Good day, ladies and gentlemen. Thank you for standing by, and welcome to Skullcandy's Fourth Quarter 2012 Earnings Conference Call. Presenting on today's call will be Rick Alden, Interim Chief Executive Officer; and Kyle Wescoat, Senior Vice President and Chief Financial Officer. As a reminder, today's call is being recorded. [Operator Instructions] At this time, I'd like to turn the conference over to Mr. Seo Salimi, General Counsel. Please go ahead, sir.
Good afternoon, and welcome to Skullcandy's Fourth Quarter 2012 Earnings Call. Before we begin, let me remind you that certain statements made on today's call, either during our prepared remarks or in response to your questions, may constitute forward-looking statements. These statements are made pursuant to and within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to both known and unknown risks and uncertainties that can cause actual results to differ materially from such statements. Those risks and uncertainties are described in Skullcandy's quarterly and annual reports on Form 10-Q and 10-K. Investors should not assume that statements made during the teleconference today will remain operative at a later time, and Skullcandy undertakes no obligation to update any of the information discussed on this call.
With that, I'll turn it over to Rick Alden, Skullcandy's Interim Chief Executive Officer.
Thanks, Seo. Good afternoon, and thanks for joining us on our fourth quarter earnings call. You've all certainly seen the news about the CEO transition here at Skullcandy. It would be difficult to describe what this company, its products, employees and shareholders mean to me personally in the short amount of time we have today, but let me just say that I'm very energized to be back in the role during this transition period.
Clearly, companies going through an executive transition like this don't typically do them at a high point of corporate health. That implies that my first role when arriving 4 weeks ago -- actually 4 weeks ago today, was to do a deep dive into what is working well for the company, but most importantly, to make an honest assessment of where things has gone off track, then to keep the organization moving on the right direction. I think that will be the theme for my call today will be "honest assessment."
Our fourth quarter results were within the expectations that we set at the beginning of the quarter, though at the lower end of the plan. This quarter capped off a year meeting the financial goals and growing sales by 28% and net income by 39%. But as you will hear in Kyle's discussion, we are unfortunately going to lose money in the first quarter and be down for the overall year versus 2012.
Part of this decline will be driven by important changes to the way we do business. So I'm going to spend most of the next few minutes addressing what is behind this outlook.
Skullcandy continues to command significant brand strength and has at our disposal an array of key assets that continue to make us an industry leader. Some of these assets, like our world-class supply chain, we continue to leverage. One thing that has been reaffirmed since my return are the incomparable foundational strengths of this organization. We are recognized by our wholesale customers as beyond dependable and best in class. Let me say that despite some missteps, Skullcandy is still the #4 performing audio brand in total dollar sales and the #2 brand in unit sales at the most elite retailers in North America. And we are quickly spreading globally. We have tremendous brand recognition and a strong reputation with both our target customers and potential new international customers. I'm very confident that as long as we stay focused on what has made us unique, we can leverage our brand along with our size and strong retail relationships to create tremendous future success.
Looking at 2013. An immediate personal focus will be the low-quality sales that comprise roughly 10% of our total 2012 revenue, much of which was driven through the off-price channel. Not only do we need to cut this back significantly, which is already being implemented for 2013, but we also need to make sure that we do not rely on this channel in the future. Our first quarter guidance reflects this effort, and the long-term benefit to our margins and our relationships with our full-price retailers is certainly our focus at this point.
This brings me to the team's second immediate focus: packaging. At some point, back in 2011, a group of creative employees started discussing a desire for a packaging update, which internally was called Skullcandy 2.0. Since our inception, Skullcandy's packaging has been incredibly unique, creative, colorful; told a great brand, product and feature story; and for years, was part of what attracted customers and drove sell-through. End users and retailers alike responded extremely well to the Skullcandy product line and our unique packaging as it stood next to all the other brands in the category. While the new packaging created an immediate increase -- the new 2.0 in 2012 packaging created an immediate increase in channel filled sales over the first quarter of 2012, in our opinion, it did not support acceptable sell-through metrics throughout the year, and this has set us on a course for more reliance on the off-price channel. The new look is too clean. Clean lines, clean fonts, lots of negative white space, all of which surrounds a small window through which you can barely see a pair of headphones. We have already launched an initiative to make rapid corrections to this 2.0 packaging issue. We will be able to speak to these changes and timing of the changes to our packaging on the first quarter call. We see this as a major issue when looking back on 2012 and a major opportunity for 2014.
