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Executives

Seo Salimi

Jeremy Andrus - Chief Executive Officer, President, Chief Operating Officer and Director

Kyle B. Wescoat - Chief Financial Officer and Senior Vice President

Analysts

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Sean P. Naughton - Piper Jaffray Companies, Research Division

Ryan Macdonald

Andrew Burns - D.A. Davidson & Co., Research Division

David M. King - Roth Capital Partners, LLC, Research Division

Jay Sole - Morgan Stanley, Research Division

Aziz Pirbhoy

Michael Fawzy Malouf - Craig-Hallum Capital Group LLC, Research Division

Skullcandy (SKUL) Q3 2012 Earnings Call November 1, 2012 4:30 PM ET

Operator

Good day, ladies and gentlemen. Thank you for standing by, and welcome to Skullcandy's third quarter 2012 earnings conference call. Presenting on today's call will be Jeremy Andrus, President and CEO; and Kyle Wescoat, Senior Vice President and Chief Financial Officer. As a reminder, today's call is being recorded. [Operator Instructions] I'd now like to turn the conference over to Mr. Seo Salimi, General Counsel. Please go ahead, sir.

Seo Salimi

Hello, everyone, and welcome to Skullcandy's third quarter 2012 earnings call. Before we begin, let me remind you that certain statements made on today's call during our prepared remarks or in response to your questions may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions 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 registration statement on Form S-1 and its quarterly and annual reports on Form 10-Q and 10-K. Investors should not assume that statements made today during the teleconference call 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 Jeremy Andrus, Skullcandy's CEO.

Jeremy Andrus

Thanks, Seo, and hello, everyone. As many of you know, we hired a new CFO, Kyle Wescoat, in mid-September. Kyle comes to Skullcandy with over 25 years of experience in the areas of finance, accounting, strategic planning, IT and supply-chain management. He's been the CFO of both public and private companies in the branded consumer electronics, lifestyle accessory and consumer goods categories. Most recently, Kyle was the CFO of the VIZIO, a leading seller and distributor high quality HD televisions and consumer electronics. His tenure also includes periods at Advance Cherokee and the Los Angeles Dodgers. His financial and operating experience at leading consumer brands across both the action sports and consumer electronics sector make him a great fit for Skullcandy. We are pleased to have him join our leadership team here in Park City.

As we previously announced, we also brought in a new EVP of Product Development and Merchandising, Sam Paschel, and a new VP of Global Business Development, Brent Wilkins, over the past few months. Sam came to us from Burton and has over 16 years of product, merchandising and marketing experience. While, Brent came from HTC America with a strong background in executing long-term strategic partnerships with leaders within consumer electronics industry. We have a strong leadership team in place and continue to invest in our people and process.

We had another good quarter. Third quarter operating income increased 29% on solid sales growth, high gross margin and SG&A leverage. We feel good about our position in the growing audio and gaming headphone markets, but there are some uncertainties in the market right now. We continue to see a shift toward over-ear, competition in low-price bud categories intensified, retailers are becoming very promotional heading into the holidays and we don't yet know the near-term impact of Hurricane Sandy.

The headphone market continues to grow in connection with the growth in mobile smart devices. As these devices become more complex and integrated in the everyday lives of consumers, the audio experience becomes increasingly important. We think this is a very positive backdrop for the broader audio and gaming headphone and accessories markets over the next several years.

We are focused on 4 key strategic areas to drive continued long-term growth: Raising our average selling price, expanding the gaming category, growing international and developing other brands and categories. Let me touch on each of these 4 and update you on how we are executing the strategy.

On raising our average selling price, headphones are clearly becoming a lifestyle accessory item. Authenticity, style, performance and price are all important elements to young audio accessory buyers today. Over the past 10 years, Skullcandy built a distinct audio brand around color, design, performance and sound. As the industry continues to evolve and headphones become more of a lifestyle-driven product, there's a significant opportunity to evolve our portfolio of products as well.

To support this strategy, we have invested heavily on product development and are re-engineering the development process through an in-house team of designers, developers and acoustics engineers. Everything from the form, function and sound quality are now being controlled in-house in order to drive innovation and performance. We believe the $50 to $100 price band is an area that we can offer high-quality differentiated products that appeal to both our core consumer and a growing number of consumers. This is a relatively undeveloped price band that allows us to aggressively compete on a branding, performance and design level.

Our Hesh product is a good example of how we are raising price through reengineering and proprietary sound quality. The original Hesh headphone has been in our line for many years. Like many of our earlier products, it was an OEM-designed product that sold very well. Our in-house design and development team set out to completely rebuild Hesh. They essentially started over and redesigned everything from the form to the sound quality. The Hesh 2 was the first product that incorporated our Supreme Sound audio technology, and we believe it is one of the best-sounding headphones on the market today regardless of price.

We priced the Hesh 2 at a suggested retail of $60 and $70, which is 20% and 40% increased over the old price of $50. Hesh 2 launched in the second quarter this year and has been one of our top-performing products.

