Skullcandy’s Strong Quarter; It’s Amazing What an IPO Can Do for Your Balance Sheet

My favorite footnote in Skullcandy’s 10Q for the quarter ended September 30 is footnote nine and specifically the table on long term debt (Yes, I know it’s kind of sad that I have favorite footnotes). It shows no long term debt at the quarter’s end compared to $73.4 million on December 31, 2010. They raised $77.5 million through the IPO, and you can see what they used it for. Equity is now $92 million compared to a deficit of $16 million a year ago. The current ratio improved slightly from 1.89 to 2.19. They’ve got $15 million in cash at the end of the quarter compared to $2.3 million a year ago. Their bank debt is up a bit from $11.2 million to $14.2 million. 

Sales rose 58% from $38.5 million to $60.6 million. But they said in the conference call that sales in the 3rd quarter last year were impacted by late deliveries, difficulties getting product made, and inventory shortages. They note as a result that “…our increased sales guidance implies second-half sales growth of 38%, this year, versus 29% last year.” International sales were up 75.9% to $14.6 million. They closed the acquisition of their European distributor on August 26th. Online sales were up 413% to $6.2 million. That growth includes $2.9 million of sales of Astro Gaming products which Skull acquired in May.

Skull notes that they “…rely on Target and Best Buy for a significant portion of our net sales.” Each accounted for more than 10% of sales in 2010. Best buy continues to account for more than 10% in the first three quarters of 2011. As I noted when I reviewed their initial public offering documents, the bet Skull is making is that they can be very widely distributed but still be cool and desirable to their target market.
The gross profit margin fell from 52% to 47.5% though gross profit rose from $20 million to $28.8 million. Like most companies, they are experiencing higher product prices in China and they rely on two manufacturers there for “substantially all” of their product line.
Selling, general and administrative expenses were up from $13.3 million to $20.6 million. As a percentage of sales, they declined slightly from 34.5% to 33.9%. There was an additional $1.3 million of marketing expenses during the quarter.   Interest expense to related parties was $2.77 million during the quarter. That’s gone with the IPO complete and will mean improved profitability in future quarters. Profit was $952,000 compared to a loss of $1.22 million in the same quarter last year.
I’ve laid out the numbers first so we could talk about Skull’s strategy and positioning a bit. Skull is the first mover in a market they identified. The brand reflects “…the collision of the music, fashion and action sports lifestyles.” They have stylized “…a previously commoditized product… The Skullcandy name and distinctive logo have rapidly become icons and contributed to our leading market position.”      
As you’ve probably noticed, many companies are jumping into the market Skull created. There are limited barriers to entry and, right now at least, not a lot of technological product differentiation. In those circumstances maintaining and improving its market position requires Skull to grow quickly and continue to spend freely on advertising and promotion because that’s what the product differentiation is based on. And they are.
But growing costs money. You need more people and more inventory and continued marketing. In the 10Q Skull notes that they “…typically receive the bulk of our orders from retailers about three weeks prior to the date the products are to be shipped and from distributors approximately six weeks prior to the date the products are to be shipped…Retailers regularly request reduced order lead-time, which puts pressure on our supply chain.”
It would really be interesting to know more about the order cycle so we had a better understanding of how much Skull has to build inventory with growth.
Skull’s management talked in the conference call about how they are addressing some of these competitive issues. They indicate they are transitioning to “…an in-house ODM model, where we originate and control more of the design and manufacturing process.” The goal is to help them create new, proprietary products. They’ve also hired a “very senior acoustics engineer” to work with the product development team. “Dual sourcing remains a key priority…” Approximately 10% of products were dual sourced at the end of the third quarter, and this is to increase over the next year.
Importantly, they refer to an increasing average selling price (ASP), though they don’t give any specifics. They say that was “…driven by growth in our own premium category along with mid-shift towards higher priced products across our entire line of headphones.” Domestically, their ASP was up double digits.   That’s great. When you spend a bunch of money on creating the brand, you’ve got to get higher product prices for the business model to make senses. That’s why you build a brand.
High end headphones feel a bit like a little luxury people can afford (and need) in a tough economy. Maybe that’s why there’s room to move up in price point. I really wish all the money from the public offering hadn’t gone right out the door to pay the investors. I’ll bet Skull could do even better things with some more working capital.