Continuing this "honest assessment" portion of business is our looking at our marketing and demand creation efforts. A high priority for this company in 2013 will be a better utilization of our brand ambassadors in telling product stories, especially at point of sale, and offering transparency around product differentiation and improving the activation of our marketing assets. Since our inception, Skullcandy has compiled a remarkable demand creation team, including our newest relationships with pro athletes, such as Kevin Durant and Derrick Rose; musicians like Wale; continuing to grow relationships with Roc Nation; core additions, such as skateboarder Eric Koston and Olympic medalist snowboarder Danny Kass; and of course, my personal favorite, our supermodel crew, including two-time Sports Illustrated cover girl Kate Upton. As I look in at our point of sale, where the majority of purchasing decisions are made, we have failed to leverage these personalities with either our products or our consumers at the most important point of contact, on the retail sales floor.
When Skullcandy launched, no other brand had looked at the headphone space as a lifestyle niche product category. At that time, we had first mover advantage, as we hit the market with great products, great marketing and packaging and a unique message that resonated dead-on-point with a consumer who we know well. For most of the past 10 years, we have maintained this position and have always had a clear brand message, clarity around our customer and a product roadmap that kept our customers engaged with every new release.
Over the past couple of years, we've grown to be as strong operationally as we had been with our product mix and brand building in our early days. We didn't even know retailers had words like "Vendor of the Year" until we started stacking trophies on the shelf. We have tremendous relationships with our retail partners and are recognized for our world-class supply chain and infrastructure and fulfillment capabilities. Our quality control, sourcing and delivery capabilities are bar none. This is a sustainable competitive advantage. However, during this time, some of the products, branding and demand creation elements of the business were less of a focus at the sacrifice of continuing to build a best-in-class, operationally bulletproof-proof company.
This brings me to the final and most important area of focus: product. I've spent the last month heavily involved in product. I'm very impressed by the caliber of the team and recent product initiatives that I have to call out as being led by one of our internal rock stars, Sam Paschel. When we focus on making great stuff, we get it right. The Navigator, for $99, offers unmatched quality even at much higher price points, and the update of the Crusher, being introduced in April as a $99 headphone that incorporates amplified subwoofer technology, causes bleed-through-your-eyes amounts of bass. There is nothing like the Crusher on the market today, I'd say, except for our earlier versions of Crusher, which we have just dramatically improved on.
However, we have not kept up with all changing trends, nor have we led with our own innovations. Bluetooth, for example, is heavily in the market, Skullcandy is not sufficiently there. This is unacceptable, and we need to get back to creating the leading edge rather than waiting to see what our competitors are doing.
Our inability to be cutting edge has nothing to do with our people or our infrastructure. We have remarkable resources to get this done. We now need to refocus these resources to get back to building remarkable products.
As an aside, let me address the comment about Skullcandy, sometime used as an indictment, but to me, there's only a high-class problem that we're now addressing. And that is that Skullcandy has moved too slow to enter higher price points in our core headphones business.
How many brands in how many industries actually have retailers, customers and analysts, criticizing them, and rightly so, for moving too slow to migrate to a more premium higher ASP product? While we will not enter the premier price points merely for the sake of raising prices, know that it is not lost on us, that when we are motivated by the right product and inspired to tell our story at a specific price point, we will not hesitate. We have some remarkable product now in this space, specifically with our Aviator and Navigator headphones at $100 and $150 price points, which I feel are 2 of the most authentic, best-looking, highest-quality products in the category today. I'd call your attention, just last week, to the inclusion of the Navigator in the Forbes Best Headphones of 2013 release. Our challenge with these products is not the quality or relevance of the products, but rather, we go back to issues #1 and 2, packaging and storytelling, which, trust me, we are on.
Another honest assessment opportunity is best illustrated by one of our largest customers in the world, retail customers, who called us out recently on disappointing him because we are the only major brand in this category that fails to leverage his shelf to extend our brand into adjacent categories such as speakers and mobility products. Brand extension is a long-term opportunity and absolutely a major shape for the future of Skullcandy.
On an end note, I'd like to call special attention to one of our greatest success stories of 2012: Astro Gaming. Founders of Astro built an authentic gaming headset brand that was exclusively sold online at the time we acquired the business in 2011. Skullcandy has introduced the brand profitably to retail. And in the last year, Astro has almost tripled revenue. They are now in over 8,500 retail doors, both domestically and internationally, and they control more than 50% of the over $200 premium price point in gaming. Astro has also helped Skullcandy launch our own gaming headsets, with more than $2 million of sales in Q4 of 2012 alone. Skullcandy also leveraged our manufacturing and supply-chain strengths to increase Astro products' margins by more than 15 percentage points, and Astro has contributed nicely to our 2012, both top and bottom. Both the Astro and Skullcandy teams have done an amazing job bringing the 2 teams together for a huge win in 2012. And trust me, we are just getting started.