Navigator is our most recent new product launch that was developed by our in-house team. Navigator's an on-ear style headphone with a retail price of $100. The inspiration of Navigator came from the success of our award-winning Supreme Sound Aviator headphone. The design and development team started with the Aviator and engineered it around a new on-ear platform. The Apple retail stores launched the Navigator product with a 30-day exclusive offering at October. And we will be broadening distribution to the specialty and consumer electronic channels over the next several months.

The Crusher, which is slated for a limited launch in the fourth quarter, is another exciting product that resulted from our in-house team redesigning a very successful older model, Skull Crusher. The Crusher is a bass-enhanced powered headphone that features supreme sound audio and a set of dual subwoofers to deliver rich, powerful and attacking bass without sacrificing vocals or highs. The bass-enriched power feature is now built directly into the ear cup rather than the cable, making for better functionality and aesthetics. There's really nothing like it on the market today. Suggested retail price is $100.

Turning to gaming, we are very pleased with our efforts to develop and expand this category, but there is still a lot of room for growth here. When we acquired Astro in April of last year, we knew there were significant number of synergies between the gaming and audio headphone categories. These synergies included product development, supply chain, sales channels and customers. The gaming headphone category is growing, especially at the high end and there are limited number of established brands in the space. Barriers to entry are high because of the sophistication and technology involved with developing such a complex product. In addition, the U.S. retail gaming channel is heavily consolidated between a few very large retailers.

We paid $10.8 million for Astro in the spring of 2011. At the time, Astro was a small niche business, achieving approximately $10 million in annual sales and targeted primarily at professional gamers. They had great products and a highly respected brand, but their product margin was below 30% direct-to-consumer, making it difficult to sell anywhere but their own website.

Just over a year later, we began testing the Astro brand in a limited number of Best Buy doors. Strong sell-through in the test doors quickly led to a chain-wide launch of the A50 and A40 models over the past couple of months. The new Astro models had become some of Best Buy's top-performing gaming headphone products, and we are now testing Astro in select number of GameStop doors. The new Astro products carry retail prices at $250 to $300 range and a blended product margin in the mid-40% range.

The new A50 model has won numerous high-profile editors' choice awards, including most recently Game Informer, the largest gaming industry publication in the U.S. with a circulation of over 8 million subscribers. With the investment in Astro, we have built a strong gaming platform and are beginning to realize product design and operating synergies. We recently launched the first of several Skullcandy gaming products, the Slayer wired headset at a retail price point of $80. The early feedback has been positive and we are currently expanding distribution into over 2,000 doors across a number of key retailers. We believe gaming represents a significant growth opportunity for the company, and we are penetrating this market through a dual brand strategy with Astro and Skullcandy. Astro will continue to target the Ultra Premium segment, whilst Skullcandy will target the mainstream segment of the market.

With a multi-branded platform in place, we now have the ability to look at accessory-related gaming products, which we estimate to be a $6 billion million to $7 billion market globally.

Turning to international. We are still in the early stages of building our direct business in Europe and expanding distribution in other foreign countries. We opened a European office and warehouse, filled most of the key positions, and are focused on the key influencer doors. We are seeing early success in building the brand in these key influencer doors, which don't account for a significant amount of sales but are very important to the broader market from a brand perspective. The retail environment in Europe remains challenging, but we are continuing to invest in this region and building infrastructure to support significant long-term growth.

As a part of our international strategy, we are beginning to recognize substantial tax benefits. We expect our effective tax rate to continue to decline as we have a higher levels of earnings outside of the U.S., particularly in Europe. Outside of Europe, China remains in its infancy stage, but it's showing strong early growth and should breakeven this year. Mexico, Latin America, the Middle East and Africa have been strong and are developing in line with plan. We have also opened a small office in Japan and are taking a conservative approach to building this direct business.

Commenting lastly on our strategy to develop other brands and categories, we continue to look for areas of opportunity to carve out complementary brands or adjacent product categories, either organically or through acquisition. A good example of this is our 2XL brand, which is a subbrand that was developed to sell into drug, convenience and grocery channels. Whilst still small, this brand is growing very quickly and allows us to expand distribution in other channels that may not be appropriate for the Skullcandy or Astro brands.

With the building of our in-house design and development groups and Asia's sourcing team, we have built core competencies in design, production and distribution that can be leveraged with other brands or product categories. We believe this gives us the opportunity to launch or acquire a small but well positioned brands that could benefit from our operating platform. We have proven this model with a significant value created in the Astro acquisition and believe there could be additional opportunities around tuck-in acquisitions.

In closing, we are confident in our ability to continue to drive long-term sales and earnings growth. That said, the overall retail environment is a bit choppy right now in both the U.S. and Europe. The near-term impact from Sandy is yet to be seen, but we know hundreds of stores and warehouses from some of our largest customers are closed and could be remain hindered for some time. We're facing the challenges head-on and feel very good about our positioning and strategic initiatives to drive the business.

The headphone market is growing rapidly, and we continue to gain market share in the categories in which we have established product assortment. We will continue to move our business to the mid-range price band of $50 to $100 through the introduction of new products that combine leading performance, design and Supreme Sound. We believe this is an untapped segment of the market that we can leverage for years to come.

I'll now turn the call over to Kyle for a more detailed review of our financial results.

