Skullcandy’s IPO; What’s New?

I guess it was around the time of the SIA show in Denver that Skullcandy announced they were going to do an initial public offering. They came out with the draft of the prospectus, and I took a pretty detailed look at it.

Typically, the “quiet period” after you file with the SEC lasts 40 to 90 days while they review your prospectus (known as a form S-1). When 90 days passed and I hadn’t heard anything, I got a bit curious. The company isn’t allowed to tell me anything so I went to the Security and Exchange Commission web site and searched for Skullcandy documents. Guess what? I found a revised S-1 dated April 28th.

The original S-1 had an income statement for the nine months ended September 30, 2010 that showed (in millions of dollars):
 
Net Sales                                           $95,940
Cost of Goods Sold                          $46,629
Gross Profit                                        $49,311
Selling, General and
 Admin. Expenses                            $30,206
Operating Income                            $19,105
Other (Income) Expense                $14
Interest Expense                             $6,559
Net Income                                       $7,645
 
The amended S-1 shows the income statement for the whole year ended December 31, 2010 and the picture is a bit different.
 
Net Sales                                            $160,583
Cost of Goods Sold                          $75,078
Gross Profit                                        $85,505
Selling, General and
 Admin. Expenses                             $67,602
Operating Income                             $17,903
Other (Income) Expense                 $14,556
Interest Expense                               $8,387
Net Income (Loss)                           $(9,723)
 
If you look back at the sales numbers for the 2009 complete year, you see that sales in 2010 grew nearly 36%. The gross profit margin was 48.6% in 2009. It was 53.2% in 2010. That’s a good improvement. So how did they turn a nine month profit of $7.6 million into a loss of $9.7 million for the year and $17.3 million for the final quarter of 2010?
 
For the whole 2010 year, compared to 2009, Selling, General and Administrative Expenses rose from $27 million to $67 million. This included, in the fourth quarter, “…one-time charges of $17.5 million in management incentive bonuses and $2.9 million payable as additional consideration to certain employee stockholders pursuant to the securities purchase and redemption agreement.”
The “Other” expense of $14.6 million in the fourth quarter “…consisted primarily of $14.6 million resulting from recording the fair value of amounts payable to non-employee stockholders as additional consideration pursuant to the securities purchase and redemption agreement.”
 
They also disclosed that “Additionally during the quarters ended March 31, June 30, September 30 and December 31, 2010, we recognized other expense of $1.5 million, $2.2 million, $3.7 million and $7.2 million, respectively, which represents the changes in the fair value of amounts payable as additional consideration to non-employee stockholders pursuant to the securities purchase and redemption agreement.”
 
Meanwhile, over on the year-end balance sheet, there’s a stockholders’ equity deficit of $22.7 million, up from $18.8 million a year ago. Next to that is an unaudited pro-forma balance sheet for the same date that “… gives effect to the conversion of all outstanding shares of preferred stock into 321,980 shares of common stock, the conversion of the convertible note into 275,866 shares of common stock, the payment of accrued interest on the convertible note and the reduction of deferred debt issuance and debt discounts related to the convertible note, as if an initial public offering occurred on December 31, 2010.”
 
Doing all this gets their stockholders’ equity up to $6.4 million. Against that, the pro forma balance sheet shows total liabilities of $77 million. That’s a debt to equity ratio of 12 times and that’s high. The current ratio, at 2 to 1 is fine.
 
Here’s how I read this. Skullcandy is counting on the success of its IPO to reduce its leverage and give it the working capital it needs to execute on its plan. Shareholders and executives have taken a bunch of cash out of the company in the fourth quarter, resulting in a big loss. They were entitled to do that under existing agreements, but how does it look to a potential stock purchaser? Those potential investors also see a company whose 2008 net income of $13 million fell to $3.5 million in 2009 even as sales grew 47% to $118 million. Now, on sales of $160 million, there’s a loss of almost $10 million.
 
It can be explained as I did above. But if you have to explain, you have a problem. I’m not quite sure people are in a hurry to invest in companies that lose money, even with a valid explanation. It will be interesting to see if this deal happens and what the pricing is. It may be even more interesting to see what Skullcandy does if it doesn’t happen. 