While our financial results may be taking a step back in 2013, we are focused on making the year a very important step forward for the company. As a young company, we have experienced a tremendous amount of success, and we have also learned a lot about what makes the Skullcandy brand special and, frankly, what can also make it not so special in the market place. As an agile, very hungry young company, we can apply quickly these learnings to the future success of the company.
With that, I'll turn the call over to Kyle, who will run through our financial results and our outlook for 2013.
Kyle B. Wescoat
Thanks, Rick. Before I get started, let me say the 4 weeks since Rick has been here, he's infused an energy and a sense of urgency within our team around sell-through, leveraging our exceptional marketing assets, improving margins, spending smart and, above all, innovation. Now I will review our fourth quarter and full year 2012 financial results and then briefly provide some comments on 1Q 2013.
Fourth quarter net sales increased 21% to $101 million from $83.4 million in fourth quarter a year ago. By segment, North American sales increased 12% to $82.7 million and international net sales increased 90.2% to $18.3 million. The increase in North American sales was driven largely by our Astro Gaming and 2XL product lines. This was partially offset by lower CE and mobility sales following slower-than-expected sell-through during the holiday season.
The strong gain in international sales included mid-teens growth in Europe, the region's first quarter of true comps since going direct after acquiring Kungsbacka 57 North in late summer 2011. We think this is a very respectable comparison given the current challenging retail environment in Europe.
An additional 25% of international growth was attributed to our launching direct sales efforts in both China and Japan in 2012. The final piece of the story was a shift in the origin of sales for customers in the Middle East, Africa and Asia-Pacific to locations outside the U.S., which resulted in these sales, now and in the future, being reported in the international segment and not in North America.
From a product mix perspective, in Q4, our top-selling buds were Ink'd, Smokin' Buds, 50/50 and FIX. Our top-selling headphones were Hesh, Uprock, Lowrider, Aviator and Astro's A50. The Navigator, which we introduced in September, gained traction during holiday and was one of our top-selling new products. We also saw a continued shift towards mic products and overall higher ASPs during Q4. ASPs grew high teens, led by sales of our gaming products. With respect to the price band, sales in the $50 to $100 range grew single -- mid-single digits, and sales in the over $100 band more than doubled, primarily from the sale of our premium gaming headphones.
Gross profit for the fourth quarter increased 8.5% to $45.2 million. Gross margin was 44.7% as compared to 49.7% in the same quarter a year ago. Fourth quarter 2012 gross margin was unfavorably impacted by 3 principal factors: one, the shift in sales towards higher-priced, low-margin products accounted for 200 basis points of the decline; two, higher levels of promotional sales and retailer discounting accounted for 180 basis points of the decline; and finally, product liquidations through the off-price channel, which contributed 140 basis points to this decline.
Selling, general and administrative expenses for the quarter increased 29.8% to $27.5 million, which included $2.1 million of bad debt expense, primarily attributable to the bankruptcy filing of a large U.K. retailer and the settlement expense associated with a patent litigation matter for $700,000. In Q4 2011, SG&A expense of $21.2 million included $1.3 million of legal and settlement expenses associated with a lawsuit. Excluding these certain expenses, SG&A expense as a percent of revenue increased to 25.1% of sales from 23.8% of sales a year ago. This increase was driven primarily by $2.8 million in higher payroll and benefits to support our international and Astro expansion and higher marketing spending and depreciation, offset somewhat by lower travel and commissions. Skullcandy had 335 employees at year-end 2012 compared to 290 employees at year-end 2011, with almost the entire headcount increase coming in international and Astro.
We continue to invest in key areas to support our long-term growth; namely, product development, international Astro expansion and point-of-sale merchandising. Operating income in the fourth quarter was $17.7 million, down from $20.4 million in the fourth quarter of 2011. Excluding the aforementioned SG&A expense that totaled $2.1 million in this year's fourth quarter and the $1.3 million in last year's fourth quarter, adjusted operating income was $19.8 million or 19.6% of sales, down from $21.8 million or 26.1% of sales.
GAAP net income for the fourth quarter of 2012 was $11.5 million or $0.41 per diluted share based on 27.8 million -- 28 million diluted shares outstanding. Excluding certain expenses related to the bankruptcy filing of a U.K. retailer and expenses associated with the settlement of the patent litigation matter, non-GAAP adjusted net income in the fourth quarter of 2012 was $13.2 million or $0.47 per diluted share. This matched non-GAAP adjusted net income of $13.2 million and non-GAAP adjusted earnings per diluted share of $0.47 in the fourth quarter of 2011.