Kyle B. Wescoat

Thanks, Jeremy. And good afternoon, everyone. It's a pleasure to be here and to be part of such an exciting company with such great products, great people, and such great bud. Skullcandy is such a terrific brand. I'll review our third quarter financial results and provide our updated outlook for 2012. After that, we'll then open the call up for questions.

Third quarter net sales increased 17.1% to $71 million. The increase was primarily driven by strong gaming and international sales. As Jeremy mentioned, these are 2 areas of the business we have significant strategic investments, which are beginning to pay off and are now showing accelerated revenue in profit growth. The launch of our giving products at retail extends our reach into the adjacent product category, expands our footprint within our current distribution and liaison new distribution globally.

It also demonstrates our ability to leverage our core competency in design, sourcing and supply-chain management and be a leader in the premium, over-ear performance segment at price points in the $300 range. All of the gaming headset market is smaller than the broader audio headphone market, it is growing at a more rapid pace, particularly at the premium price points. It also possesses high barriers of entry and a limited number of players due to the complexity of the product. We are very optimistic on the long-term growth opportunities in gaming and the synergies between the gaming and audio markets.

Sales at our top 10 domestic customers increased 39% in the third quarter and accounted for approximately 43% of sales versus 36% last year. The launch of the gaming products into existing customers contributed to higher concentration within our top 10 customers. We continue to see a shift towards higher-priced, over-ear product, and our growth in gaming is part of that trend. As Jeremy discussed, our customers are trading up in the newer styles and price points and we believe there is a real opportunity in the $50 to $100 price band for Skullcandy branded products.

In the third quarter, sales of products in the $50 to $100 retail price band increased 60% year-over-year. While this segment is still relatively small, it's an under-indexed segment of the market where we believe we can tell a defendable story about performance, design and brand.

While we no longer break out online sales in our financial table, online net sales were essentially flat at $6 million for the quarter. An increase in Astro online sales was offset by declines in our direct audio consumer business. As Jeremy discussed, online sales continue to be negatively impacted by price competition in the ease of online price shopping. We have taken steps to better control the pricing at selling of our products by third-party online retailers, but this remains a challenge for us, as well as many others.

Gross margin in the third quarter increased 50 basis points to 49%. Gross margin in the last third quarter was negatively impacted by fair value inventory accounting related to the Astro Gaming and Kungsbacka acquisitions. So the improvements in margins on a year-over-year basis was predominantly driven by the fact that we experienced more normalized margins in the Astro Gaming and European businesses. That being said, gross margin was approximately 100 basis points below our expectation for the quarter as a result of higher-than-expected mix of over-ear in gaming products, which, as we've said before, carries a lower gross margin.

Selling, general and administrative expenses increased 14.2% to $23.5 million as a percent of sales. SG&A expenses decreased 80 basis points to 33.1% or 33.9% in the prior-year period. In the quarter, we saw expenses leveraged in the payroll and benefits, marketing and advertising, and professional legal fees. This was somewhat offset by higher depreciation and amortization expense of $1.7 million and $500,000 last year.

As a result, third quarter operating income increased 29.1% and operating margins increased 140 basis points to 15%. Interest and other expenses decreased to $403,000 from $4.8 million in last year's third quarter. Last year's third quarter included a onetime $3.6 million charge for interest and other expenses resulting from the company's 2008 equity transaction that was paid upon completion of our initial public offering in July of 2011.

Our effective tax rate was 37% in the third quarter. Onetime and nondeductible tax rate related to the company's 2008 equity transaction in last year's third quarter made the tax comparisons noncomparable on a year-over-year basis. Our year-to-date effective tax rate as of 9/30 2012, was 36.8% compared to 40.9% for the same period last year. This 140 basis point decrease is due to an increase in income earned in jurisdictions with lower tax rate than those in the United States. We anticipate the sales of these jurisdictions to outpace those in the U.S. over time, resulting in further potential tax reductions.

On a GPS basis, net income in the third quarter increased to $6.5 million from $958,000 last year, Excluding the aforementioned $3.6 million of onetime interest and other expenses in last year's third quarter, adjusted net income decreased 42.7% year-over-year from $42.6 million to $6.5 million.

From an operating standpoint, we believe adjusted net income represents the most accurate comparison because it excludes the onetime transaction expenses and [indiscernible] by changes in the weighted average share count. For reconciliation of adjusted income, see the financial tables in the press release.

Our balance sheet remains healthy, with increased working capital, credit availability and no long-term debt. At quarter end, working capital increased by $28.9 million to $88.4 million year-over-year. Accounts receivable and inventory were $60 million and $55.4 million, respectively. While these are up significantly year-over-year, acquisition activities related to Astro Gaming and Kungsbacka in 3Q 2011 make year-over-year noncomparable. On a year-to-year basis, their increases of 18.6% and 26%, respectively, are lower than the 36% -- the 32% rate of sales growth over the same 9-month period. Cash at quarter end was $1.9 million, and we had $22.9 million of availability under our revolving credit facility.

Let me now move on to some comments around the current retail environment and our update for the outlook for 2012. We are confident in our ability to continue to drive long-term sales and earnings growth. That said, the overall retail environment is definitely a bit uneven right now in the U.S. and overseas, particularly in Europe. Over the past few months, we have seen retailers become more cautious in their outlooks for the holiday season and at this point, it is impossible to gauge the impact of Hurricane Sandy.