 

 

50 replies
  1. Glenn Brumage
    Glenn Brumage says:

    Um, Wow!
    Changes the complexion entirely. Rather than a strong growth company looking to make the jump to the big time, it looks more like a company in need of capital to offset its leverage.
    And what does it mean when the current investors are taking big cash out right before the IPO?
    Thanks Jeff,
    G

    • jeff
      jeff says:

      Hi Glenn,
      Yeah, you consider what new investors might think, and they could be wondering why the early stage investors don’t have more confidence in the company’s prospect.
      J.

  2. Calle Eriksson
    Calle Eriksson says:

    Really good assessment Jeff, thanks!
    Keep an eye on ZoundIndustries out of Stockholm, Sweden.
    They will offer SC and other headphone brands a though match the cumin years.
    C

  3. Yves Van den Meerssche
    Yves Van den Meerssche says:

    Sounds like there not ready for an IPO that will benefit new investors. Sounds more like they want to sing a song for the early stage investors. I’m not deaf, I’m not buying this. But I’ll listen & watch …

    • jeff
      jeff says:

      Yves,
      As I think you know, when you’re trying to build a business you often have to take your money when and where you find it. It sounds to me like that’s what Skullcandy did, and I don’t fault them for it. But now the terms of those early stage deals may be impacting their ability to get their IPO done. Raising money is hard.

      Thanks for the comment,
      J.

  4. Yves Van den Meerssche
    Yves Van den Meerssche says:

    Early stage investors take the biggest risk , so they should get the highest reward, but when it impacts the numbers this much , even possibly putting the IPO in danger, it no longer sounds like a win-win. Maybe for early stage investors who pick up below value shares of a not so hot IPO ? Raising money is an art, I’m loving the learning curve Jeff, thanks for your post & feedback !

    By the way I just read today they bought a gaming headphone maker for 10 million ? Not sure why ! http://online.wsj.com/article/BT-CO-20110429-709589.html

  5. Sebastien Marcq
    Sebastien Marcq says:

    Thanks Jeff for your analysis.
    It seemed to be a good Cie to invest in, they are doing an awesome job in marketing and developing their distribution, but I may be cold feet now after your review.
    Do you have more info on their free cash flow position?
    I’m curious to see how they will finance their growth (and price their equity)… Imagine in 2011 they continue growing 36% and manage to keep the same GP rate. With a 9 million $ net loss, how will they finance 115 million of COGS amongst other payables, knowing they already have 77 millions $ in liabilities with a gearing of 12?
    The interest expenses are already higher than 10%. Who will/ can take that risk?
    Thanks for your feedback.

    • jeff
      jeff says:

      Hi Sebastien,
      I mostly feel as you do. Really impressed by what Skullcandy has accomplished. With regards to free cash flow, I don’t have any access to any information you can’t see, so you’ll have to dig into their S-1 filings. It’s fairly normal for early stage investors to cash out when the company goes public. But this happened before the company went public and kind of put it in an awkward position for getting its IPO done. So we’ll see what happens.

      thanks for the comment,
      J.

  6. Bill Byrne
    Bill Byrne says:

    Great analysis Jeff. Like yourself, I’m truly impressed with the success of Skullcandy and other accessory manufacturers tied to the action sports/youth culture space.

    In terms of shareholders and executives pulling out… I wouldn’t blame them (not that you are either). Not because I don’t have faith in what Skullcandy has done/is doing though. If I was an early investor in a new company and was able to receive a healthy return now or gamble on a healthier return later, it’d be a tough decision to make.

    • jeff
      jeff says:

      Bill,
      What’s a bit unusual is that they didn’t cash out as part of the public offering, but before it. I can’t help but feel that maybe they don’t think the offering is going to get done.

      Thanks for the comment,
      J.

  7. Frank Johnson
    Frank Johnson says:

    Sounds like they “cleared the decks” of all one time charges in 2010 in order to provide for a strong 2011,No doubt the “road show” and final prospectus will contain 1st quarter 2011 figures. Absent all of those non recurring charges in 2010, these figures should provide possible investors with a more realistic picture of current operations and cash flow. If revenues continue to advance at a robust pace, and earnings are well in the black,the IPO will likely go forward and will probably be successful.