Turning quickly to the full year of 2012 results, net sales increased 28.1% to $297.7 million. This increase is primarily attributable to increases year-over-year for Astro and international, where both units and ASPs increased double-digits from 2012 over 2011. Gross profits increased to $40.9 million from $115 million in the prior year period. Though gross margin declined to 47.3% from 49.7% in 2011, due largely to the aforementioned mix shift to higher-priced, lower-margin products, the impact of the packaging switchover and the liquidation of products and the more competitive promotional environment versus 2011 that we commented about in the third quarter call.
Our effective tax rate in 2012 was 36%, down from 43.5% in 2011. GAAP net income for the full year 2012 was $25.9 million or $0.92 per diluted share on diluted shares outstanding of 28 million compared to GAAP net income of $18.6 million or $0.79 per share of diluted shares outstanding of 23.6 million. Adjusted net income for 2012 was $28 million or $1 per diluted share compared to $23.5 million or $1 per diluted share in 2011.
For reconciliation on non-GAAP adjusted net income to net income and non-GAAP diluted earnings per share to GAAP earnings per share, please see the accompanying table at the end of our earnings release.
Turning to our balance sheet. At December 31, 2012, cash and cash equivalents totaled $19.3 million compared to $23.3 million at December 31, 2011. At year end, the company had outstanding borrowings -- at year end, the company had no outstanding borrowings, versus $9.9 million at year-end 2011. Accounts receivable increased to $76.3 million compared with $50.6 million a year ago due to higher fourth quarter revenue in 2012 and sales materializing later in the quarter. Included in this increase is $13.7 million of incremental receivables due to the launch of Astro products at retail in the fourth quarter. Additionally, the company entered into a multi-buyer credit insurance program in Q4 to help mitigate and manage the risks associated with our worldwide receivable portfolio going forward.
Inventories were $41.6 million at the end of 2012, down 5.5% from $44 million at the end of 2011, in line with our efforts to control inventory balances. And by selling off older and end-of-life, much of this occurred in the second half of 2012.
And now I'd like to share some thoughts regarding the first quarter of 2013, which is always our lowest revenue quarter of the year. We plan to immediately address the changes Rick has identified that will unfavorably impact our 1Q result. Our goal in 2013 is to reset and get back on track. To accomplish this, we need to balance our sales channel and improve sell-through, and do this in the face of a very challenging comparison to last year, when channel inventories were very low going into 2012, a packaging swap-out generated additional sell-in, and additionally, we are down a major customer this year in HMB, and as Rick pointed out, we are reducing our sales into the off-price channel, which has already started in the first quarter.
Consequently, we now expect 1Q 2013 sales to be down approximately 30% from 1Q last year. Due to this lowering of expectation related to sales combined with expenses related to increased demand creation efforts for our Crusher launch and higher operating costs to support our Astro and international expansion, we believe -- we expect a reported diluted loss per share in 1Q 2013 in the approximate range of $0.25 to $0.30. Included in this projection is approximately $0.03 of severance cost associated with the departure of our former CEO.
With regards to the remainder of 2013, we'll have a better visibility around the full year and be further along with our strategic plan when we report 1Q results in early May.
I'll now turn the call back to Rick for closing comments and Q&A.
Before we open the call to questions, I just want to close by saying that obviously none of us are happy to see a loss come in the first quarter. I like to emphasize, though, that the challenges we have today we see as self-inflicted and, most importantly, fixable. As well, the initiatives that we are working on are being designed to focus our future energy on healthy revenue and best practices. I believe we have a solid handle on the issues and opportunities in the next 24 months, and we'll share more with you on our go-forward strategies during our upcoming earnings call. Q&A.
[Operator Instructions] And our first question will come from Ed Yruma with KeyBanc Capital Markets.
Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division
While I know you're not willing to provide remainder of 2013 guidance, I guess we're just trying to dimensionalize some of this technological innovation you're trying to push and, I guess, the kind of longer-term impact to the P&L. Obviously, R&D has been stepped up through all of '12. Should we expect a step-up in '13?
