted to Q3 and Q4 in fiscal 2009, and we look forward to seeing the positive effect of this strategy in the coming quarters. As well, Encore has several new publishing opportunities that are close to being finalized that will provide future growth for this division.

The distribution segment's net sales from continuing operations increased by 7.4%, with the largest sales gains coming from productivity and utility software, DVD video and the video games category. The segment's gross margin was adversely affected by a major blend shift in the quarter to video games and to the software productivity categories that carry lower gross margin rates. The company will undertake initiatives to improve its distribution margins and/or reduce expenses to offset these blend shifts.

DVD video had a very strong quarter, exhibiting a 20% net sales gain on a year-over-year basis. The success of a vendor-managed inventory program with a major electronics retailer continues to fuel the growth in this category.

Video games experienced a 100% increase in net sales compared to Q1 of last year. This increase came from both exclusively distributed products, as well as the result of strong releases of non-exclusive products. We anticipate this category will continue to show strength during the remainder of this fiscal year.

With that, I'd like to now discuss our outlook for the remainder of the fiscal year. The company is maintaining its previously released guidance for the fiscal year of net sales between $640 million and $670 million, EBITDA between $28 million and $31 million, and anticipated net income of $7 million to $9 million. The company continues to anticipate that cash flow from operations will be positive for the fiscal year 2009.

I would like to thank all of our constituents for their time and support. With that, I would like to now open up the call for any analyst questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Bob Evans of Craig-Hallum Capital. Please proceed.

Bob Evans - Craig-Hallum Capital

Good morning, Cary and Reid. Nice job in a tough environment. First, can you comment on the SAP expense, how much was it this quarter, how much more do you expect next quarter and what was the level of CapEx?

Reid Porter

Okay. This is Reid, Bob. I'll handle that. Our CapEx in the first quarter was $2.4 million. About $1.5 million of that related to ERP. Our full year projection for CapEx is $4 million, so with very little ERP remaining basically in July, and so CapEx will be winding down this year.

Bob Evans - Craig-Hallum Capital

Okay. So from a maintenance CapEx standpoint, going forward, kind of view it as $2.5 million, $3 million?

Reid Porter

Yes. Right in the $2 million to $3 million range is what we would expect to do annually.

Bob Evans - Craig-Hallum Capital

Okay.

Reid Porter

On the expense side, ERP expenses were about $1 million in the Q1, which was a $300,000 some more than last year. As you recall a year ago, we are also still developing ERP. Of that $1 million, about $650,000 was related to duplicate systems running, and that $650,000 will be eliminated on a go-forward basis. And that's why Cary referred to the second half of the year being $1.3 million in savings due to ERP duplicate savings. In addition, we had other ERP spending of $350,000. About $250,000 of that should be eliminated on a quarterly basis on a go-forward basis.

Bob Evans - Craig-Hallum Capital

Okay. Will that affect Q2 though, will there still be spending in Q2?

Reid Porter

July was pretty full blown, and given that we went live August 1, a cleanup effort after August 1 gives us pretty much a full blown expense in August. So we may save a third of that in the second quarter, and then all of it in the third and fourth quarter.

Bob Evans - Craig-Hallum Capital

Okay. So you really think second half.

Reid Porter

Yeah.

Bob Evans - Craig-Hallum Capital

Okay. And on the title side, Afro Samurai, Cary, can you give us a ballpark idea of how big that was last year?

Cary Deacon

That title I think its original shipping was about $4.5 million.

Bob Evans - Craig-Hallum Capital

Okay.

Cary Deacon

As you may recall, Afro Samurai is a one release, a single release.

Bob Evans - Craig-Hallum Capital

Right.

Cary Deacon

I believe it was a six episode. So it doesn't come out in multiple releases. It's a single release. But it was the best-selling anime title in North America last year.

Bob Evans - Craig-Hallum Capital

Okay. And as you look at the content that you have internally, and then Geneon and ADV. beyond the other Afro Samurai that's coming out, are there any other titles we should look for that you are excited about that could have a chance to be bigger titles?

Cary Deacon

Yeah. Bob, we recently have added several new titles, but we have not finalized contracts. So at this time I apologize, but I can't name those titles. But I think between the title acquisition we've had in place for the last six months with Afro Samurai coming on board, with the ADV and Geneon additions, we're looking for a very, very strong year next year out of FUNimation.

Bob Evans - Craig-Hallum Capital

Okay.

Cary Deacon

And easily in double-digit sales increases.

Bob Evans - Craig-Hallum Capital

Okay. And what should we view the Geneon and ADV be altogether, what type of annual contribution, once you have it all in place, could that provide?

Cary Deacon

I would say that it would be annually probably somewhere between $7 million and $10 million.

Bob Evans - Craig-Hallum Capital

Okay. And with traditional margins kind of around the 40% type level?

Cary Deacon

Yes. I mean if they fall right into our normal operating.

Bob Evans - Craig-Hallum Capital

Okay. And as we look at the title release for this year, what quarters would be the bigger quarters in terms of FUNimation title releases?

Cary Deacon

Q3 and Q4.

Bob Evans - Craig-Hallum Capital

Okay. I think that's all I've got. Thank you.

Cary Deacon

Yeah. Bob, for example, Afro Samurai, as we've scheduled at this point unless there is any production issues to come out in Q4.

Operator

And your next question comes from the line of Ernie Andberg of Feltl & Company.

Ernie Andberg - Feltl & Company

Hello, Reid, Cary.

Cary Deacon

Hello, Ernie.

Reid Porter

Good morning, Ernie. He butchered your name a little bit there, Ernie.

Ernie Andberg - Feltl & Company

That's okay. I got Ernie. What happens to the interest expense line going forward with using your revolver to pay off the Term B?

