Retailers More Cautious Than Before On Q4, Skullcandy CEO Says

Skullcandy is looking to the high-end gaming headset market, higher priced over-ear headphones and international sales to offset lower average selling prices in earbuds and a “very promotional” retail environment going into the holiday sales season, CEO Jeremy Andrus said on an earnings call Thursday. Skullcandy is forecasting flat sequential revenue growth from Q3.

Retailers have become more cautious in their outlook for the holiday season and “it’s impossible to gauge the impact of Hurricane Sandy,” said Chief Financial Officer Kyle Wescoat. Margins are “much more difficult than we would like and difficult to predict,” Wescoat said. He cautioned about a slowdown in Europe and “the escalating promotional environment surrounding the holiday” that will impact Q4. Skullcandy is focusing on a shift in mix, away from price competitive earbuds to higher-priced product that will be “positive for gross profit dollars, but negative for gross profit margins,” Wescoat said.

Q4 at Skullcandy “will roughly mirror” Q3 in revenue, Andrus said. He expects some increase in promotions and “some deceleration in our online business,” the company’s highest-margin sales channel. Citing those factors, he predicted “a reduction in gross margin” for Q4.

Skullcandy is hoping growth in gaming, international sales and “newer, high-priced products” will offset competitive pricing for the quarter, he said. The new Hesh 2 headphones are priced at $60 and $70, a 20 and 40 percent hike over the $50 first-gen phones, and Hesh 2, launched in Q2, has been one of the “top performers,” Andrus said. Skullcandy’s most recent line, the on-ear Navigator, developed by the company’s in-house team, retails for $100 and was modeled on the success of the company’s Aviator on-ear headphone design, he said. Navigator launched in Apple stores, which had an exclusive 30-day run, and Skullcandy is taking the phones to broader CE retail distribution over the next few months, Andrus said. The company plans a limited-release headphone for the holiday season called the Crusher, which also came from the in-house design team’s effort to refresh an older OEM model. The bass-enhanced $100 headphone boasts two subwoofers built directly into the ear cup rather than the cable making for “better functionality and aesthetics,” Andrus said: “There’s really nothing like it on the market today."

Skullcandy plans to leverage synergies between audio headphones and gaming headsets, Andrus said, including product development, supply chain, sales channels and customers. The high-end of the gaming headphone market is growing, he said, and “there are a limited number of established brands in the space,” saying barriers to entry are high because of the “sophistication and technology involved in creating such a complex product.” The U.S. retail gaming channel is “heavily consolidated” among a few very large retailers, he said. He cited the purchase of Astro Gaming, a $10 million company specializing in high-end gaming headphones, in April 2011 and said Skullcandy has been testing the Astro brand in a limited number of Best Buy stores. “Strong sell-through” led to a chain-wide launch of the A40 and A50 models over the past couple of months,” he said.

To expand its business, Skullcandy will launch some Astro PC headsets this quarter online and will take them to retail next year, Wescoat said. Skullcandy is also eyeing opportunities in other game-related categories, he said, including keyboards, mice and controllers. And the company is looking at opportunities in the mobile market, too, he said. The foundation of “product, brand and distribution” is allowing the company to take advantage of additional opportunities, he said.

The gaming market offers Skullcandy the best opportunity for boosting distribution globally in 2013, Wescoat said. The gaming retail market is consolidated around four key companies: Best Buy, Walmart, Target and GameStop, he said. The company is now testing its $250-$300 Astro phones in select GameStop stores, he said, and product margin is in the mid-40 percent range. “We've just scratched the surface,” he said.

As part of a dual-brand strategy, Skullcandy has also launched gaming headphones under the Skullcandy brand at a more affordable $80 price point, and the company is expanding distribution to more than 2,000 storefronts at “key retailers” nationwide, he said. Gaming represents a “significant growth opportunity for the company,” he said. Astro will continue to target the “ultra-premium category,” he said, while Skullcandy will remain mainstream. He estimated the gaming accessories market to be $6 billion-$7 billion globally and the console headset market at $1 billion with double-digit growth.

Skullcandy’s early presence in Europe hasn’t generated a significant amount of sales but is “important to the broader market from a brand perspective,” Andrus said, saying the European retail market “remains challenging.” Skullcandy will continue to invest in the region to build the infrastructure for long-term growth, he said.

For the year, Skullcandy tightened its net sales outlook to $290 million-$300 million from $280 million-$300 million projected earlier in the year, according to Wescoat. The company predicts sales growth of 27 percent over 2011, but with margins and profitability “much more volatile than we would like.” Citing caution about Europe and escalating promotional spending for the holidays, Wescoat said the company lowered operating margin and profit projections for Q4 and is revising its diluted earnings-per-share outlook for 2012 to $1-$1.04 from $1.10-$1.20.