Our R&D efforts right now -- anyone on the call who wants to come out, from consumer to analyst, come out and see the world-class product development effort that we've got, the resources that we've got available here, it would be difficult to -- there's just no need to be putting additional investments in. We have got the right team, the right equipment overseas in Asia, the right support staff from -- all the way from development to quality control. Right now, what we've got to do is actually utilize the resources on some -- on the project that we've known all along that we need to be bringing out, and just that we haven't been. For some reason, we've been chasing too much price points and backward-looking results off of NPD data rather than forward-looking innovation and unique product that we find inspiring inside or outside, so that's the real new effort. Fortunately, the investments that we've made are solid and in place, and you're not going to see a lot more going into development. I hope that's what you're looking for.
Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division
That's great. And I guess second question, given that you're in the midst of transformational activities, how should we think about uses of cash and your ability to generate cash in 2013 and whether the existing cash balance is sufficient to fund some of these activities you're talking about?
Kyle B. Wescoat
Well, this is Kyle. Thanks. I think that our view is that we throw off cash, and our expectation is to continue to throw off cash and meet the requirements of the business. And we've not deviated from that perspective at this time.
And the next question comes from Mike Malouf with Craig-Hallum Capital.
Ross Licero - Craig-Hallum Capital Group LLC, Research Division
This is Ross, on for Mike. First question, about Astro Gaming. Just wanted to see how the sell-through is going on. I know you said the sell-in was really good. But any color on sell-through would be great.
Yes, you bet. You know something, I'll give you a little more information than I probably ought to. Sell-through has been fantastic. The only piece that I'd say is probably less than -- more than I should give you is that this was an entirely online business. And so the growth due to our really fantastic sell-through at retail is definitely taking a bit of a toll on the online, which I'd say is still also growing, just not quite as fast due to relocation of some of those sales at point of -- to great retailers. What I can tell you about Astro is these guys are on fire. They are the rock stars of the organization, and I expect nothing relative to that assessment to slow down any time soon.
Ross Licero - Craig-Hallum Capital Group LLC, Research Division
Okay, great. And, I guess, the previous strategy has really been to focus on the $50 to $100 range. Now that you're onboard, are you taking another look at that strategy, or is that still the course that we're taking?
Yes, it's a great question. I'd say that, that is kind of the way that we used to look at things around here, which is, "Let's look at a price point, find a product to fill it." I think what you're going to find is we're going to be developing products. We'll figure out what they cost to manufacture and put on the shelf, and then we'll figure out a price point. So I'm far more interested in filling an emotive need and something cool to bring to the market than to fill a price point. So we've got some fantastic products in the Navigator, Aviator, $99 to $150. We got some great products, especially the new release of Hesh, which has been called -- we actually had a review calling it the best headphone under $400, remarkable headphone. And then, of course, the rebuild of the Crusher, which is, as you know, that's our maiden product. It's an amplified subwoofer headphone that blows people's minds. And the complete rebuild of that, bringing it down to $100. Those are, randomly, price points against products that we have in the market now. As far as what we're developing in the future, we'll figure out what the preferred price points will be after we figure out what they cost.
Ross Licero - Craig-Hallum Capital Group LLC, Research Division
Okay, great. And what does the new product pipeline look like?
I'd call it thin. I would say that the products that we have in mix right now, I'm sticking a fork in several of them, because I find them chasing price points as opposed to inspiring me personally or the guys that are developing them. Even the guys that were developing them were developing them because they were told to bring out a new $50 bud. We don't need a new $50 bud. We might bring one out if it's a pretty amazing product. But no, we completely flipped the thing upside down. We've hit stop on a number of products. And I think what you would say, if I were to address it, I would say look for more categories rather than headphones.
Moving on to Jay Sole with Morgan Stanley.
Jay Sole - Morgan Stanley, Research Division
Rick, I had a question. I think -- just curious about the people who are going to be leading the new initiatives that you're talking about, because it sounds like you're really involved in product, you're also talking about packaging and marketing. Who are going to be leading the new packaging initiatives, and who's going to be in charge of marketing?
Great question. Right now, we have Sam Paschel, who I called out earlier in the call. Sam is over all things product development. I came in -- Sam and I knew each other years ago, back when he was VP of Marketing over Burton Snowboards, and we have a lot of history. We actually brought Skullcandy integrated products through his product mix -- boy, 2004 I want to say, we were putting Skullcrusher into helmets that he was bringing out way back then. We've always had a number of initiatives with Burton Snowboards over the years. And it was a coup to get him to come over here. It was the first time he and I had worked in house together, I'd only heard how remarkable he was from the Burton guys and how remarkable he was from guys working with him here, and he is that guy now. He is taking the lead, as I have driven it down, particularly on packaging. And point-of-sale is another guy, Jeff Chuh, who will be following Sam's lead on that. Product falls underneath him as well. He got fantastic resources underneath. And I'm telling you, there is no challenge with depth of bench within the creative community at Skullcandy. It was -- the only thing that was missing was the drive to -- what to apply those resources to. So we feel really good about the resources we have at hand.