    • jeff
      jeff says:

      Hi Frank,
      That’s certainly the way I’m hoping it works out. I just wish they could have managed it so it didn’t happen during the quiet period. Philosophically, and more generally, I’d note that most times when I analyze a financial statement and read the company’s explanation of what happened, there are always “one time events” that aren’t going to occur next year, and the company then provides pro forma financial statements “as if” those events hadn’t happened. But then next quarter, or next year, there’s a different “one time event.” Those types of occurrences just seem to be part of business for any company and I don’t think anybody should act as if they aren’t.

      Let’s hope SkullCandy’s first quarter results are as you expect and show improving profitability and margins.

      Thanks for the comment,
      J.

  8. Frank Johnson
    Frank Johnson says:

    Jeff,
    You might want to look at the “adjusted Ebidta” figure for 2010. That was $38 million on $160 million in sales, or about 23.7%. It was $30 million in 2009, on $118 in sales. That works out to 25.4%. So the Ebitda percentage was down slightly, but it presents a very different picture from GAAP income, which is where the loss come in for 2010. My impression is that most potential institutional investors look at ebitda, rather than GAAP, as the most pertinent metric in evaluating a company. On that basis I think Skullcandy’s IPO may do just fine.

    • jeff
      jeff says:

      Hi Frank,
      I don’t remember what “adjusted EBITDA” was. It’s not plain old EBITDA I assume. I’m not saying EBITDA is a bad metric. All I’m saying is that tactically, it would be better to have a bottom line profit than a loss to go public with, and that I wish the pay out of the investors could have been managed differently. People would prefer to buy stock in a company that’s making money at the bottom line rather than losing money no matter how you explain it.

      And, philosophically again, and not just talking about Skull, there’s EBITDA, and various pro forma income figures and operating income and gross margin and pretax income and apparently “adjusted EBITDA” as well. They all have their uses. But at the end of the day, taxes and interest are actual cash business expenses and those depreciating assets are going to have to be replaced. So I have to admit that while I do look at other measurements to help me understand what’s going on and to understand the quality of earnings, I do tend to focus on net income according to GAAP. Call me old fashioned.

      Thanks,
      Jeff

  9. Frank Johnson
    Frank Johnson says:

    Hi Jeff,

    Do you know where the complete text of Skullcandy’s S-1 A filing is available? Thanks?

  10. Frank Johnson
    Frank Johnson says:

    Jeff.

    Yes, originally I did see the whole text from Google, but when I wanted to go back and look at it again tonight, I could not find it anywhere. So thanks for the link again. I particularly wanted to make sure I understood what “adjusted ebitda” was as Skullcandy defined it.

    What I was able to verify was that adjusted ebitda was after taking normal ebitda and subtracting all of the costs to the company relating to an agreement going back to November 2008, which in turn related to the redemption of shares at that time by existing shareholders.
    I believe it related to total bonuses of $35 million to be paid out to both management and non employee stockholders based upon a future performance record. That level of performance was evidently achieved and management was to get one half and other stockholders would get the other half. Management’s half appears to constitute the two charges against ebidta of $14.6 million (paid out last December) and another $2.9 million yet to be paid. The other half–$17.5 million– has not been paid as yet and is contingent on the first of either an IPO or Jan. 31, 2013.
    You have to do some digging into both SEC filings to find this out, but it is there and it is all public info.
    I don’t know why they chose to record all these amounts as charges against 4 Q 2010 earnings, but I suspect it may have been on the advice of their lead underwriters, Merrill Lynch and Morgan Stanley. When they go on the “road show”, whenever that is, they would want to have all that behind them and have a clean slate going forward. I Q 2011 EPS numbers should soon be available, and I am sure will be available both at the road show and in the final prospectus. That should be the key as to how well the IPO does. Institutional investors are always the key to success or failure of a proposed IPO,and they are usually pretty sophisticated about things like ebidta. And, like I said, when you compare apples and apples ebidta between 2009 and 2010, there was a nice increase year over year.
    All of this is just my own opinion, for whatever it is worth.

    • jeff
      jeff says:

      Hi Frank,
      This is a great discussion. Thanks. I read that all when it first came out but honestly just didn’t remember what they’d done. Adjustment fatigue maybe.

