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SKUL > SEC Filings for SKUL > Form 10-Q on 2-Aug-2013All Recent SEC Filings

Show all filings for SKULLCANDY, INC.

Form 10-Q for SKULLCANDY, INC.


2-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis of the financial condition and results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission on March 13, 2013. Cautionary Statement Regarding Forward-Looking Statements This quarterly report contains forward-looking statements. The words "may," "will," "plan," "believe," "expect," "anticipate," "intend," "estimate" and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters identify forward-looking statements. Although forward-looking statements reflect our current views, reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements speak only as of the date the statements are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise. These forward-looking statements are subject to numerous risks and uncertainties, including the risks and uncertainties described under "Risk Factors" in Part II of this quarterly report and in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission on March 13, 2013, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this quarterly report. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement. We qualify all of our forward-looking statements by these cautionary statements.
Overview
Skullcandy, Inc., a Delaware corporation (the "Company"), is the leading global lifestyle and performance audio brand driven by the creativity and irreverence of youth culture. Skullcandy designs, markets and distributes audio and gaming headphones and other related products under the Skullcandy, Astro Gaming and 2XL brands. Skullcandy became one of the world's most distinct audio brands by bringing color, character and performance to an otherwise monochromatic space and helped revolutionize the audio arena by introducing headphones, earbuds and other audio and wireless lifestyle products that possess unmistakable style and exceptional performance. From the award-winning Crusher, and optic-inspired Roc Nation Aviator headphones to the evolutionary fitting FIX earbuds and a roster of some of the world's finest athletes, musicians and artists, Skullcandy continues to redefine world-class audio performance and lifestyle. Our net sales are derived primarily from the sale of headphones and audio accessories. We pioneered the distribution of headphones in specialty retailers focused on action sports and the youth lifestyle, such as Zumiez, Tilly's and hundreds of independent snow, skate and surf retailers. Through this channel we reach consumer influencers, individuals who help establish and maintain the credibility and authenticity of our brand. Building on this foundation, we have successfully expanded our distribution to select consumer electronics, sporting goods and mobile phone retailers such as Best Buy, Target and Dick's Sporting Goods. Skullcandy products are sold in the United States and in approximately 80 other countries around the world.
We face potential challenges including, among others, the risk that we may not be able to effectively extend the recognition and reputation of our brand or continue to develop innovative and popular products. Furthermore, our industry is very competitive and we cannot assure you that we will be able to compete effectively. See "Risk Factors" in Part II of this quarterly report and in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission on March 13, 2013 for a more complete discussion of the risks facing our business. Historically, we have experienced greater net sales in the second half of the year than those in the first half due to a concentration of shopping during the fall and holiday seasons. We anticipate that this seasonal impact on our net sales is likely to continue. Accordingly, our results of operations for any particular quarter are not indicative of the results we expect for the full year. Segment Information
We operate exclusively in the consumer products category in which we develop and distribute headphones and other audio accessories. Prior to our acquisition of Kungsbacka 57 AB on August 26, 2011, we operated in one business segment. Following that acquisition we began to operate in two segments -North America and International. The North America segment primarily consists of Skullcandy and Astro Gaming product sales generated in the United States and Mexico (through our joint venture). The International segment primarily includes Skullcandy and Astro Gaming product sales generated in Europe and Asia that are served by our European and Asian operations.


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Basis of Presentation
Our net sales are derived primarily from the sale of headphones and audio accessories under the Skullcandy, Astro Gaming and 2XL brands. Amounts billed to retailers for shipping and handling are included in net sales. Sales are reported net of estimated product returns and pricing adjustments. Gross profit is influenced by cost of goods sold, which consists primarily of product costs, packaging, freight, duties warehousing, warranty costs and depreciation on tooling assets held at our contract manufacturers.
Our selling, general and administrative expenses consist primarily of wages and related payroll and employee benefit expenses, including stock-based compensation, marketing and advertising expense, commissions to outside sales representatives, legal and professional fees, travel expenses, utilities, other facility related costs, such as rent and depreciation and amortization and consulting expenses. The primary components of our marketing and advertising expenses include in-store advertising, brand building fixtures, sponsorship of trade shows and events, promotional products and sponsorships for athletes, DJs, musicians and artists.
Results of Operations
The following table sets forth selected items in our statements of operations in dollars and as a percentage of net sales for the periods presented:

