The News is Good, But the Loss is Higher? Skullcandy’s March 31 Quarter

Skull’s loss for the quarter ended March 31 rose 27.9% from $3.7 to $4.9 million.  Sales rose just 1.4% to $46.3 million while the gross profit margin dropped from 40.9% in last year’s quarter to 37.5% in this year’s.  The pretax loss rose 50% from $4.6 to $6.9 million.

The balance sheet remains as strong or stronger than it was a year ago.  Cash on the balance sheet rose $12 to $14 million, as did accounts payable, as Skull stopped taking some discounts for early supplier payments.  Paying early would boost the gross margin and stopping early payments would reduce it.  They don’t tell us what the impact was.

I don’t judge a company by a single quarter.  And I expect management, in conference calls, to explain the longer term strategic opportunities and to put their best foot forward.  There is, after all, and whether there should be or not, a marketing component in the call presentation.

I always start with the financial statements as reported on the 10-Q or 10-K under generally accepted accounting principles before I move on to the conference call because I want to know what REALLY happened before I see management’s spin.  CEO Hoby Darling’s spin in the second paragraph of the conference call was:

“Our recent performance was extremely rewarding, given the number of headwinds we faced to start the year, including heavy audio inventory with key U.S. retailers coming out of the holiday, issues with our China region and out of stock situations with Astro…”

My interpretation?  “We’re glad we didn’t do worse given that conditions kind of sucked.”  God, just once I’d love to see a CEO say something like that.  I’d probably rush out and buy their stock.

He goes on to say:

“Nearly tripling the market in sell-through and accelerated market share gains clearly indicate that we’re winning with our consumer and for our retailers. This drove our market share to 7.1% from 6.6% last year, earning number one dollar market share position for under $100 our kill zone.”

“In the overall market, Skullcandy moved into the number four spot and it was closely and quickly on to number three while continuing with our strong ownership as a unit sales leader overall. Our strategy of increasing ASP [average selling price] is also working as we saw ASP increasing mid-teens, generally due to the introduction of our wireless products. According to the NPD data, the consumer is choosing the Skullcandy brand.”

Uh, look, sorry to be a bit of wet blanket here, but didn’t you guys just lose 28% more than you lost in last year’s quarter?  I love that you’re moving to higher ASPs even at the expense of some margin.  I understand some of your new Astro product was such a hit you couldn’t meet demand (and I’d always rather bemoan missing sales than having to liquidate inventory).  I’m a fan of your move into wireless and the long time strategy of reducing sales of off price product.  It’s great that inventory is low and under control, and I love the strong balance sheet.  I think you do have a sustainable market niche based on your brand positioning .  I know you had a mess in China you’re well along in cleaning up.

BUT:

1. I wonder if the niche you can reasonably hope to control is big enough for you as a public company.
2. I have concerns about your products becoming commoditized.
3. I have no idea how much of your business is the Astro brand, which you point to as just starting to realize its potential.
4. I don’t know what part of your sales are still off price product.
5. When you tell me that your market share grew, I’m not sure what market, exactly, you mean.
6. I have the sense that you’re in a very tough market, and I don’t know why or how you can change that.

CFO Jason Hodell, in providing guidance for the second quarter and year, seemed to agree with some of my points.

“…we again want to remind everyone of the complexity of accurately assessing our future earnings and revenue growth given the competitive nature of the industry, competitive pricing and promotion shifts, potential manufacturing delays, the difficulty in predicting sales of our products into key retailers especially with new products and new technologies, changes in market technology, operations in international markets, unforeseen legal matters, retailer and distributor operational challenges, sourcing costs, foreign currency impacts, and shifts in consumer preferences.”

Let’s take a little closer look at the financials.

Domestic sales rose 3.64% from $30.6 to $31.8 million.  International fell 3.34% from $15.0 to $14.5 million.  Two customers represented 35.8% of total sales during the quarter.

The domestic gross margin was 38.0%, down from 40.3% in last year’s quarter.  For international, it fell from 42.2% to 36.4%.  “We are experiencing higher product costs due to increasing labor and other costs in China. If we are unable to pass along these costs to our retailers and distributors or shift our sales mix to higher margin products, our gross profit as a percentage of net sales, or gross margin, may decrease.”

The gross margin decline also “…reflects product mix shifts to lower margin audio wireless products as percentage of net sales, increased warehousing costs as a percentage of net sales, together with higher retailer promotional credits and returns in the U.S. and China. Wireless products typically have lower margins which are partially driven by higher third party technology and licensing costs.”

Hmmm.  Apparently they don’t own the technology in their products.

Domestic operating income declined from a loss of $4.83 million to a loss of $5.94 million.  The international operating income of $1.18 million in last year’s quarter was reduced to a loss of $830,000.

In the second half of the year, Skull expects to see revenue grow faster and to be profitable again.  This is to happen due to “…new launches and full in-stock levels, new launches in wireless from Skullcandy, cleaner domestic audio inventory levels with key retailers, and the China clean up behind us.”

That all sounds promising.