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Summary

  • Small beat on revenue likely driven by Q4 channel stuffing, evidence is on Amazon.com.
  • Founder and recent interim CEO Rick Alden sells nearly $14 million in stock last week.
  • Online popularity for the brand continues to trend down, according to Google Trends and Alexa.
  • Margins are down due to increased product return rates which are on the rise.

Headphone maker Skullcandy (NASDAQ:SKUL) reported their Q4 earnings on March 6th, which were highlighted by a revenue beat of a few hundred thousand dollars over analyst projections that sent the stock in to a sheeple buying frenzy during the following trading session. I previously speculated that the company was at risk of missing estimates, and I was wrong. What I underestimated was the effect of the channel stuffing on the Q4 numbers themselves. I maintain that the "beat" (which is very small), could have easily been the result of channel stuffing.

Evidence of this is as clear as day on Amazon.com (NASDAQ:AMZN), where the supposedly marquee Crusher product is now selling at a near 10% discount by no less than 16 different 3P (third party) sellers after being held steady at MAP (Minimum Advertised Price) during Q3 and early Q4. The price has been trending down in the past several weeks and with the product distribution obviously not being tightly controlled, I'd expect this general pricing weakness to accelerate throughout 2014. These 3P sellers are sitting on a large amount of inventory that they bought from Skullcandy during Q4.

The important thing to note with regards to the Q4 beat is that revenue from these sales was all front-loaded and recognized by Skullcandy in Q4, despite the fact that the inventory indigestion will linger throughout 2014. Remember that these 3P sellers can be fooled once, but generally not twice. These same resellers will not pay a premium again for a product they cannot unload at MAP. So this is a one-time sales event, at least with the Crusher. I imagine that the traditional retailers are feeling the pinch also, tempted to start lowering prices to compete with the Amazon.com sellers. Other Skullcandy products fare far worse in terms of holding MAP. In comparison, Beats Electronics has managed to maintain MAP on their marquee Studio product. So it can be done, it is possible and successful companies are able to control distribution and MAP. Of course with Beats being a private company there is no urgency surrounding the need to beat earnings.

Selling in to this post-earnings strength is company founder and recent interim-CEO Rick Alden. It was reported on Friday, after-hours, that Alden sold 1.5 million shares at an average price of a little over $9. This mammoth vote of non-confidence totaled nearly $14 million. All of this following the company's disclosure of a special $360,202 payment to Alden for "his important contributions to the company in the midst of significant management transitions". Apparently they were important enough to get Alden the high volume pop he needed to be able to dump an extraordinary amount of shares in to the open market.

Perhaps Alden, who is a trend setter himself, took notice of the declining overall popularity of the Skullcandy brand? While popularity in the Philippines and Peru seem to be on the rise, the critical US market is under significant pressure. Take a look at this compelling data generated by Google (NASDAQ:GOOG) Trends, as it tells the story of a brand in continuous decline since late December 2010. With North American sales down 30.3% in Q4, clearly there is no sign of a bottom. Further evidence of the decline in popularity of the brand can be seen on Alexa. Just like we see on Google Trends, the popularity of the brand (and in this case the Skullcandy.co website) is in steady decline over the past several years with no indication of a reversal.

With overall interest in the brand declining, along with the website traffic, and North American sales in a freefall, what positives could we take out of the Q4 results? Certainly not the precipitous decline in gross margins. Dropping from an already weak and beaten down 44.5% Q4 2013 rate to 43.5% in Q4 2014, Skullcandy reports that "The decrease in gross margin was primarily attributable to increased sales returns and allowance expense due to increased returns rates...". Pretty much a worst case scenario for any consumer electronics company. Despite CEO Hoby Darling's comments to the contrary at the ICR XCchange in January, margins are down because the products are breaking and consumers are returning them at record rates. Even more so, the company needs to increase their allowance expense because they are predicting an increasing future rate of product returns. Hoby is a great speaker, but even he cannot escape the facts. Despite all their efforts to silence the critics, product quality remains a growing concern for the company. The Skullcandy Facebook (NASDAQ:FB) page continues to be littered with consumer complaints regarding products and poor customer service. Nobody ever seems to address them.

Jefferies analyst Randal Konik summed up the Q4 earnings best by stating:

SKUL's 4Q EPS came in better than expected and, justifiably, the market is rewarding the co. for making good progress on its structural changes and trajectory towards sales growth in 2014. However, with the stock up ~40% YTD, we think the bull case is getting too ahead of itself, pricing in a turnaround that has only just begun to formulate. We are not as convinced just yet and await further evidence of business stabilization.

He lowered his FY 2014 EPS from $0.16 to $0.12 and maintained his "Underperform" rating. I have no position in this stock and will continue to stay on the sidelines until I see evidence of a real turnaround. So far I have been disappointed, although the public seems to be far more optimistic. I wonder if that positive sentiment changes following the new disclosure of the massive 1.5 million share sale by Rick Alden? Selling in to hype, just like I would do, Rick Alden is a smart man.

Source: Skullcandy Turnaround Not Likely