                                Three Months Ended June 30,                      Six Months Ended June 30,
                                2013                    2012                   2013                     2012
Net sales               $ 50,789     100.0  %   $ 72,436     100.0 %   $ 87,839     100.0  %   $ 125,716     100.0  %
Cost of goods sold        28,004      55.1  %     37,228      51.4 %     48,568      55.3  %      64,893      51.6  %
Gross profit              22,785      44.9  %     35,208      48.6 %     39,271      44.7  %      60,823      48.4  %
Selling, general and
administrative
expenses                  23,951      47.2  %     23,491      32.4 %     50,262      57.2  %      47,622      37.9  %
Income (loss) from
operations                (1,166 )    (2.3 )%     11,717      16.2 %    (10,991 )   (12.5 )%      13,201      10.5  %
Other expense
(income)                    (249 )    (0.5 )%        421       0.6 %        290       0.3  %         373       0.3  %
Interest expense             111       0.2  %        147       0.2 %        214       0.2  %         271       0.2  %
Income (loss) before
income taxes and
noncontrolling
interests                 (1,028 )    (2.0 )%     11,149      15.4 %    (11,495 )   (13.1 )%      12,557      10.0  %
Income tax expense
(benefit)                   (339 )    (0.7 )%      4,342       6.0 %     (3,726 )    (4.2 )%       4,609       3.7  %
Net income (loss)           (689 )    (1.4 )%      6,807       9.4 %     (7,769 )    (8.8 )%       7,948       6.3  %
Net loss (income)
attributable to
noncontrolling
interests                     54       0.1  %          -         - %         87       0.1  %         (24 )       -  %
Net income (loss)
attributable to
Skullcandy, Inc.        $   (635 )    (1.3 )%   $  6,807       9.4 %   $ (7,682 )    (8.7 )%   $   7,924       6.3  %

Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012 Net Sales
Net sales decreased $21.6 million, or 29.9%, to $50.8 million for the three months ended June 30, 2013 from $72.4 million for the three months ended June 30, 2012.
North America net sales decreased $25.1 million, or 39.1%, to $39.0 million, or 76.8% of our net sales for the three months ended June 30, 2013 from $64.1 million, or 88.4% of our net sales for the three months ended June 30, 2012. We experienced lower sell-in at a key customer and a decline in sales to several of our specialty retailers. Consistent with our


