Skullcandy’s June 30 Quarter; Focus on the Strategy

Skull had a strong quarter, and we’ll review the numbers. But what intrigues me more are the investments Skull is making and the steps they are taking to implement their strategy. That’s where I want to spend most of our time. In what was, and continues to be, an oversimplification I’ve written that the bet Skull was placing was that they could be cool in retailers like Fred Meyer. We’re going to dig a little deeper now and talk about some things they are doing that are consistent with the requirements for success in what we all know is a dramatically changing retail environment.

Sales for the quarter ended June 30 were up 38.2% to $72.4 million from $52.4 million in the same quarter last year. Domestic sales rose 34.1% to $50.6 million from $37.7 million in last year’s quarter. International sales rose $6.2 million or 59.9% to $16.5 million and represented 22.8% of total sales for the quarter. Skull acquired their European distributor in August of last year, and that increased its international sales.
As a reminder, each of Target and Best by accounted for more than 10% of Skull’s net sales during the first six months of 2012.   
Online sales increased $1.0 million to $5.3 million. That 22.8% increase is almost entirely the result of their acquisition of Astro Gaming in April, 2011. As a percentage of total sales, online sales declined from 8.3% to 7.4%. Skull says this was because they stopped using their web site to sell clearance product “…in order to better preserve the integrity of the brand.” Good decision.
Gross margin percentage fell from 51.1% to 49.2% in this quarter. As reported in the 10Q, “The decrease in gross margin is mostly due to a shift in sales mix to higher price point products with lower gross margin structures.”
It would appeal to my sense of organization to just review the financials then move on to the strategic issues but, unsurprisingly, it’s hard to separate them. It was many years ago that I first suggested that it might be a good idea to focus not just on your gross margin percentage but on the total gross margin dollars you earn, as that was what you paid your bills with. A few years after that, Cary Allington at Action Watch pointed me at the idea of Gross Margin Return on Inventory Investment. It was a more formal approach to what I’d already been saying and I urged the adoption of the idea in some presentations and in a Market Watch column. It’s a particularly valuable concept in a weak economy.
Skull’s management is apparently all over this. They noted that their average selling price increased by double digits in the quarter. One of the analysts asked how they should think the “…margin dynamics between these on-ear and over-the-ear versus buds?”
Skull VP of Finance Ronald Ross had already noted that Skull was continuing “…to see a mix shift toward over-ear styles and higher-priced product.” Responding to the analyst, CEO Jeremy Andrus indicated they viewed these trends very favorably. He acknowledged buds had less technology and materials in them, so were cheaper to produce. But he thought the trends would “…increase our revenue and the dollar share of gross margin.” Another executive noted that they saw the trend as positive not just financially, but for the brand as well.
So Skullcandy, though of course they would love a higher gross margin, is arguing that they end up with more gross margin dollars with a higher priced product even if the gross margin is a bit lower, and that’s okay with them. I agree.
Selling, General and Administrative Expenses (SG&A) rose from $17.2 million to $24 million. As a percentage of sales, it went from 32.9% to 33.1%. They note that “Approximately half of the increase was related to strategic investments in our direct international and gaming platforms, including expansion of personnel.” The areas they are investing in include, “…an in-house product design model, fixtures and point of purchase displays developed to improve our in-store presentation, property and equipment to support operational growth and the purchase of certain intangible assets related to our acquisition of the distribution rights in Europe.”
Another argument I’ve made from time to time is that a weak economy and tough competitive conditions offer opportunities to well positioned companies with strong balance sheets. I’m not going to spend a lot of time on Skull’s balance sheet, but since their public offering it’s been strong enough to allow them to pursue their strategy with few, if any, financial constraints. I mostly like where they are spending their money.
One of the facts of our new retail environment, whether you’re a brand or a retailer (and assuming we can still tell the difference), is that doing all the operational and back office stuff right is no longer a source of competitive advantage. It’s a minimum bar to have a chance to compete. Doing all that stuff right costs money and requires, I’ll say again, a strong balance sheet.
Also due to its public offering, Skull’s interest expense fell from $2.3 million in last year’s quarter to $147,000 in this year’s. Net income rose from $4.3 to $6.8 million, and you can see that without that decline in interest expense, the growth of net income would have been a lot lower.
With the financials reviewed, let’s move on to other strategic considerations. Skullcandy rather eloquently expresses the connection between action sports and its target market as follows:
“Our brand also benefits from the increasing popularity of action sports, particularly within the youth culture. Our consumer influencers are teens and young adults that associate themselves with skateboarding, snowboarding, surfing and other action sports. These consumers influence a broader consumer base that identifies with authentic action sports lifestyle brands. In addition, music is an integral part of the youth action sports lifestyle, and headphones have become an accessory worn to express individuality.”
That action sports brands try and use their involvement with the core to reach a much broader customer base is hardly a new idea.   But Skullcandy draws the smaller core towards the much broader consumer market using the commonality of music and the actual product- the headphones. I’m sitting here trying to think of another company that has a product that can do this quite so well but I’m coming up blank. Maybe Nixon is another example. Perhaps this is the bedrock of Skullcandy’s success.
You’ll also note in the quote the term “consumer influencers.” We’re all aware of the declining role of traditional advertising and the importance of engaging with your customers. You do that, I think, by controlling as much of your value chain as you can. It’s especially important that you control it at the point of contact with the consumer, and Skull is trying to do that in various ways.
They are “…rolling out new point-of-sale fixtures and powered listening stations globally. By the end of the year, we plan to have over 5,000 in place.” About half of these are powered listening stations where you can listen to your own music on Skullcandy headphones as you make purchase decisions.  Some of them have video as well.
Their thinking is that higher price point products especially require a listening experience for the consumer at the point of sale. Where they’ve installed them, they’ve seen it “…impact sell-through from sort of low-double digits up to significantly higher than that, depending on the retailer or the fixture type.”
They have a retail education group within Skullcandy which is going into retailers and educating sales people on the Astro brand. I can’t see any reason you wouldn’t do that for the high end Skullcandy product as well.
They’ve been auditing all their retail customers in Europe since acquiring their distributor and it’s apparently leading to some changes in what they sell to whom; even at the initial cost of some sales.
They’ve launched the 2XL brand as a price point product they can sell to places like Walgreens and Rite Aid without damaging the Skullcandy brand. I guess I’m not quite certain why you can sell Skullcandy to Fred Meyers but not to Walgreens, but what do I know.
During the conference call, they were asked about selling to Walmart and the answer was along the lines of there’s no current active conversation or commitment, but we’re watching them and it’s kind of hard to ignore the biggest retailer in the world.
This goes back to the ability to control your value chain at the point at which it contacts the customer. If you can manage the experience the consumer has with your product so that it’s a positive one and represents the brand in the way you want, does it matter if you’re showing the product in a core shop or in Walmart? That’s an important point, and not just for Skullcandy. The breakdown of the traditional retail/wholesale distribution system requires that brands think about it.
Skullcandy’s financial results are good, and their balance sheet is solid. But what I really like is first, the way they are reaching their market using the commonality of music and headphones to draw together the action sports core and the broader market and, second, their strategic initiatives that seem to address the rapidly changing and emerging retail environment.