Reid Porter

Basically what we had left on the Term B was just a little less than $10 million that we paid off.

Ernie Andberg - Feltl & Company

Right.

Reid Porter

There is $6 million of that $9 million on the revolver we peg that the Term B old interest rate of 7 and LIBOR plus 7.5. So there will be a modest rate reduction in that versus what we had before, but taking out of the Term B was more because of administrative issues being easier just to deal with the revolver than any significant reduction in rates from that transaction. So we'd expect rates to be similar to what they were.

Obviously, as we go into the third quarter, our working capital builds and our interest expense increases. But overall, on a year-to-year for the first quarter, we saved about $500,000 in interest expense year-to-year that was offset by the write-off of the fees associated with the Term B player. We expect to save some interest on a go-forward basis on a similar delta.

Ernie Andberg - Feltl & Company

Fair enough. On the increase in receivables, I think that you said, Reid, about half of it was just volume-related and half of that was an extension of DSOs.

Reid Porter

Yes, I did say that.

Ernie Andberg - Feltl & Company

I may be mischaracterizing what you said. You weren't concerned about that at this point in time, you think it was timing rather than anything else?

Reid Porter

No. When we look at it, there has been no increase in terms to our customers and no real decrease in their performance in payment to terms. It was really a number at month end timing issue and when things flowed that increased the day sales outstanding year-over-year. But we don't believe there is any long-term impact of that and day sales outstanding should return to expectations.

Ernie Andberg - Feltl and Company

So the quality of the receivables is high and there aren't any distressed retailers in there?

Reid Porter

Well, we continue to watch the retail environment closely. There's been no change in payment patterns from any of our customers and no one under distress in terms of the ability to pay us.

Ernie Andberg - Feltl and Company

Thank you. In Cary's comments, he was quickly going through some metrics on software and video games and the increases in video games, could you go back through that, Cary? You said there was 100% increase in video games versus last year, and I thought you said something about 20% year-over-year.

Cary Deacon

In the video game category for the quarter we doubled our sales, so 100% increase.

Ernie Andberg - Feltl & Company

Okay.

Cary Deacon

If you look at the industry, I saw a metric the other day and I think it was for the month of June, video console game sales were up 53% or 52%, I believe. So of all the entertainment categories, that category has been very, very strong in the marketplace and we happen to have quite a few new exclusive titles released in the quarter, so we took advantage of both our title release and the strength in the category. So that's what drove video games. And the 20% I referred to was our DVD distribution category.

Ernie Andberg - Feltl & Company

Yeah.

Cary Deacon

And that one was related primarily to a major vendor-managed inventory program we do with one of the largest electronic retailers that has continued to fuel growth in that category.

Ernie Andberg - Feltl and Company

Does that continue to give you favorable comps or is it a seasonal kind of timing thing?

Cary Deacon

No. I think I would look at the 20% in the quarter in DVD, it way outstrips the DVD business in total, which I think was only up in the industry about 7% in the quarter. But I would say we would continue to see strength in our management there of that vendor-managed inventory program. I don't know if it will keep going at 20, but it definitely will have some great, pretty strong year-over-year comps.

Ernie Andberg - Feltl and Company

All right. Bob had asked about the SAP implementation. I looked in notes and I thought that you had suggested after the first quarter that there would be about $500,000 of increased implementation costs for duplicate systems through the first five months. How does that square, Reid, with your comments on the $650,000 of duplicate systems in the first quarter plus another $350,000 of ERP implementation costs?

Reid Porter

I lost part of your question. But I can say that our view of duplicate costs hasn't changed a bit in the last couple of quarters.

Ernie Andberg - Feltl & Company

Okay.

Reid Porter

The paired duplicate systems work we've had over the past nine months has been $650,000 a quarter in terms of duplicate costs.

Ernie Andberg - Feltl & Company

Fair enough.

Reid Porter

Then there are some other costs associated with the ERP implementation that go away as well.

Ernie Andberg - Feltl & Company

Okay, fair enough. Thank you very much.

Reid Porter

Thanks, Ernie.

Operator

And your next question comes from the line Bob Evans of Craig-Hallum. Please proceed.

Bob Evans - Craig-Hallum Capital

Hello, again. Reid, just to follow-up on the accounts receivable, should we expect a more normalized level next quarter or how long does it take you to kind of get AR back to where you want it?

Reid Porter

No. Given that they were just quarter timing differences, I would expect on end of September to have a receivable level that reflects the increase in volume we have, but be similar in days to prior year.

Bob Evans - Craig-Hallum Capital

Okay, good. So we should see some cash flow generation in the next quarter?

Reid Porter

Yes.

Bob Evans - Craig-Hallum Capital

Okay. And then Cary, as it relates to BCI, I know you said things improved both sales and reduction of the loss, can you give us some sense of magnitude?

Cary Deacon

Well, just bear with me one second. I have it here, Bob. I'll give it to you. Net sales at BCI were up about 25%, I think, quarter-over-quarter

Bob Evans - Craig-Hallum Capital

Okay.

Cary Deacon

And the profit improved dramatically.

Bob Evans - Craig-Hallum Capital

Okay. So you went from a meaningful loss to something relatively modest?

Cary Deacon

Yes, relatively modest. But from a cash flow perspective, cash flow positive.

Bob Evans - Craig-Hallum Capital

Okay, good. Nice job on that. Thank you.

Cary Deacon

Thanks Bob.

Operator

(Operator Instructions).

Reid Porter

No other questions?

Operator

No other questions.

Reid Porter

Okay.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have an excellent week.

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Source: Navarre Corp. F1Q09 (Qtr End 6/30/08) Earnings Call Transcript
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