Fortunately, growth at gaming, international and some of our newer high-priced products should support solid overall sales growth in the fourth quarter. So we have tightened our 2012 net sales outlook to a range of $290 million to $300 million from the previous range of $280 million to $300 million to reflect this. At the midpoint of this range, this represents sales growth of 27% over 2011.

The margins and profitability side of the business has proven to be much more volatile that we would have liked and difficult to predict. An ongoing mix shift towards high-priced lower-margin products, including gaming, continues to be positive for gross profit dollars but negative for gross profit margin. Layering on some added caution about Europe and the escalating promotional environments surrounding the holiday contributes to even less visibility in the product and geographical mix, gross margin and promotional expense in the fourth quarter.

As a result, the company is lowering its operating margin and profit projections in the fourth quarter and revising its fully diluted earnings per share outlook for 2012 to a range of $1 to $1.04 from the previous range of $1.10 to $1.20. These adjustment in earnings per share outlook assumes an effective tax rate of approximately 36.5% and diluted weighted common shares outstanding of approximately 28.3 million. It also excludes $400,000 of after-tax expense related to the Monster litigation from the first quarter.

With respect to 2013, it's obviously a bit early to be commenting on much of this, especially with some of the aforementioned uncertainties around holiday and the retail environment. We have not completed our detailed budget process for 2013 and there are a lot of moving parts in both our business and in the broader retail environment, in the U.S. and Europe. On a preliminary basis at this time, we are looking for minimum sales and earnings growth in the low- to mid-teen range for next year. We will provide more detailed outlook for 2013 on our fourth quarter earnings call, but want, at least, to establish some type of floor for next year.

Finally, I would like to share with you some of my observations in areas where I will be focusing my attention in the coming months. First, I believe the fundamentals are in place to position ourselves in the high-priced over-ear category both at gaming and audio. We have a solid balance sheet and access to capital and have made timely investments in Astro Gaming in international, which are our growth engines. We have also made investments in products and people that will help us compete in today's environment.

Some of the areas that I and my team will be addressing include: Maintaining a strong balance sheet with access to capital; greater financial management and discipline around investment and SKU productivity; customer profitability to ensure that we are adjusting to the changing marketplace and working with our key partners to improve inventory turns in retail and end-to-end profitability; gross margin, specifically input costs around higher priced products where growth has been outpacing the lower-priced earbuds; and working with Jeremy on strategic initiatives that will support our growth into the future and tell that story to our current and future investors.

In closing, we plan on Investor Day in Park City later in the first quarter where we will outline the long-term strategic and financial plans for the business and hope that everyone will be able to attend this event.

This concludes our prepared remarks, and we'd now like to move to Q&A. Operator, please open the call and poll for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And first we'll go to Edward Yruma with KeyBanc.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

Can you talk a little bit about the competitive environment, particularly in the low-end buds. I know you said that, that was one of the reasons for adjusting your guidance, but are you seeing new entrants placing incremental pressure? Are you losing slotting in some of your key retailers? And how do you feel about inventory levels on those lower-end buds?

Jeremy Andrus

Sure, Ed. So first, the competitive landscape. We have seen some increased competition at the low-end buds. It's clearly the lowest barrier to entry part of this category. We started to see that, I would say, in the reset of planograms in April, the big-box retail. And we have not lost space on shelf. We continue to maintain space on shelf. Although we sit next to other competitors that have offerings that, I would say, are competitive certainly from a price, but also sort of from a color perspective as well. Our view is that, while the category, like other consumer product categories, is facing increased competition now, we don't believe that there are really compelling new competitive entrants. We believe that we'll continue to hold our shelf space and that we'll continue to remain competitive. But we certainly see, in the near term, before we go through a period of consolidation in the category, that we have lost some share to those competitors. In terms of inventory levels, we feel very good about where inventory levels are. We've become significantly more sophisticated in managing inventory, both from a process and a systems perspective. And we're very comfortable with our inventory levels, where they are relative to growth.

Edward J. Yruma - KeyBanc Capital Markets Inc., Research Division

And one follow-up. As it relates to some of these newer products in the $50 to $100 price point, I guess, I'm just trying to understand some of the sales assumptions baked in for those new products relative to your existing portfolio. And as it relates to the initial 2013 guide, how much of that is predicated on some of these newer product introductions?

Jeremy Andrus

Sure, so let me just finish the last question around the inventories. In terms of the channel level inventories, we feel very good about those. Our largest customers are, we believe, continue to watch their inventory levels very carefully. And we'd not characterize them as being different now than they have been historically. Let me address the $50 to $100 price band. We have -- as I've said earlier in my remarks, we have seen some success in Hesh. That's always been a successful product for us and we continue to see success there in higher-price points at $60 to $70. And as we look to the fourth quarter, particularly into next year, I wouldn't say that we're putting a meaningful amount of sales forecast behind those new products. We tend to be fairly conservative about how we think about new product introductions, both from an inventory, as well as from a sales force casting perspective. I will say that products like Navigator and Crusher, we believe, are very unique in their positioning and expect, particularly Crusher, to be one of the key product stories next year. We're not going to overforecast the sales, but we think we certainly have the ability to build something unique in the market. There could upside with those products in that price band.