      As you say, both Merrill Lynch and Morgan Stanley are sophisticated and certainly understand all this (although Merrill Lynch was not sophisticated enough to avoid basically going broke in the financial melt down). My concern is when it’s time to sell the stock to less sophisticated investors- especially retail investors. I would not be surprised if the reported loss impacted the pricing of the IPO.

      Thanks again,
      J.

  11. Frank Johnson
    Frank Johnson says:

    Jeff,

    Friday is the 15th, by which time public companies must file their 10 Q’s for the first quarter of 2011.
    My guess is that Skullcandy will file a further amended S-1A shortly thereafter, which will include 1 Q numbers. If they do, let’s continue the discussion then.

  12. Frank Johnson
    Frank Johnson says:

    Skullcandy filed a new S-1 A on June 1. First quarter revenues were $38 million vs. $21 million the same quarter in 2010. Net after tax earnings were around around $1 million vs. a loss of $802,000 in 2010.

    Net,net, I believe the market will focus on the increased rate of revenue growth. Keep in mind that 1 Q is always the lowest quarter of the year in revenues and eps. I Q bodes well for a gangbuster year for Skullcandy,IMO

    The roadshow should begin in next two weeks. I believe the IPO itself is planned now for late June.

    Frank

    • jeff
      jeff says:

      Hi Frank,
      I saw it, but was traveling last week and not working this weekend. I’ll be through it tomorrow and will write something then. Thanks for the alert.
      J.

  13. Frank Johnson
    Frank Johnson says:

    Thanks, Jeff. I will look forward to your analysis of the latest numbers. What I particularly like is their ability to grow revenues over 50% in a difficult global macro environment.

    Frank

  14. Conger Stevens
    Conger Stevens says:

    I’m really interested to hear your comments about the new numbers too, Jeff. I thought Skullcandy was in trouble and possibly not doing its IPO—but could be wrong. If I am–the company should be on its roadshow now…

    Conger

    • jeff
      jeff says:

      Conger,
      I posted a short article providing the numbers. As far as I know, that’s the only difference in the amended S-1, so there isn’t much to analyze. As I said in that article my opinion remains the same. I glad to see them have a good quarter compared to last year. I still think Skullcandy needs the IPO to strengthen their balance sheet, and I also think they would be better off if they didn’t have to explain the loss the previous year. The question is at what price per share the deal happens, and the behavior of the market recently doesn’t make it any easier to get a higher price.
      Thanks for the comment,
      J.

  15. Frank Johnson
    Frank Johnson says:

    Skul’s IPO was originally planned to debut in June, I believe. Now they have apparently postponed it until ” market conditions” improve–the same reason other IPOs have been formally postponed. I suspect that this will turn out to have been a wise decision if they do not go on the road until they can discuss their 2Q results. If revenues continue to expand YOY at the same pace as in 1Q, they will be on track to top $220 million in 2011 vs. $160 in 2011. This could give them an EBitda in excess of $50 million. These are just my guesses, of course, but I think they are doable. In the meantime, they don’t seem to need the money, so the longer they wait the better price they may get.

    Frank

    • jeff
      jeff says:

      Hi Frank,
      Thanks for the info. I had heard something about this myself, and was kind of hoping for a formal announcement, but I guess there’s no benefit to them doing that. What I’d wish, of course, is that the offering was strong enough so that market conditions didn’t require it to be postponed. It seems obvious to me that there’s some reticence here that goes beyond market conditions. I’m concerned about their ability to maintain their competitive advantage based on just marketing. Their March 31 balance sheet certainly suggests that they can get by a quarter or longer without getting the offering done, but there will come a time when sitting with a negative equity of $20 million just won’t work. Frank, who are you exactly and what’s your interest in this? Investment banking background?

      thanks,
      J.

  16. Conger Stevens
    Conger Stevens says:

    You may be right, Frank. It seems like things are going well for SKUL. I just think they’re picking low hanging fruit right now. As competition increases, margins are going to decrease considerably. No comparative advantage here except for their brand…. That’s why they’re trying to sell high end headphones and acquired the Astro Gaming company for gaming headphones. I see that they’re trying to expand product into clothes, etc. to diversify revenue–typically for this type of lifestyle company. Don’t know how this company will do long term–but it will probably take advantage of the current market euphoria and make a good IPO showing….executives are going to do well–but not sure about other shareholders.