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strategy, we purposefully scaled back sales to the off-price channel which were down approximately 51.7% compared with the second quarter of 2012. In addition, the second quarter of 2012 included increased sales from a packaging change. International net sales increased $3.4 million, or 40.6%, to $11.8 million, or 23.2% of our net sales for the three months ended June 30, 2013 from $8.4 million, or 11.6% of our net sales for the three months ended June 30, 2012. Included in the North America segment in the three months ended June 30, 2013 and 2012 are net sales of $1.8 million and $7.8 million, respectively, that were sold from the United States to customers with a "ship to" location outside of the United States. Including these sales in the international segment, international net sales decreased 15.9%, and North America net sales decreased 33.9%. The decrease in adjusted international net sales is due to decreased sales of $2.4 million to our former distributor in Canada as we transition to a direct sales model in that country. As of July 1, 2013, the Company has established a subsidiary in Canada and expects to have sales starting in the third quarter of 2013.
Gross Profit
Gross profit decreased $12.4 million, or 35.3%, to $22.8 million for the three months ended June 30, 2013 from $35.2 million for the three months ended June 30, 2012. Gross margin was 44.9% for the three months ended June 30, 2013 compared to 48.6% for the three months ended June 30, 2012.
North America gross margin was 44.3% for the three months ended June 30, 2013 compared to 48.5% for the three months ended June 30, 2012.
International gross margin was 46.6% for the three months ended June 30, 2013 compared to 49.1% for the three months ended June 30, 2012.
The decrease in gross margin is primarily due to the impact of the gaming category carrying lower gross margins, coupled with higher sales allowances on gaming products in the retail channel which was not in place a year ago. In addition, gross margin was negatively impacted by certain sales allowances associated with the transition to a direct sales model in Canada and higher raw material costs.
Certain reclassifications have been made to the 2012 balances to conform to the 2013 presentation so as to better reflect where these costs should reside in the statement of operations. For this reason, tooling depreciation and warranty related expenses are being included in cost of goods sold for all comparable periods.
Selling, General and Administrative Expenses Selling, general and administrative expenses increased $0.5 million, or 2.0%, to $24.0 million for the three months ended June 30, 2013 from $23.5 million for three months ended June 30, 2012. Selling, general and administrative expenses in the second quarter of 2013 include $1.1 million in costs related to the closure of the San Clemente, California office. In June, 2013, we announced plans to consolidate our marketing, creative, business development and legal departments as well as certain sales and international personnel to our headquarters in Park City, Utah and plans to close the office in San Clemente, California. The relocation is expected to commence in the summer of 2013 and be completed by the fourth quarter of 2013. We expect to incur an associated pre-tax restructuring charge for employee severance, employee relocation and office closure costs of $3.0 million to $3.8 million. We continue to invest in marketing and demand creation with an increase in marketing expenses of $0.6 million compared to the same quarter of the prior year. These increases were offset by the our cost control initiatives which included a reduction in travel related expenses of $0.7 million.
As a percentage of net sales, selling, general and administrative expenses increased 14.8% percentage points to 47.2% for the three months ended June 30, 2013 from 32.4% for the three months ended June 30, 2012.
We expect to continue to make critical investments in the business to support long-term growth. These investments include demand creation including point of sale merchandising and higher operating costs to support our gaming and international expansion.
Income (loss) from Operations
As a result of the factors above, income (loss) from operations decreased $12.9 million to $(1.2) million for the three months ended June 30, 2013 from $11.7 million for the three months ended June 30, 2012. Income (loss) from operations as a percentage of net sales decreased to (2.3)% for the three months ended June 30, 2013 from 16.2% for the three months ended June 30, 2012.


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Other Expense (Income)
Other income was $0.2 million for the three months ended June 30, 2013 which was related to foreign currency transaction gains. Other expense for the three months ended June 30, 2012 primarily consisted of foreign currency remeasurement losses.
Interest Expense
Interest expense for the three months ended June 30, 2013 was consistent with interest expense for the three months ended June 30, 2012. Interest expense primarily includes the amortization of deferred financing fees and unused line fees associated with our credit facility. Income Taxes
The income tax benefit was $0.3 million for the three months ended June 30, 2013 compared to income tax expense of $4.3 million for the three months ended June 30, 2012. Our effective tax rate for the three months ended June 30, 2013 and June 30, 2012 was 34.8% and 38.9%, respectively. Our effective tax rate differs from the United States federal statutory rate of 35% mostly due to incentive stock options as well as its operations in countries that have different statutory rates than the United States. Our effective tax rate may fluctuate significantly on a quarterly basis dependent upon the proportionate levels of income in countries with lower statutory rates versus countries with higher statutory rates.
Net Income (Loss)
As a result of the factors above, net loss was $0.7 million for the three months ended June 30, 2013 compared to net income of $6.8 million for the three months ended June 30, 2012.
Noncontrolling Interest
We entered into a joint venture in Mexico in September 2011 to facilitate distribution of our products in Mexico. We own a majority of the joint venture and the voting rights and control the day-to-day operations.
Noncontrolling interest for the three months ended June 30, 2013 and 2012 consists of losses from our Mexico joint venture that are attributable to the other partner in the joint venture.
Net Income (Loss) Attributable to Skullcandy, Inc. As a result of the factors above, net income (loss) attributable to Skullcandy, Inc. was $(0.6) million and $6.8 million for the three months ended June 30, 2013 and 2012, respectively.
Six Months Ended June 30, 2013 Compared to Six Months Ended June 30, 2012 Net Sales
Net sales decreased $37.9 million, or 30.1%, to $87.8 million for the six months ended June 30, 2013 from $125.7 million for the six months ended June 30, 2012. North America net sales decreased $42.5 million, or 38.6%, to $67.7 million, or 77.0% of our net sales for the six months ended June 30, 2013 from $110.2 million, or 87.7% of our net sales for the six months ended June 30, 2012. Consistent with our strategy, we purposefully scaled back sales to the off-price channel which were down approximately 56.0% compared with the six months ended June 30, 2012. The prior year was aided by lower retail customer inventory coming out of the holiday season and a packaging change that led to higher sales.
International net sales increased $4.7 million, or 30.0%, to $20.2 million, or 23.0% of our net sales for the six months ended June 30, 2013 from $15.5 million, or 12.3% of our net sales for the six months ended June 30, 2012. Included in the North America segment in 2013 and 2012 are net sales of $3.9 million and $11.2 million, respectively, that were sold from the United States to customers with a "ship to" location outside of the United States. Including these sales in the international segment, international net sales decreased 9.8%, and North America net sales decreased 35.6%. The decrease in adjusted international net sales is primarily due to decreased sales of $2.9 million to our former distributor in Canada as we transition to a direct sales model in that country. As of July 1, 2013, we established a subsidiary in Canada and will have sales starting in the third quarter of 2013.