Jay Sole - Morgan Stanley, Research Division
Okay, interesting. Now on the packaging, are we -- you're talking about like -- last year, there was the changeover. There's a lot of flushing out the old products through the channel. Are we talking about going through that again this year? It will be -- what kind of SG&A you think is going to be associated with coming up with new designs and kind of going through the process all over again?
As we look at packaging, the initiative is running change. That's the key word here, that's the operative word. Maintaining packaging within the same size, shape, inner carton quantities, master carton quantities, the product inside the package is exactly the same. And we are essentially telling better stories using more color, opening up windows and doing a better job of presenting the product, but not as a closeout and a reset as we did when we -- Q1 2012 when we shut down 1.0 to 2.0, but rather using the existing form factor, staying within that limitation, and going for a running change. So you should see fairly little.
Kyle B. Wescoat
This is Kyle. As I said in my earlier remarks, we may have some additional clarity on the first quarter call. But at this point, what I'd like to say is that the way I think you should be thinking about this is that sales are expected to decline over the rest of the year at an improving rate in each of the quarters beyond Q1. I think the way you should think about gross margin is that gross margin in 1Q should be in line with 4Q 2012, and then we expect it to be moderately higher than it was in 1Q for the rest of the year. As you think about SG&A, it will increase through the rest of the year on a dollar basis, but not nearly at the rate it did in Q1. So I think that -- and the tax rate we expect to be down, oh, 100 basis points from 2012. So I think that given those metrics, you could calculate pretty much what it looks like.
Jay Sole - Morgan Stanley, Research Division
Got it. That's super helpful. If I could squeeze in one last one. And Rick, I hope this isn't like a tough question, but you sound like really energized about being back at Skullcandy. How do you feel now that you've been in the seat for 4 weeks? Are you -- do you still consider yourself interim, or do you kind of feel like this is your #1, main priority going forward?
Great question. There's absolutely a capital I in front of the CEO here. I kind of always had the opinion that, at Skullcandy, we need to be the best representative of our customers, the best versions of our best customers. So probably for the same reasons that motivated me to transition over to a board role a couple of years ago, I came to really believe that a $300 million publicly traded company probably needs someone who's a better representative of the company than I would be. I feel like I'm a great voice and representative for our customer. That said, I kind of slid too far back into a CEO role, quiet CEO role, 2 years ago, and I think that we lost something by me taking such a backseat on the board. In here, the only guy that I am trying to keep up with is Kyle as far as the 70- to 80-hour workweeks around here. I do not see, whatever happens around here, that changing the number of hours I'm putting in. So when we find the right guy to be CEO of this organization, my role is not going to be a quiet board member into the future. I'm going to be here long and loud for a long time representing the customer. I think we'll find the right guy to come in and represent the company.
And the next question comes from Robbie Ohmes with Bank of America Merrill Lynch.
Robert F. Ohmes - BofA Merrill Lynch, Research Division
I was hoping you could maybe talk a little bit more about what you're seeing at the moment in the competitive environment. And also, as you look across the customer base, you mentioned HMB, but is there any other major customers that you could potentially see a big shift with, or is that sort of revenue decline just against a tough comparison? I basically want to know, is it sort of a broad-based, year-over-year reduction in how it plays out, or is it isolated to a few larger customers that you could be exiting with?
Yes. Robbie, great question. Listen, the competitive arena, I think that any time you have -- headphones are not a new category. Headphones, we've changed up what that category looks like over the last few years. And so yes, we do consider it a fairly new approach to this category. A lot of companies have come in, a lot of brands have come in to try and play inside this space. Some had done remarkably well. One has done beyond remarkably well: Beats. The guys are freaking killing it. Am I allowed to say that on the phone? All right, there we go. So -- I mean, these guys, they're on fire. When we launched, back when, we were looking at a 14- to 24-year-old customer. We really identified kind of the $29 to $69 price point. That was our going forward as a nice impulse buy for a category that really hadn't been called out. We launched in surf, skate, snow shops, and then extended out to music shops. Beyond that, out to e-shops, and it worked great for us. Then all of a sudden, Jimmy and Dre pop up with, "No, no, no, it's not $69, it's $300." And suddenly, that aspirational product line nailed it. Guys, listen, they're freaking brilliant guys. They've got it done. Fortunately for us, we are still dialed in at that kind of $19 to $100, $19 to $150 price point where they are not. They are different price points, different categories. It doesn't mean that we don't have appetite for that space, but those are the guys to be dealt with. One thing that's going on right now inside the retail space was so many young brands popping up saying, "Hey, we want to be in this space also." And you see retailers experimenting out, seeing who else might be able to get traction at point-of-sale. Fortunately for us, you've got Beats killing it. You got Bose and Sony, who've always been there, and you have Skullcandy.
