Driven By Paulson Power

In the past decade, Navarre Corp. has transformed itself from just another midlevel indie distributor into one of the largest and most powerful entertainment software wholesalers in the industry.

Since 1995, when the Minneapolis-based company had revenue of $119 million, Navarre has grown sixfold to reach what Billboard estimates will be more than $700 million in revenue in its current fiscal year, which ends March 31.

Founder Eric Paulson—who is stepping down as CEO but retaining the title of chairman—says Navarre is on its way to $1 billion in revenue.

That kind of volume catapults the company into the ranks of super-wholesalers that consists of Anderson Merchandisers, Handleman Co., Source Interlink (which owns Alliance Entertainment Corp.), Baker & Taylor and Ingram—all entities with revenue bases believed to exceed $1 billion annually.

While only about one-tenth of Navarre's sales volume (about $75 million) comes from independent music distribution, the remainder of the growth is the result of Paulson's original game plan, which included computer software.

Paulson says that when he founded the company in 1983, "I believed [software] would change the way we lived our lives at work and home, and that somewhere the music industry and computer software would merge under some kind of convergence in technology."

In addition to software, Paulson had experience with the emerging video business thanks to his employment from 1967 to 1983 at Pickwick, the then-giant music company that consisted of its wholesale operation, label and the Musicland retail enterprise. When Pickwick closed its music wholesale business, Paulson saw an opportunity to fill the void and started Navarre.

In its most recent fiscal year, software sales, which includes business software and computer games, accounted for $449 million of the $686 million generated in the year ended March 31, 2006, while DVD sales pulled in $53 million, videogames $40 million and indie distribution $72 million. The company derives the remainder of its revenue from the creation and/or licensing of video product and computer games through subsidiaries Encore and FUNimation.

Encore is a software publisher that licenses or owns everything from spyware to the Print Shop desktop publishing software, as well as a broad array of computer games like the Hoyle franchise, the Hasbro line and the new version of "Monopoly." FUNimation licenses Japanese anime for DVDs in North America.

"Twenty-three years ago, I don't think too many people saw the convergence of media coming the way Eric did," says Navarre director of national accounts Vyto Lazaukis, who joined in 1995. "It's been a hell of a ride."

The ride began when Paulson mortgaged his house to fund his new company. He supposedly tells people, "When I started this business, I walked into an empty building, we had nothing to sell and nobody to sell it to."

Lazaukis wasn't there in the early days, but he repeats company legend that Paulson "laid everything that he had on the line personally a number of times to meet payroll or keep the company going or to expand the company. Can you imagine coming home to your wife and saying, 'Let's mortgage the house, I think this will work,' and then doing it more than once?"

He had to do it more than once through the years, because the ride included some close calls that the company survived thanks only to Paulson's leadership and bravado, according to former employees, partners and competitors.

"I have never seen anybody that is a survivor like him," says Joe Weinberger, CEO of Navarre-distributed Lil' Joe Records in Miami. "He seems to be able to pull a rabbit out of the hat when he needs it."

Veteran industry sales consultant Esa Katajamaki, who was with Navarre from 1983 to 1989, says, "If Navarre's finances were weak, Eric would never show the employees that something was amiss. Eric never saw a bad day and never saw a question that had the answer 'no' to it. Like a bull in the china shop, he would make it happen."

In fact, Paulson's natural salesmanship skills often literally forced the company's capabilities to grow.

"I'd be sitting there in meetings either with accounts or suppliers and listening to what Eric was saying, and wondering, 'How are we going to do that?' "Katajamaki says. "Then when we would leave the meetings, Paulson would say to me, 'We have to figure out how to do that.' "

One of the close calls Navarre had was when Paulson sold the company to video distribution company LIVE Entertainment, which attempted to vertically integrate other elements of home entertainment software by also buying the Lieberman rackjobbing operation and the Strawberries record store chain.

LIVE's ambition soon proved to be too much. The company found itself with a liquidity problem that forced it to do a prepackaged Chapter 11. In that reorganization, Paulson found a way to buy back Navarre. "When I sold them Navarre, we were heading to $100 million, and what we bought back was a company that was under $20 million in annual revenue."

Paulson had to start the company all over again in January 1992. Yet, by 1995, Navarre had gone public and finished that year with $119 million in revenue. But even at that point, it still struggled to attain Paulson's vision.

"Back in 1995, when I came to Minnesota to discuss working at Navarre, Eric showed me a little shit-hole building with no windows," Lazaukis says. "He then took me to a cornfield and said, 'This is where our new headquarters will be.' "

Today, the Navarre headquarters takes in 321,00 square feet in two buildings, not to mention the company's offices in Canada and California. Navarre employs nearly 700 people.

From the time it went public in 1994, except for 2002, Navarre's sales revenue has grown steadily each year, even though there have been some missteps along the way.