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Gross Profit
Gross profit decreased $21.6 million, or 35%, to $39.3 million for the six months ended June 30, 2013 from $60.8 million for the six months ended June 30, 2012. Gross margin was 44.7% for the six months ended June 30, 2013 compared to 48.4% for the six months ended June 30, 2012.
North America gross margin was 44.0% for the six months ended June 30, 2013 compared to 47.9% for the six months ended June 30, 2012.
International gross margin was 47.2% for the six months ended June 30, 2013 compared to 51.5% for the six months ended June 30, 2012.
The decrease in gross margin is primarily due to the impact of the gaming category carrying lower gross margins, coupled with higher sales allowances on gaming products in the retail channel which was not in place a year ago. In addition, gross margin was negatively impacted by certain sales allowances associated with the transition to a direct sales model in Canada and higher raw material costs. In addition, there was a write-off of $0.8 million of inventory related to end of life, or EOL, products that contributed to the decline in gross margin.
Certain reclassifications have been made to the 2012 balances to conform to the 2013 presentation so as to better reflect where these costs should reside in the statement of operations. For this reason, tooling depreciation and warranty related expenses are being included in cost of goods sold for all comparable periods.
Selling, General and Administrative Expenses Selling, general and administrative expenses increased $2.6 million, or 5.5%, to $50.3 million for the six months ended June 30, 2013 from $47.6 million for six months ended June 30, 2012. Selling, general and administrative expenses for the six months ended June 30, 2013 includes $1.2 million in expenses associated with the departure of our former chief executive officer. We also recorded a loss of $2.0 million related to disposals of property and equipment for certain EOL products. Additionally, we recorded $1.1 million in costs related to the closure of the San Clemente, California office. In June, 2013, we announced plans to consolidate our marketing, creative, business development and legal departments as well as certain sales and international personnel to our headquarters in Park City, Utah and plans to close the office in San Clemente, California. These increases were offset by our cost control initiatives which included a reduction in travel related expenses of $1.1 million.
As a percentage of net sales, selling, general and administrative expenses increased 19.3% percentage points to 57.2% for the six months ended June 30, 2013 from 37.9% for the six months ended June 30, 2012. Income (loss) from Operations
As a result of the factors above, income (loss) from operations decreased $24.2 million to $(11.0) million for the six months ended June 30, 2013 from $13.2 million for the six months ended June 30, 2012. Income (loss) from operations as a percentage of net sales decreased to (12.5)% for the six months ended June 30, 2013 from 10.5% for the six months ended June 30, 2012. Other Expense (Income)
Other expense was comparable for the six months ended June 30, 2013 and 2012, and related to foreign currency transaction losses. Interest Expense
Interest expense for the six months ended June 30, 2013 was consistent with interest expense for the six months ended June 30, 2012. Interest expense primarily includes the amortization of deferred financing fees and unused line fees associated with our credit facility. Income Taxes
The income tax benefit was $3.7 million for the six months ended June 30, 2013 compared to income tax expense of $4.6 million for the six months ended June 30, 2012. Our effective tax rate for the six months ended June 30, 2013 and June 30, 2012 was 32.7% and 36.8%, respectively. Our effective tax rate differs from the United States federal statutory rate of 35% mostly related to incentive stock options as well as operating in countries that have different statutory rates than the United


