NAVR III
MARKET OVERVIEW-SOFTWARE
Distribution of personal consumer software is less concentrated than distribution of prerecorded music because software sales are attributable to a large number of software publishers, whereas the vast majority of prerecorded music sales are attributable to five record companies. Consolidation is well underway on the publisher side of the business, with large software publishers such as The Learning Company, Electronic Arts and CUC Software acquiring a number of smaller publishers. The trend of larger publishers acquiring smaller publishers should continue, as larger publishing entities have greater ability to influence key points of influence at the point of sale such as pricing, packaging and return policies, making it more difficult for smaller publishers to achieve broad distribution. Key retail distribution channels are mass merchants, computer and electronic superstores, warehouse clubs and specialty retailers, such as bookstores and music stores. Additionally, Computer manufacturers have become an increasingly significant source of distribution as most computers are now sold with software already installed.
Larger software publishers, that have the critical mass and infrastructure necessary to support distribution operations, typically sell directly to retailers. Conversely, smaller software publishers that lack the infrastructure and critical mass necessary to sell direct to large retailers, typically utilize distributors to access retailers. Trade data estimating industry revenue share attributable to the various distribution channels is not readily available. However, P.C. Data, a trade publication, estimates that 1997 consumer software sales totaled $4.4 billion (wholesale). Business software accounted for 80% of industry sales. The next highest volume software categories were entertainment, finance, personal productivity, education and reference. Navarre focuses on four software product categories: education, entertainment, personal productivity and reference. These product categories accounted for about 20% of 1997 consumer software sales based upon the data provided by P.C. Data. Navarre believes that the majority of these product category sales are attributable to distributors rather than publishers. Navarre's March 1998 fiscal year consumer software sales approximated $137 million, or 17% total industry sales in these four product categories.
COMPETITION
Music. Including Navarre, there are a number of independent music distributors that distribute on a national basis. Most of these entities focus primarily on functioning as either a distribution source for small music retailers or serving large music retailers as a temporary inventory-out-of-stock supply source. Navarre has distinguished itself from other independent music distributors by establishing itself as the leader among all independent distributors, generating more revenue from exclusive independent artist and label distribution relationships than any other independent distributor. To a much lesser extent, Navarre functions as a temporary inventory-out-of-stock supply source. Navarre's music customers include all music retailers and all other distributors of music by virtue of its status as the exclusive supply source for the independent artists and labels that it represents. Navarre's strategic alliance with NetRadio will further distinguish Navarre from other independent suppliers as it will have a distribution and marketing platform that no other independent distributor has.
Consumer Software. Navarre differentiates itself from other computer product distributors on the basis of product categories that it carries and the service it provides. Navarre distributes only personal computer product targeted for four product categories (entertainment, education, productivity and reference) and is typically selected by the retailer as a preferred distribution source for those product categories because of its ability to provide a higher level of service. Most competing computer product distributors focus on higher volume products, and in some cases, different product categories. Some of these competitors often do not provide the level of service (such as delivery to individual store locations, customized product identification and price labeling, more flexible credit terms and other services) that Navarre will provide. All of Navarre's software distribution competitors are larger than Navarre in terms of revenue. Significant competitors include companies such as Ingram, Tech Data, Merisel and Handleman. These companies generate most of their software revenue through business and higher volume education and entertainment software titles, and typically provide less service than Navarre. Navarre believes that it is the largest supplier of many of the software titles that it carries.
BUSINESS OVERVIEW
Navarre's objective is to become a leading provider of software and entertainment products. The company has built a strong base of music and software business by developing state-of-the-art fulfillment capabilities and strong relationships with all leading retailers of music and personal computer software. Two years ago, Navarre acquired NetRadio Network, the first Internet-only radio network. It has since become the world's largest on-demand Webcaster of originally programmed audio content and an emerging player in electronic commerce. Operationally, Navarre has established two product divisions, music and computer products, to separately address the market for both types product offering. NetRadio, which is discussed at length later in the report, is operated as a subsidiary company. Each product division utilizes the company's distribution facility and state-of-the-art fulfillment capabilities.
