Maybe a Public Company Can Actually Pull This Off! Skullcandy’s June 30 Quarter

I’ve written probably way more times than you want to hear about how it’s been a good time to focus on brand building, distribution, and gross margin dollars rather than generating big sales increases that can only be realized in the short term with resulting long term damage to a business.   And I’ve sympathized with public companies who’d like to take this approach, but have a hard time doing it because of Wall Street growth expectations.

Well guess what? It looks like Skullcandy might just have a chance to do it. For the quarter, they reported a 6% sales increase to $53.9 million from $50.8 million in the same quarter last year. They had net income of $1.58 million compared to a loss of $689 thousand last year.
That’s nice, and it’s necessary. But from my point of view, what it does is buy Skull some time, and acquiescence from Wall Street, to continue doing what they’re doing.

Before I go any further, you can see the 10Q here.
Strategy
Just to review, here’s what Skull says it is doing:
  • Slashing off price business.
  • Controlling pricing and distribution and closing accounts that won’t cooperate.
  • Reducing G&A expenses but increasing spending for brand building and demand generation.
  • Improving quality and building internal product development capabilities.
  • Focusing on retail presentation.
  • Prioritizing retailers with whom they think they can grow their business.  Opening new accounts will be very selective.
To sum it up, they want to solidify Skull’s market position as “…the original performance and lifestyle audio brand inspired by the creativity and irreverence of youth culture.”
That’s a solid goal and might give them a defendable market niche and set them up for some good profitability with modest growth in their core ear bud/headphone market. Which might be fine if they were a private company, but they aren’t.
So, what to do?
Skull thinks it has some opportunities in wireless, women’s, gaming (remember Skull owns Astro Gaming), and performance sports. Products in some of these areas have rolled out, others are just happening now. This is described in the conference call. If anybody wants to see the transcript, but doesn’t have a copy, let me know and I’ll be glad to send you one.
Brand extensions always make me nervous, but one thing is for sure. If they are going to be successful, the brand under which they are being extended better be strong, strong, strong. CEO Hoby Darling makes it clear that making Skullcandy into such a brand is job one for the whole company.
Brand extensions are what they need to accelerate revenue growth.   As I suggested above, having a defendable market niche that’s profitable but doesn’t have great growth prospects just doesn’t cut it for a public company. Brand strength that provides product extension opportunities is where they have to be.
Skullcandy CEO Hoby Darling has been consistently (and patiently, I’d say) explaining this to Wall Street and, perhaps more importantly, to the whole company. He started the conference call again by reminding the audience of “…the progress we made against our 5-pillar strategy during the quarter. As a reminder, our pillars are: one, marketplace transform; two, create innovation in the future; three, grow international to 50% of the business; four, expand and amplify known-for categories and partnerships; and five, team and operational excellence.”
He talks in some detail about how they are doing that. I’ve given you some of the highlights above. The one sentence I’ll pull out from his discussion is, “The brand and protecting price have to be above short-term revenue gains.”
Seems to me he’s enunciated the strategy consistently and simply for long enough that, given the apparent progress the company has made, Wall Street might cut him some slack. I think they are, actually.
Even more important than giving the branding message to outside stakeholders is communicating it internally. It’s important because building that focus and consensus helps you make sure you have the right people and that they are focused on the right things. It’s liberating and rigorous all at the same time. You know where to spend your time- and where not to. It makes you efficient and saves time and money.
Some Numbers
Domestic sales rose 6% from $37.2 to $39.5 million. International sales were up 6.1% from $13.6 to $14.4 million. International sales represented 26.7% of total revenue, unchanged since last year’s quarter.  They make an interesting comment that “Domestic net sales increased primarily due to sales of earbuds, wireless speakers and opening a new account.” A new account in a quarter that moves sales isn’t a specialty shop. In this case, I’m guessing they might mean Walmart, where they started selling in the June 30 quarter.
As long as they take the same care in representing their products in Walmart as they describe taking in other retailers, I think it’s a good decision if they proceed (as they say they are) cautiously. I’ve speculated in a column, maybe over a year ago, that where you distributed might be becoming less important than it used to be as long as the quality of the product presentation and your connection with your customers at all their touch points was high. Maybe this is an example of that. I’ve got to get to a Walmart and see what it looks like.
The overall gross profit margin rose very slightly from 44.9% to 45%. Gross margin on domestic sales fell from 45.3% to 44.4%. It rose in international from 43.8% to 46.6%. I’m guessing the domestic margin decline involves some inventory cleaning that’s still going on. They specifically mention some over the ear product with lower margins they are still clearing out, though they don’t give us any numbers.
Selling, general and administrative expenses fell by $1 million to $22.9 million. As a percentage of sales they declined from 47.2% to 42.6%. The long term goal is 30%. They delayed some demand creation expenses to later in the year, but “The decrease in SG&A expenses is primarily due to a decrease in personnel expenses, licensing royalties and co-op retailer spending.”
Total operating income improved from a loss of $1.17 million to a gain of $1.3 million. Operating income on domestic sales went from a loss of $2.57 million to a positive $1.06 million. My belief is that this improvement reflects not only expense cuts but cleaning up inventory and getting out of off-price channels.
International operating income, however, declined from $1.4 to $0.24 million. As with the change in sales, I’m not sure of the extent to which this is impacted by reclassifying Mexico and Canada as international.
Skullcandy did what it needed to do to grow its revenue and profits to get the point where it could go public. As you may recall its balance sheet required that it go public or, alternatively I guess, find a buyer. But it turned out, as I suggested when they first went public, that Skull couldn’t be cool in Fred Meyer. Its distribution and brand positioning were in conflict. It couldn’t compete selling low cost, low quality product.
Skullcandy’s old model didn’t offer the company a long term future. The new one, in spite of tough competition and a target customer with less money to spend than they used to have, might.   If the brand is rock solid and product extensions consistent with the brand’s positioning are successful, the nascent turnaround can succeed. They are doing the right things- in my judgment, taking the only realistic course they have. So we’ll see.