Operator

And next, we'll go to Sean Naughton with Piper Jaffray.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Can you talk a little bit about the performance of the different channels of distribution and are there continued opportunities, potentially for more expansion within electronics retailers for the Skullcandy brand in the U.S.? And then maybe just talk a little bit about some of the products that you've introduced outside of headphones to really leverage the brand, specifically during the back-to-school season?

Jeremy Andrus

Sure. Sean, I'd be glad to address this. So first of all on the distribution front, going forward, I think our real opportunity in increasing distribution, certainly globally and as well as within, including the U.S. is gaming. As we said, we're very early in that process. The gaming retail channel is really consolidated primarily around 4 key customers: Best Buy, Target, Walmart and GameStop. And so we just scratched the surface. We've just begun to sell into that category within Best Buy and Target. We've recently shipped GameStop. That's where we see the growth potential at least in 2013 with respect to new retail distribution. Of course, globally, there is significant opportunity to continue to add new distribution in a disciplined way, and we feel good about the platform that we're building internationally. With respect to other categories, in back-to-school, I'd speak to a couple of things. One, we do have a licensee that we work with for non-headphone categories, including bags, hats, accessories, as well as protective cases for phones, primarily iPhone 5. And we're pleased with how that new program is taking shape. And I'd also, I guess lastly, from a new distribution perspective, would mention 2XL and the opportunity there. It's a small brand, but we think it's, based on their performance today, it's got legs. It's doing well in retailers such as Walgreens and Rite Aid, we believe, there is a significant new distribution opportunity that this brand can be sold into.

Sean P. Naughton - Piper Jaffray Companies, Research Division

Got it. And then just secondly on the gross margin, you talked about on the quarter you had some improvements in Astro and international, they got better, but obviously drags down the mix.

And then there were some components associated with the on-ear and over-ear buds on the mix impact on the rate. Can you talk about any impact you had from promotions in the quarter, as well as how should we think about the gross margin rate moving forward based on kind of your visibility into your order book and geographical segments moving forward?

Kyle B. Wescoat

Sure. As we look at the puts and takes impacting the third quarter margin, international margins were accretive. Astro margins actually are down but getting better. And then we have the impact of some closeout business, which really is a part of the -- is part of being in branded consumer, has been my experience. And so there will always be some amount about it. I think this year the company's had some repackaging and a few other things have gone on that have impacted that. But those are the major puts and takes. I think that the -- I think that those things are the primary drivers behind the margin question you asked.

Sean P. Naughton - Piper Jaffray Companies, Research Division

And I guess, just any outlook you have in terms of just thinking about the gross margin rate moving forward. It looks like it's going to be down pretty substantially in Q4, just trying to think about what you believe, based on your order book, what you think kind of the potential long run term or just given the next kind of 12 months what that kind looks like from a gross margin rate perspective or how should we think about gross margin rate?

Kyle B. Wescoat

Yes, again, in the time that I've been here, I would say that our expectation in the fourth quarter is that the shift to higher-priced, lower-margin products will impact margins. We hope those to be offset or mitigated by higher margins in on-ear international channels. And then overall, although we don't have -- haven't concluded our budget and don't have complete visibility on that, I think that the feeling is that, that our margins should continue in that kind of high-40s range.

Jeremy Andrus

Yes, I think that's accurate. Obviously, we're in a period where our channel and product mix is moving around quite a bit. But net-net, we feel comfortable in saying that we will stabilize in mid-, high-40s.

Operator

We'll now go to Mike Latimore with Northland Securities.

Ryan Macdonald

This is Ryan MacDonald in for Mike Latimore. Have you seen, first of all, with the announced recent announcements by some of the retailers with price matching, have you seen any effect from that on holiday order volume at all or anything?

Jeremy Andrus

We certainly track that very carefully and are in discussions with all of our large retailers that have put those price matching policies in place. Answer is, first of all, no, we have not seen that impact holidays. We certainly recognize that the markets are becoming more efficient between online and offline. And it's part of our strong motivation commitment to ensuring that there is price integrity online. And we have been very committed and continue to work on having a clean channel there where the product is merchandised properly and where the pricing is appropriate for the brand. But we've undertaken a number of initiatives around products serialization, reducing our online resellers and just generally supporting those who are selling online. So the answer is, no, we have not seen those policies impact Q4.

Ryan Macdonald

And then do you have what the revenue mix between headphones and ear buds was roughly during the quarter?

Kyle B. Wescoat

Yes, we're looking at that right now. Here we are, I'm sorry, third quarter the -- I guess, these are -- it looks like 38% for a dollar volume; 67% on a unit volume; 26.5% in dollars; 7.4% in units; 28.1%, dollars; 15.4% in units and 5.3%, dollars; and just under 1% in units. And those are -- the breakdowns are in-ear less than $30; all over-ear products, all products in the $30 to $75 range and all products $100 and over.

Ryan Macdonald

Okay. And then just the final question is do you have a percentage of what the mic products were for revenues during the quarter?