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States. Our effective tax rate may fluctuate significantly on a quarterly basis dependent upon the proportionate levels of income in countries with lower statutory rates versus countries with higher statutory rates. Net Income (Loss)
As a result of the factors above, net loss was $7.8 million for the six months ended June 30, 2013 compared to net income of $7.9 million for the six months ended June 30, 2012.
Noncontrolling Interest
We entered into a joint venture in Mexico in September 2011 to facilitate distribution of our products in Mexico. We own a majority of the joint venture and the voting rights and control the day-to-day operations.
Noncontrolling interest for the six months ended June 30, 2013 and 2012 consists of income (losses) from our Mexico joint venture that is attributable to the other partner in the joint venture.
Net Income (Loss) Attributable to Skullcandy, Inc. As a result of the factors above, net income (loss) attributable to Skullcandy, Inc. was $(7.7) million and $7.9 million for the six months ended June 30, 2013 and 2012, respectively.
Liquidity and Capital Resources
Our primary cash needs are working capital and capital expenditures. Historically, we have generally financed these needs with operating cash flows, sales of equity securities and borrowings under our credit facility. These sources of liquidity may be impacted by fluctuations in demand for our products, ongoing investments in our infrastructure and expenditures on marketing and advertising.
The following table sets forth, for the periods indicated, our beginning balance of cash, net cash flows provided by and used in operating, investing and financing activities and our ending balance of cash (in thousands):

                                                           Six Months Ended June 30,
                                                           2013                 2012
Cash and cash equivalents at beginning of period    $        19,345       $        23,302
Net cash provided by (used in) operating activities          12,114                (7,882 )
Net cash used in investing activities                        (1,907 )              (4,172 )
Net cash provided by (used in) financing activities             120                (4,337 )
Effect of exchange rate changes on cash and cash
equivalents                                                      36                    60
Cash and cash equivalents at end of period          $        29,708       $         6,971

Net Cash Provided by (Used in) Operating Activities. Cash from operating activities consists primarily of net income adjusted for certain non-cash items including depreciation and amortization expense, provision for doubtful accounts, deferred income taxes, non-cash interest expense, stock-based compensation expense and the effect of changes in working capital and other activities.
For the six months ended June 30, 2013, net cash provided by operating activities was $12.1 million and consisted of a net loss of $7.8 million plus $8.6 million of non-cash items, plus $11.3 million of working capital and other activities. Working capital and other activities consisted primarily of a decrease in accounts receivable of $33.3 million, a decrease in prepaid expenses and other current assets of $2.7 million, offset by an increase in inventory of $9.6 million and a decrease in accounts payable of $6.9 million and accrued liabilities of $8.2 million.
For the six months ended June 30, 2012, net cash used in operating activities was $7.9 million and consisted of net income of $7.9 million plus $5.1 million of non-cash items, less $20.9 million of working capital and other activities. Working capital and other activities consisted primarily of a decrease in prepaid expenses and other current assets of $2.7 million, offset by an increase in inventory of $11.3 million and a decrease in accounts payable of $5.1 million and accrued liabilities of $7.2 million.


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Net Cash Used in Investing Activities. Net cash used in investing activities relates to capital expenditures. Net cash used in investing activities was $1.9 million and $4.2 million for the six months ended June 30, 2013 and 2012, respectively.
Net Cash Used in Financing Activities. Net cash provided by financing activities was immaterial for the six months ended June 30, 2013. Net cash used in financing activities was $4.3 million for the six months ended June 30, 2012 and primarily resulted from the repayment of our credit facility. We believe that our cash, cash flow from operating activities, available borrowings under our credit facility will be sufficient to meet our capital requirements for at least the next twelve months. Indebtedness
On August 31, 2010, we entered into a revolving credit and security agreement, or the credit facility, with PNC Bank and UPS Capital Corporation, as lenders. The credit facility provides for revolving loans and letters of credit of up to $28.8 million (which may be increased to up to $50.0 million upon our request subject to certain conditions) and expires on August 31, 2013. The credit facility is secured by substantially all of our assets. The total amount of available borrowings is subject to limitations based on specified percentages of the value of eligible receivables and inventory. At June 30, 2013, there were no . . .

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