Some of the bets that didn't pay off and resulted in millions of dollars in write-offs include investments in Internet radio channel Net Radio; eSplice, an early attempt at putting together a digital aggregation company; Mix & Burn, which builds CD-on-demand kiosks; Digital Entertainment, a CD-ROM company; and Velvel Records, founded by former Sony Music chief Walter Yetnikoff. The acquisition of Surfside Distributors also didn't pan out.

Paulson concedes that Navarre may have stepped in too early and heavily on Internet plays like Net Radio and eSplice. Investments that don't work out "are part of business," he says.

Despite consistently rising sales, net losses piling up on the bottom line during a five-year period from 1997 to 2001. Investors also suffered through the fall of 2001, when Navarre shares fell in value, before the company began turning things around in 2002.

Beginning with that year through fiscal 2005, Navarre generated black ink all four years, culminating in the $10.2 million net income on sales of $596.6 million.

Navarre's winning streak ended in fiscal 2006 when the company posted a $3.2 million loss on $686 million in revenue. The loss resulted from a $4 million write-off when Navarre parted ways with an undisclosed label and the $12 million hit Navarre took when Musicland went bankrupt. But during that period, shareholder equity grew from $24.3 million in 2002 to $89 million by the end of 2006.

The company is even more solid than those numbers suggest.

In the past year, Navarre also withstood the Tower Records liquidation. Yet the wholesaler still has produced $6.4 million in net income on sales of $529 million in the nine-month period ended Dec. 31, 2006.

What's more, some of Navarre's latest investments are paying off dividends.

"FUNimation looks to be a win-win, but first they had to turn it around like they did for Encore and BCI Eclipse," says Michael Catain, CEO of the Navarre-distributed Liquid 8 label.

When Navarre bought FUNimation the company took on debt to finance the $87 million acquisition in 2005, leaving the balance sheet with debt of $140 million.

"Since then, the company has paid down debt to about $80 million, and its revolving credit facility balance stands at zero," says Cary Deacon, president/CEO of Navarre, who previously was the company's president/COO. "We have positive operating cash flow for this year in spite of the other issues. That is my goal to push for operating cash flow in all divisions . . . and get debt paid off."

FUNimation will do $50 million in revenue this year, according to Navarre, and the company started a TV channel that has a viewership of about 1 million cable subscribers. Navarre says it is the No. 1 distributor of Japanese anime in the United States.

Deacon says he also expects the software division Encore to produce $50 million in revenue. Meanwhile, its acquisition of BCI, which licenses documentaries and other niche categories for DVD, has doubled its sales to $32 million from the $16 million the company produced when it was acquired.

Music now accounts for about 10% of the company's revenue, down from 34% in 2000. With all of Navarre's non-music enterprises—distributing computer software, videogames and DVDs, and its increasing publication of company-created or licensed DVDs and computer software—some wonder if music is part of Navarre's future, especially since Deacon is taking over day-to-day control and doesn't have a music industry background like Paulson.

Deacon responds that music is one of the support beams in Navarre's business.

"I put my faith in Bob Freese," who is VP/GM of Navarre Entertainment Media, its indie distribution business. "Bob has done a great job in bringing music-industry sensitivities and business disciplines to our indie [distributor]. He has enough rope to run the business as he sees fit."

One of the things Freese has done to keep growing the business is move into niche areas, as catalog has become a difficult sell with the closure of Tower and Musicland, Deacon says.

"We have spent a lot of our attention on Nashville, and now we are growing that business there," Freese says. "A lot of country music is being purchased out of the big box, so the loss of Tower doesn't hurt that genre. Also, it's less likely to be downloaded than other genres."

In addition, Freese says that some of Navarre's distributed labels are determining how to create music that appeals to mass-merchant consumers.

Brian Perera, owner of Los Angeles-based metal/punk label Cleopatra Records, says, "I definitely feel that Navarre has helped us to grow where retail is right now. Navarre is getting into Nashville, so we are moving into Southern rock."

Also, the label has shifted its focus from putting out new music and hawking its entire catalog to "compilations like [collections of] '80s hair bands and essential metal classics and funk and soul greatest-hits albums," Perera says. "This product is very good for Navarre, because they are really good in selling to the mass merchant."

Traditional retail has abandoned the catalog business, and the only way the genre can be sold now is through Amazon or iTunes, Deacon says.

Since Navarre has been making a big push to be a digital aggregator for its labels, it expects to rejuvenate those sales.

Also, Navarre itself is enjoying digital sales success with three FUNimation titles recently featured on one of the video home pages of the iTunes Music Store.

But with all the emphasis on digital sales, Deacon says Navarre is working to improve its physical distribution capabilities. Like music, computer software is also under siege in a marketplace where downloading is rampant.

But Deacon predicts a strong physical-goods marketplace for the next five to 10 years in all its product lines.

Whichever way the marketplace evolves, Deacon says he is inheriting a company that Paulson built well to handle those challenges and opportunities.

"Eric built a hell of a workplace for a lot of people," Deacon says. "He is the patriarch of the company. It will be an interesting transition without having Eric here every day. It will be bittersweet, because he will still be involved in the business as chairman and as a large shareholder."