Jeremy Andrus

Sorry, can you repeat that?

Ryan Macdonald

Yes. So what percentage -- do you have a percentage for what the mic ear buds were per quarter as a part of revenues?

Jeremy Andrus

Yes, I think we've got that data here, and back to your original question, Kyle gave a level of detail, pulling that up to just sort of in-ear versus on- and over-ear, revenue mix is approximately 50/50. In terms of mic headphones as a percentage of revenue, it's crossed just north of 50%.

Operator

We'll move on to Andrew Burns with D.A. Davidson.

Andrew Burns - D.A. Davidson & Co., Research Division

You gave a lot of growth drivers and potential headwinds there and my question is, particularly into 4Q. Your guidance, you imply, there's a potential for a reacceleration of growth in the fourth quarter at the high end. Hoping you could build up the growth drivers that would get you there in the context of all these headwinds that you outlined, including promotional activity in Europe?

Jeremy Andrus

Looking at the fourth quarter, I'm not sure that I would say there will be an acceleration in the quarter of high-end product sales, at least within the Skullcandy line. We view that -- we are launching -- we did launch the Navigator and now launching the Crusher and we view those as important launches. But really from a revenue mix perspective, those are longer-term initiatives of the business. So we don't expect a meaningful shift from a product price point perspective in the fourth quarter. The exception of that would be gaming. As we said, we launched the A40 model at $250 and the A50 at $300. That will certainly begin to increase ASPs companywide. But in terms of where the growth is coming from, we did mention headwinds in Europe and some challenges there. But I would say that we expect the fourth quarter to roughly mirror what the third quarter has been in terms of revenue.

Andrew Burns - D.A. Davidson & Co., Research Division

Okay. To put it in another way, on the $2.90 in EPS, the low-end, is that low-end incorporating an acceleration in the current promotional activity and a deceleration in Europe to get to that lower end of the guidance?

Jeremy Andrus

So I would say it includes a couple of things. One, it includes some acceleration in the promotions, and we have assumed that in the, both the revenue and the gross margin for the quarter. But it also assumes some deceleration of our online business in the fourth quarter, which tends to be -- which is our highest margin sales channel. And so for those reasons, we forecasted some reduction in gross margin in Q4.

Andrew Burns - D.A. Davidson & Co., Research Division

And then just on the margin, could you maybe prioritize some of the headwinds you talked about in terms of their impact on the quarter, some seems structural with the mix shift, some seems more competitive in terms of the promotional activity, could you maybe prioritize some of those headwinds?

Kyle B. Wescoat

Yes, just to provide you some perspective on the bridge, I think that 1/2 is really a revenue driven -- about 1/4 of it is a mix shift to higher-priced lower-margin product. About -- the last quarter of it is really has to do with our feelings about marketing and promotional spending in 4Q. Some legal and other costs associated with accelerating the establishment of our Chinese and Japanese distribution that we think is going to follow in the fourth quarter. And some defense cost associated with just our ongoing protection of the brand. And then higher interest and other expenses related to the acceleration of our international expansion. So those are the major buckets that contribute to the difference from the previous guidance to here.

Jeremy Andrus

And we just want to clarify, that's fourth quarter we were talking about there.

Kyle B. Wescoat

Right.

Andrew Burns - D.A. Davidson & Co., Research Division

Last question, is there the chance to accelerate the Navigator and the Crusher rollout given the consumer preference for on- and over-the-ear products and your early success potentially of the Navigator?

Jeremy Andrus

Sure. And Andrew, that's a great question. That's something that we've talked about. I would say that there's probably more potential -- there is some potential to accelerate those, although there is a balance that we think about around building brand in the influencer channel and the sustainability of those products going forward. And so we've got some discipline around the model in the launching, first, within specialty retail after we've begun to create demand in the marketplace. And we tend to -- we'd like to leave the product 6 to 12 months in that channel before we give a broader distribution. We have that in discussion of shortening that window to 6 months for those products, really trying to strike a balance between supporting our specialty retailers, which we view as critical to our business model and driving revenue in those models going forward, the sustainability of those models. So there's a potential to pull that a little bit, but we still believe in the discipline of launching in specialty and rolling out into consumer electronic retailer after.

Operator

Next, we'll go to Dave King with Roth Capital.

David M. King - Roth Capital Partners, LLC, Research Division

I guess first off, just following up on the gross margin, the last question about gross margin. Is there anything in that kind of 25% bucket surrounding promotion, marketing, et cetera, that you're seeing today already at this point, that's making you concerned or is it just more, just general caution based on what you're hearing from retailers, et cetera?

Jeremy Andrus

We think it's general caution at this point.

David M. King - Roth Capital Partners, LLC, Research Division

Okay. So nothing specific to lead you to believe that or nothing you're seeing today based on everything, selling, et cetera? And then I guess as a follow-up question, another one on the percentage of the in-ear versus over-ear, on-ear, Jeremy said it's 50-50. How does that compare to a year ago at this time, give or take?