  17. Conger Stevens
    Conger Stevens says:

    Frank–how accurate is the info. that the company is waiting for market conditions to improve–?
    I had thought the company actually started its road show. Maybe there wasn’t strong demand …. Interesting. August is approaching fast and my understanding is that the market dies then as bankers, etc. go on vacation. I wonder if the company is going to try to wait for 2nd Q numbers and push this through before August or wait until the fall.

    Also, I keep seeing other companies encroaching on SKUL’s space — companies are trying diversity their own product lines by making headphones…..

  18. Frank Johnson
    Frank Johnson says:

    No investment banking background. Just a long term stock investor. I’ve been watching SKUL ever since it was founded, and look forward to it becoming a public company. My info on the road show postponement until after July 4 comes from monitoring “Skullcandy IPO” on Google. I also read the S-1 filings very carefully. I note that they expect pretty good acceleration of revenues in Europe, and that they increased revenues 65% YOY in 1Q 2011. To me, that negates the fears over the 4Q one time write-offs. Or should, anyway.
    Whether they go forward soon after July 4 or wait until fall will probably be dependent,I should think, on how the market behaves over the next two or three weeks. They know by now what their 2Q numbers will look like. They may decide to wait until they can talk about them at the road show if they look really good. But I have no knowledge of that one way or the other.

    Frank

  19. Frank Johnson
    Frank Johnson says:

    Given this week’s strong market, I will wager that SKUL will “hit the road” sometime next week.

    • jeff
      jeff says:

      Hi Frank,
      Well, maybe. But one week isn’t much to change the tenure of the market, and the issue is not the market, but how Skull’s investment bankers feel about their ability to sell the stock given the market. I’m sure there are some interesting discussions going on between Skull and the investment bankers about the price at which the company would go public.

      Thanks,
      J.

  20. Conger Stevens
    Conger Stevens says:

    Let’s see if that happens. I guess they won’t wait for the new quarter numbers to come out. It’s hard for me to believe that institutional investors will be bullish on this company…

    • jeff
      jeff says:

      Conger,
      I would like Skull candy to succeed, but I have some of the same concerns you have about the sustainability of their competitive advantage.

      Thanks for the continuing discussion.

      J.

  21. Frank Johnson
    Frank Johnson says:

    I read their prospectus more bullishly than you guys do. And I am particularly impressed by the 1Q 2011 report. That 65% YOY revenue increase allayed my worries over competitive pressures.
    But I would agree that if the road show does not launch this coming week (thursday or Friday) then there may be something that does not meet the eye. I do believe it was “the market” that torpedoed a launch a couple of weeks ago.

    Frank

    • jeff
      jeff says:

      Frank,
      I am impressed as you are by what Skullcandy has accomplished. But I also know that it’s hard to maintain a competitive advantage based strictly on brand and marketing. That’s true for almost every company in this industry- not just Skullcandy. Doesn’t mean they can’t do it, but it’s not easy.

      Thanks,
      J.

  22. Conger Stevens
    Conger Stevens says:

    In the short term–they may be able to continue to grow. Looking at their S-1, the company wants to mimick its U.S. marketing strategy to other countries outside of the US (less competitive–at least right now). This seems to be working (low hanging fruit). They’ve hired guys that know international markets, trying to get new distributors, etc. Much larger market outside the U.S., especially with the increased competition in the U.S.: Nixon, Monster, etc.

    But I think investors might ignore the long-term prospect and issues and buy in, executives will get rich, and investors will questions their decision to buy. We see this over and over again.

  23. Frank Johnson
    Frank Johnson says:

    Differences of opinion are what make markets. Look at the recent IPO of Fusion 1-0 (FIO). There’s one that has little or no earnings at present but is holding on to its huge post IPO gains.

  24. Frank Johnson
    Frank Johnson says:

    The announcement is out. $17-19 price range, Target date July 19 for pricing.

    Frank

    • jeff
      jeff says:

      Maybe we’ll see their smiling faces opening the market tomorrow! They certainly picked a good day to be pricing.
      J.

  25. Frank Johnson
    Frank Johnson says:

    I think they will price it tonight. Apparently road show has gone well, and they are well over subsribed .

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