2 replies
  1. Kelly Dole
    Kelly Dole says:

    Jeff, Well put, as usual. Skullcandy’s sales increases and strategy is impressive.

    Q1: Was anything said about pressure from their competition?

    Certainly one key to Skullcandy’s success is the lack of any large, direct, serious competitors in the action sports arena. Before you BBQ me, I know the earbud and headphone space has many players; Beats, Frends, Munitio, Outdoor Research, Nixon and Sol Republic (Michael Phelps) headphones all aiming for sports marketshare. And that’s not even including the traditional powerhouses like Bose, Sony and other CE players. But Skull seems to so define the market, I just wonder how much it comes up, if at all, from the analysts.

    Q2: Within the action sports space, assuming they had significant financial backing, are there company(s) do you think are poised to take away 5 to 10% of Skullcandy’s marketshare in the near term? 12-36 mo…

    Q3: In Skullcandy’s case, do you see risks of them losing core accounts to new Brands as they expand to bigger and bigger discount chains?

    Keep up the good work…

    • jeff
      jeff says:

      Hi Kelly,
      The answer is the competition does come up, but nobody seems all that concerned about it, though that just may be the analysts being understated. Here’s the link to the conference call if you’re interested.

      Actually, I’m not going to barbecue you. Skull, as you put it, is defining the market. I was expecting much more competition before now, but it doesn’t seem to be there yet. I am not quite sure anybody can emulate Skull’s coolness factor right now, and if they can keep up with technology maybe they can continue to pull it off. As I said in the article, their ability to pull together the core and the broader market based on music and headphones as a product everybody needs is very powerful. And they are spending money on the correct strategic things even at some short term cost to their bottom line.

      Traditionally, brands lose core accounts as they grow. What I asked towards the end of the article was if you are managing all the details of your intersection with the consumer (curating the experience, if you will) is there any reason you can’t succeed in more channels if you offer the consumer the same experience, more or less in both. I don’t know the answer to that.

      Thanks for the good questions. I could have written another article answering them.

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