Jeremy Andrus

So let me just add some color to the last -- to Kyle's last answer. So it's serious general caution, but I would say what we're seeing in the price matching policy certainly suggest that the promotional environment is -- it will be aggressive going forward. And certainly, suggest that there's quite a bit of sensitivity on the part of traditional retailers around pricing. In terms of the shift in the over-, on-ear, I don't have the exact numbers in front of me but my recollection is that a year ago, we were sort of 65/35 in terms of bud to over-, on-ear revenue mix. And as I said closer to 50/50 right now. It feels like that mix is stabilizing but, of course, it's been dynamic, but that's where the market feels like its stabilizing. Our business is generally stabilizing around that mix.

David M. King - Roth Capital Partners, LLC, Research Division

That's helpful. And then I guess another question along those lines. The influencer channel, I guess, as you call that our specialty retail sort of, et cetera, what's that as a percentage of your sales these days?

Jeremy Andrus

The specialty channel, and in that channel, we'd include the national retailers such as Zumiez and Tilly's. It's around 10% of our total revenue mix.

David M. King - Roth Capital Partners, LLC, Research Division

And then lastly, Kyle, you may have touched on this, the increase, and I think you've mentioned from the working capital things, that the increase in accounts receivable this quarter was up pretty significantly over year-end and sequentially, was there something notable there?

Kyle B. Wescoat

Yes, it actually has to do with the timing of when the sales took place. If you look at this time last year, our sales were more evenly distributed across the quarter. This particular year, I think is a lead into holiday, our sales were very much skewed to the last month of the quarter. And that, that caused something of a distortion, some timing distortion in the increase. The other thing last year, the year-over-year connection, the comparison is -- we had 2 acquisitions in the third quarter of last year. The most significant being our going direct in Europe and that also created some distortion related to the receivables. But our receivables are in good condition, and I think the quality of our overall working capital is pretty good. Last year, there was 1 month of receivables from the acquisition. And just as a reminder, the acquisition took place at the end of August, so we had receivables or sales for the month of September where this year, we have receivables for the 3-month period in the same location. That's certainly not comparable.

Operator

Jay Sole with Morgan Stanley has the next question.

Jay Sole - Morgan Stanley, Research Division

Just have a quick question about, just first, housekeeping, if I missed this, I apologize. Did you give the domestic wholesale year-over-year sales number for 3Q? And then secondly, can you just talk about like bigger picture gaming, what do you see the potential for your sales looking out into 2013 and 2014? What do you see the overall big picture potential is for those -- for the products that you've just come up with?

Jeremy Andrus

Yes, sure. Let me start with the gaming piece, Jay. We're very, very early in the retail rollout, and we've had confidence in the category and particularly in the Astro brand for some time and that confidence continues to build. We had a very strong launch with the A50. We launched it first online and out of the gate, the online demand was high. And then we launched to limited doors. We've rolled it out to additional doors. But I would say it's probably early for us to comment on the longer-term opportunity. We're literally 2 weeks into having 2 of our Astro products chainwide in Best Buy. So we're watching that weekly. And needless to say, we like the opportunity. We're going to continue to make significant investments in that category both on the Astro and the Skullcandy side. But Astro, we've got a very limited data and with Skullcandy, let's say, we have less data. All the data points positively but I don't know that we're really going to have comfort in our 2013 forecast for gaming until, call it, mid, late December.

David M. King - Roth Capital Partners, LLC, Research Division

And then let me ask, if I can squeeze in one more, this is for Kyle, maybe can you start by your initial impressions since you arrived. Like what was always different from what you expected and what your top priorities are? And then again if you guys, I apologize if I missed this, but that domestic wholesale 3Q year-over-year number, if you guys have that, that will be super helpful.

Kyle B. Wescoat

Domestic wholesale number is $51 million versus $46 million for all domestic. So the year-over-year comparison. I actually, I think in my remarks, I covered that. I'm very impressed with the quality of the team and with the focus and the capabilities of the management here. I think this is a very tricky time, made even more tricky this past week. But overall, I think that we -- the focus is to try to continue to drive revenue internationally and through our Astro acquisition, to continue to move up market with respect to our products offering. And I think that everything that is being done around here seems to align with those strategic directives. So those would be my impressions in the early going here. But as with any company, I think that there are opportunities in financial management, in ways that we can contribute from a financial perspective to improve the way we do things.

Jeremy Andrus

Let me add one bit of color that we mentioned or that Kyle mentioned in his prepared remarks. And that's we have been very focused with key members of the team on really articulating, laying out our long-term strategy of the business. As it pertains to the Skullcandy brand, the channels, the geographies, Astro and where do we see opportunities, I'm working with Kyle closely on the corresponding long-term financial model, and we are looking forward to March where we have an opportunity to really have a longer-term discussion as to where we see the opportunities for the business.

Operator

We'll now go to Aziz Pirbhoy with Raymond James.

Aziz Pirbhoy

Got a quick question about 4Q outlook. We're looking at expense rate, I know you guys mentioned a few of the drivers there in marketing promotion, legal and really just defending the brand. Just wanted to ask a little more about if you could -- well, help me get a little more color on the marketing and promotional spend. Where is that coming from? Is that in Europe? And if you guys are expecting the environment to be sort of tepid, is there any way that you guys will look to cut that spend?