So one of the things that's happened is you look at these elite retailers, and they've expanded from 4, 5, 10 years ago to as many as 15, 18 brands on shelf, up -- possibly a year ago was probably the high point of it. While there is not at all any reduction in guys coming into the space, what we are seeing at retail is a consolidation effort. We see retailers bringing their selections down from a very confusing broad selection of a dozen-ish brands down to 4 or 5 or 6. And fortunately, they're picking the mainstays. And not only are they picking the mainstay brands that speak well to the customer, you've got to look at supply chain and whether or not you can deliver the product on time. That's us. And so we just simply deliver, and they keep us well inside that space. So we kind of look at the world in a category of 4 players: you got Beats, Sony, Bose, Skullcandy. And it's great to be held onto by these retailers.
Kyle B. Wescoat
Yes. I would say one other thing, Robbie, as it relates to kind of inventory levels. When I was on my first call after being here for 30 days back in November, we didn't have the benefit of holiday or had only expectations for holiday. I think it's fair to say that as it relates to this category and as it relates to Skullcandy, our results for the fourth quarter were not what we wanted them to be. And they were not what I think the retailers wanted to be for the category. So we're coming into the first quarter with a much higher level of inventory in the channel than we had at this time last year, and that is one of the things that we're concerned about. That, coupled with what Rick pointed out about the packaging and the fact that we just are not seeing the kind of enthusiasm about the packaging and the fact that we are going to have to deal with this packaging issue for a while until we can get that resolved. So those are some of the things that are headwinds that we're looking into as we come into 2013.
And moving on, our next question is from Andrew Burns with D.A. Davidson.
This is Devon [ph] on for Andrew. I was just hoping you guys could tell us, in terms of your brands' channel mix playing out over the next couple of years, do you think the core specialty channel will decrease in the mix, or maybe consumer electronics and mass markets, will they continue to increase as part of the mix? We're hoping you could tell us that.
That's great question. So we've always had the concern if you start extending outside what we call that core retailer -- Surfside, Salty Beach, Salt Lake, all the core surf, skate, snow shops, you start going into places like Target, Best Buy and Staples, is that going to shut us down at those places? The answer to that, fortunately, has been not so much. We really have had a target as calling out product differentiation to the different channels to make sure that we had unique and specialized product for those specialty retailers. And I will tell you straight up, we've done a really poor job of doing that. We tell the story real well. We just don't deliver the product highly differentiated from one channel to the other. The intent has always been, when we come up with a unique product, that you launch it first at core. You get traction, you get your manufacturing all dialed in, you get it into the hands of all the tastemakers first, and then 6 months, maybe a year later, you roll it into the larger big box. It keeps those guys interested, keeps us relevant at those retailers. And straight up, it's been talk. We just plain haven't been doing it. I think what you're going to see is a recommitment to that channel to make sure that we do stay relevant within that space.
Kyle B. Wescoat
I think that the other thing I would say is, as we start to get more engaged internationally and go more direct, we'll be able to do better with the core business that currently we're doing through distributors. And I also think that the lifestyle channel in Europe -- I mean, Europe, in general, has been very uneven over the course of the last 6 months, and I think you'll probably hear that from other consumer brands as well. And so I think that our expectation is that the core business may consolidate a little bit in Europe, but we still view that we have a great opportunity with the core customer, not only in Europe, but throughout the rest of the world, and that is an opportunity that we can leverage off of going forward.
Okay. That was really helpful. I have just one more question for you. Are there any like hotspots for excess inventory or kind of channels that have appeared to de-stock in any material way? We're trying to gauge kind of what the impact of current retail inventory levels are going to have on the business in '13.
Kyle B. Wescoat
Well, I don't know if I can comment on any specificity. I think that the point that I made earlier about the amount of inventory in the channel, I think, is really the overarching issue for us. Where that resides, in what retailer, I can't say. We just know that at this point in time, we feel that we didn't get the kind of sell-through that we had hoped for going into 2013. And as a result of that, we do have some inventory indigestion as it relates to the early part of 2013.
And our next question comes from Mike Latimore with Northland Capital markets.
This is Ryan MacDonald on for Mike. How quickly do you expect to get this new packaging out into store shelves this year?