Music. Navarre is a national distributor of both independent and major record labels. Navarre was the first national distributor of independent recording artists and record labels, and is now recognized as the leader in the distribution of independent artists and labels, as it has a larger base of independent artists and labels, and greater independent music revenue, than any other independent distributor. As a distributor of major record labels, it functions primarily as an inventory out-of-stock supplier for major music retailers such as Musicland and Best Buy. As a distributor of independent record labels, the company functions as the exclusive distributor of those labels. As such, Navarre is the exclusive distributor of artists across a broad spectrum of music, including Kenny Rogers, American Gramaphone (Mannheim Steamroller), Celestial Breakaway (Nate Dogg), Vonda Shepard, Beach Boys, Bob Marley and Charlie Daniels. Music accounted for about 30%, or $41 million, of the company's FY March 1998 revenue. Independent music distribution is Navarre's highest gross margin product offering, generating gross margins approximately 20%. Distribution of major label music typically generates gross profit margins around 11%.
Computer products. Navarre's computer products product strategy focuses four product categories: education, entertainment (including interactive games), personal productivity and reference. Navarre's software distribution strategy can be characterized as focusing primarily on software categories and titles that are not sold directly by their publishers. Additionally, by providing a very high level of service, it is often selected as the supply source of choice by retailers for certain software titles. From a service perspective, Navarre distinguishes itself by providing retailers with a higher level of service than is often provided by other distributors or publishers. Consequently, Navarre's niche may be described as distributing for publishers of low-to-mid-volume titles that typically do not have a direct sales force, and distributing to retailers that choose to purchase from Navarre rather than some other supply source because of Navarre's service capabilities. Navarre distributes for a broad range of software publishers, including CUC, Cybermedia, Disney, The Learning Company, Lucas Arts, Rand McNally, Hasbro Interactive and others. Navarre distributes to every significant retail channel, including wholesale clubs, mass merchants, computer specialty stores, music stores and bookstores. Major retail customers include Sam's Club, Best Buy, Circuit City, CompUSA, Musicland and Barnes & Noble. Software accounted for about 70%, or $139 million, of the company's FY 1998 revenue. Software product offerings typically generate gross profit margins between 7% and 15%, with most product offerings approximating 10%.
Operational Capabilities. Navarre's state-of-the-art distribution center effectively positions the company to carry a broad range of merchandise and meet the service requirements of leading retailers, which recognize it as a leader among music and software distributors in terms of ability to deliver a broad range of services. Navarre's distribution center inventories over 20,000 SKU's of compact discs, cassettes, personal computer software and interactive CD ROM software which is sold to over 500 different customers in more than 10,000 locations across the United States and the Pacific Rim. Navarre has utilized its operational capabilities to deliver a very high level of service, often differentiating itself from other supply sources. Navarre's service capabilities include:
Drop shipment to individual retail stores.
Direct to consumer fulfillment.
Cross-docking with JIT delivery capabilities.
Customized product identification and price labeling.
Assumed receipt capabilities.
Electronic data interchange and online service for vendors and customers.
Navarre's information systems are Year 2000 compatible, and the company has sufficient information system capacity to expand its SKU base to pursue additional product and fulfillment opportunities. In addition, the company has an experienced sales team that has established relationships with nearly every retailer of music and personal computer software, and established field merchandising service to ensure sell-through of product. Navarre's operational capabilities have enabled it to maintain and expand many customer relationships through industry consolidation over the last three years while many larger independent distributors have downsized or gone out of business. Navarre has the infrastructure in place, exclusive of the need to add bricks and mortar, to handle up to $500 million of annual revenue. Navarre's distribution center provides it with a platform to not only grow by expanding relationships with existing customers, but also function as a fulfillment source for on-line retailers. Navarre will function as the primary fulfillment source for a number of NetRadio's electronic commerce product offerings. Additionally, Navarre recently became a strategic supplier of consumer software offerings of Barnes & Noble, Inc.'s electronic commerce entity, barnes&noble.com. Barnes & Noble is the world's largest bookseller.
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