Jeremy Andrus

Let me answer that from a strategic perspective and that's to say that we're going to continue to invest in the brand. We're not overinvesting, but we believe that it's important to continue to build out channel and create demand in-store and with consumers outside the store. We're very committed to continuing with athlete activation, with our top athletes. As we announced recently, we've re-signed our NBA players. We've got some of the best players in the league. We continue to invest in events, as we believe grassroots demand creation is critical to our business. And we're also investing in our music strategy. So we believe that all of these are -- they're important long-term drivers of growth for the business. We will manage that investment and sequence it with the revenue growth. But we also believe that even in today's environment, that as there is some increased competition, that our ability to win long-term, as the industry consolidates, we've all seen that numerous other consumer product categories, we want to be positioned to win and to increase our market share. So we're going to continue to make those brand investments.

Aziz Pirbhoy

On the topic of grassroots marketing, I know Europe is really weak, but is there any indication so far as to how that is sort of working, that strategy working out in Europe right now?

Jeremy Andrus

Sure. So we've had some great grassroot events in Europe. We have a -- our Director of Marketing is a very seasoned marketing executive from Europe, came from Nike, and we saw some very successful events over the summer, one of which was the Supreme Sound launch in Paris. We took our skate team to Europe and we took them around Europe to visit skate shops and the top influencer shops. The response there was very positive, both on the ground, as well as at a social media level, which we track very carefully. And we continue to do product seeding at the influencer level. So we're certainly early in the process of building that infrastructure, particularly having taken over the market, which was run by distributor where I would say investing more and selling as opposed to the brand investments. But we started the process. We've began -- we've been cleaning up distribution and, frankly, we like how Europe is shaping up notwithstanding the challenging macro environment.

Aziz Pirbhoy

And then I guess switching gears a little bit, I know you guys talked a lot about gaming and what it means for the future top line growth. But can you guys remind us again how big the addressable market is or how you guys view it? And how you guys stack up the I guess, some of your biggest competitors, one of them being Turtle Beach?

Jeremy Andrus

So just to clarify, referring specifically to the gaming headset market.

Aziz Pirbhoy

Yes.

Jeremy Andrus

Okay. So it's our belief and to be transparent, there's a great data. There are some data in the U.S. and they sort of triangulated the size of the market. But we believe that, globally, the market for console headsets, which is what we're currently selling, we believe it's about $1 billion. And it seems to be growing at least over the last 12 months sort of mid-double digits in the U.S. and a little bit faster in key international markets. But we really don't view our market as limited to consoles. The console market is a piece of it. We believe that we have 2 credible brands that have significant category extension opportunities, one of which, and the most obvious would be PC gaming headsets. We will launch some Astro PC gaming headsets in this quarter online. We'll take those to retail next year. And beyond even the headsets, we see a real opportunity with 2 credible brands in other gaming-related categories such as keyboards, MICE, and moving into the mobile segment, controllers on the console side and then moving in the mobile segment, which is very early in its growth. We're working on mobile-specific accessories. But we believe that the foundation of product, brand and distribution is setting up nicely for us to take advantage of these opportunities.

Aziz Pirbhoy

Okay, great. And then finally, assume the trends you guys talked about in the shift towards on-ear and over-ear versus in-ear, do you start domestically with that? Also carry over to Europe, is that something you're seeing there? Is that not something that you could really discern?

Jeremy Andrus

Yes, so in Europe, I can speak more to what we're seeing within our own business as our data is not as good for a market perspective. But I would say that it's different by market. Europe's got a lot of markets in it, but generally speaking, Europe wasn't as heavily weighted towards earbuds, at least in our business. We had traditionally seen a higher mix of on- and over-ear products, so we're not feeling the same level of sort of pain in the gross margin degradation in Europe than we saw as the mix changed within U.S. market.

Operator

[Operator Instructions] We'll now go to Mike Malouf with Craig-Hallum Capital Group.

Michael Fawzy Malouf - Craig-Hallum Capital Group LLC, Research Division

A quick question. Now when you guys talk about 2013, I know you were just doing it briefly, but it looks like when you look back on 2012, you had degradation in the gross margins and then, of course, an increase in SG&A, which led to about 300 basis points of operating margin decrease if you sort of take the midpoint of the range that you're guiding into. And as you look out into 2013, obviously we're going to have year-over-year degradation in gross margins but you'll have a little bit of a leverage on SG&A. Are you implying that basically the operating margins are going to stay flat year-over-year? Or do you think there's any potential for a leverage in operating margins from here on out or perhaps maybe it continues to depredate further?

Jeremy Andrus

Yes, Mike. So as it pertains to next year, first off, we're right in the middle of the planning process, there are a lot of moving pieces. But my general sense is that operating margins will be flat next year. There will be some points of leverages within the business, but we continue to be focused on investment and sequencing that investment appropriately. And so net-net, we feel like operating margins will be fairly flat in 2013.

Operator

And we have no further questions. I will now turn it back over to our speakers for any additional or closing remarks.

Jeremy Andrus

Thanks for your time. Look forward to being in touch post-holidays. Take care.

Operator

This does conclude today's conference. We do thank you, all, for joining us.

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