A complicated answer. We referred to packaging as 2.0. It was the straight-up white and black Skullcandy Supreme Sound small-windowed packaging. There has been an initiative, and we have already started shipping some amount of what we call 2.1, which is a larger window with more color splashes. For some reason, some people internal at Skullcandy opted to outsource that creative to an agency someplace, I don't know where. I know we certainly will -- and personally, we have yet to see that stuff hit pegs. And so while I don't have great expectation for it to see a dramatic lift, you will see that starting to trickle in. To make it a little bit more complicated for you, in areas where that outside agency had done some work that I think is less on point for our brand, you're going to see that redone yet again, again continuing in with this redesign -- excuse me, with this running change. And I would, in a best case scenario, we're going to see some of that in Q4, but certainly for Q1 reset.
Okay. And then do you see any -- do you the opportunity to add more Tier 1 retailers during fiscal '13?
Ryan, I'm sorry. Could you repeat that for me?
Yes. Do you see the opportunity to add anymore Tier 1 retailers to distribution this year?
Absolutely. So you're going to see 2 pieces on that one. It's in Tier 1. The correct places where you would anticipate us to be going, we are in conversation with. We have been hesitant to introduce yet, but we are in conversation. We hope that will be happening within 2013. But what I would suggest that you look more for in early '14, since we really have such a broad distribution in the Tier 1 retailers, is more exterior pegs in various categories more than new retail. There's just so many retailers out there in the world.
Okay, and then just one final question here. What are your thoughts on how big gaming could be in 2013 as a percent of revenue, total revenue?
Kyle B. Wescoat
We really believe in the gaming category. We believe from the market research that we've seen that the gaming and accessories business could be $7 billion. So a very large market worldwide. And we are participating very effectively at the high end. We are also introducing Skullcandy Gaming, which will draw from the strength in the market halo associated with Astro. So our expectation is that, that business could grow for us significantly in 2013. At this point in time, I think we'll defer on final discussions with respect to 2013 until our next call, when we can be more thorough about the overall business.
And next will be Adam Engebretson with Piper Jaffray.
Adam F. Engebretson - Piper Jaffray Companies, Research Division
First, Rick, have you shared these assessments with your preferred retail partners? And if so, wondering what their initial response has been?
Very cooperative. So let me clarify just a little bit about the packaging, because that's where it really hits the road with these guys. 2.0, 2.1, 2.2. 2.0 is what is currently on shelves, small windows, black and white, says a lot of Skullcandy Supreme Sound. 2.1 is in process and is in shipping. All retailers anticipate it. Many of them have it on -- not many of them, a few of them have it on shelf right now. And the rest through the end of March and April, you should see it trickling, and again, it's a running change. So you're going to see this improved packaging mixing and mingling on shelf with 2.0. The 2.2 that we've talked about is really the intended product where -- the packaging where we take, again, the same thing, and we just do a little bit more of -- I'd probably say our internal -- our current internal creative division on fixing that up. And so it's going to be a bit of a confusing year. Fortunately for us, our retailers are doing 2 things. Number one, accepting this product as a running change rather than a closeout and a reset. And number two, very specifically working with us to do testing to clear some shelves out to put the old on, put the new on in other stores and be able to get a direct comparison. Unfortunately, because the 2.1 won't be entirely available until towards end of April, it's going to be a little bit of time. Could be mid-summer before we get great clarity on the lift. But the retailers, our partners, retail partners, are working with us to be able to do these kinds of tests. They're very -- we don't do anything without signing the retailers in.
Adam F. Engebretson - Piper Jaffray Companies, Research Division
Got you. And then second question would be regarding some of these broader changes outside packaging. Are those comments, thinking about changes in how you're going to do some marketing, distribution, are those comments limited to the U.S., or is that really directed at the global business? And so might we see some of those changes in your international segment as well?
One of the intents of the business is to codify exactly what is successful for us here in the U.S. and export that as culturally relevant as possible in a very concise manner through Aaron Behle and his international team. We have offices in a number of places around the world where we have Skullcandy employees. We've got great distribution partners in some places and in other places where we are selling to direct. And everything that we are telling you today, you should read that as a global statement.
[Operator Instructions] And that does conclude the question-and-answer session. I'll now turn the conference back over to you, sir.
So everyone, just like to say thanks for joining us, and look forward to coming back with more specific Q1 results and more information on the go-forward strategies into the future and that we are available for any more detailed questions on a direct one-on-one basis. Thanks, everyone, for taking the time.
Thank you. And that does conclude today's conference. We do thank you for your participation today.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!