10-Q 1 skul-2015930x10q.htm 10-Q 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 FORM 10-Q
 
 
 
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 001-35240
 
 
 
 SKULLCANDY, INC.
(Exact name of registrant as specified in its charter)
 
 
 
 
 
Delaware
 
56-2362196
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
1441 West Ute Boulevard, Suite 250
Park City, Utah
 
84098
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code: (435) 940-1545
 
 
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
o
  
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
o  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of October 31, 2015 28,530,493 shares of the registrant’s common stock were outstanding, par value of $0.0001.



SKULLCANDY, INC.
INDEX TO FORM 10-Q
 
 
 
Page
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
Item 1.
Item 1A.
Item 6.
Signatures
 


i


PART I
Item 1. Condensed Consolidated Financial Statements
SKULLCANDY, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands of dollars)
(unaudited)
 
 
 September 30, 
 2015
 
 
 December 31, 
 2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
10,354

 
$
21,623

Short-term investments
3,541

 
15,010

Total cash, cash equivalents, and short-term investments
13,895

 
36,633

Accounts receivable, net
65,471

 
74,358

Inventories, net
62,478

 
54,981

Prepaid expenses and other current assets
7,628

 
4,050

Current deferred tax assets
4,163

 
3,052

Total current assets
153,635

 
173,074

Property and equipment, net
14,624

 
12,911

Intangibles
7,778

 
8,814

Goodwill
13,867

 
13,867

Deferred financing fees
34

 
41

Non-current deferred tax assets
1,390

 
3,459

Total assets
$
191,328

 
$
212,166

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
15,700

 
$
27,309

Accrued liabilities
18,713

 
29,161

Current deferred tax liabilities
524

 
184

Total current liabilities
34,937

 
56,654

Non-current deferred tax liabilities
1,288

 
1,418

Other non-current liabilities
1,008

 
557

Total liabilities
37,233

 
58,629

Stockholders’ equity:
 
 
 
Preferred stock

 

Common stock
3

 
3

Treasury stock
(43,294
)
 
(43,294
)
Additional paid-in capital
137,583

 
136,132

Accumulated other comprehensive loss
(960
)
 
(625
)
Retained earnings
60,567

 
60,781

Total stockholders’ equity
153,899

 
152,997

Noncontrolling interests
196

 
540

Total Skullcandy stockholders’ equity
154,095

 
153,537

Total liabilities and Skullcandy stockholders’ equity
$
191,328

 
$
212,166

 
See Accompanying Notes to Condensed Consolidated Financial Statements

2


SKULLCANDY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands of dollars, except share and per share information)
(unaudited)
 
Three months ended September 30,
 
Nine months ended September 30,
 
2015
 
2014
 
2015
 
2014
Net sales
$
67,168

 
$
58,055

 
$
171,359

 
$
150,996

Cost of goods sold
39,615

 
31,731

 
100,249

 
82,280

Gross profit
27,553

 
26,324

 
71,110

 
68,716

Selling, general and administrative expenses
24,471

 
22,741

 
70,651

 
67,749

Income from operations
3,082

 
3,583

 
459

 
967

Other expense
261

 
934

 
1,144

 
729

Interest (income) expense
(1
)
 
(9
)
 
(12
)
 
183

Income (loss) before income taxes and noncontrolling interests
2,822

 
2,658

 
(673
)
 
55

Income tax expense (benefit)
697

 
507

 
(116
)
 
(284
)
Net income (loss)
2,125

 
2,151

 
(557
)
 
339

Net income (loss) attributable to noncontrolling interests
(176
)
 
45

 
(344
)
 
124

Net income (loss) attributable to Skullcandy, Inc.
$
2,301

 
$
2,106

 
$
(213
)
 
$
215

Net income (loss) per common share attributable to Skullcandy, Inc.
 
 
 
 

 

Basic
$
0.08

 
$
0.07

 
$
(0.01
)
 
$
0.01

Diluted
$
0.08

 
$
0.07

 
$
(0.01
)
 
$
0.01

Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
28,477,595

 
28,135,731

 
28,375,055

 
28,005,875

Diluted
28,754,262

 
28,487,657

 
28,375,055

 
28,424,555

 
See Accompanying Notes to Condensed Consolidated Financial Statements

3


SKULLCANDY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands of dollars)
(unaudited)
 
 
Three months ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Net income (loss)
$
2,125

 
$
2,151

 
$
(557
)
 
$
339

Unrealized gain on foreign currency cash flow hedges, net of tax expense (benefit) of $226 and $13 for the three and nine months ended September 30, 2015 and $61 and ($79) for the three and nine months ended September 30, 2014, respectively
408

 
539

 
23

 
650

Change in unrecognized actuarial loss, net of tax benefit of $2 and $2 for the three and nine months ended September 30, 2015 and 2014, respectively
(12
)
 

 
(12
)
 

Unrealized gain on short-term investments, net of tax expense (benefit) of $5 and ($4) for the three and nine months ended September 30, 2015
8

 

 
23

 

Foreign currency translation adjustment
(276
)
 
44

 
(94
)
 
123

Comprehensive income (loss)
2,253

 
2,734

 
(617
)
 
1,112

Comprehensive income (loss) attributable to noncontrolling interests
(176
)
 
45

 
(344
)
 
124

Comprehensive income (loss) attributable to Skullcandy, Inc.
$
2,429

 
$
2,689

 
$
(273
)
 
$
988

See Accompanying Notes to Condensed Consolidated Financial Statements

4


SKULLCANDY, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands of dollars)
(unaudited)
 
Nine Months Ended September 30,
 
2015
 
2014
Operating activities
 
 
 
Net income (loss)
$
(557
)
 
$
339

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation of fixed assets and amortization of intangible assets
8,002

 
7,020

Loss on disposal of property and equipment and intangible assets
64

 
690

Provision for doubtful accounts
311

 
618

Deferred income taxes
843

 
(2,419
)
Non-cash interest expense
7

 
186

Amortization of stock-based compensation expense
3,178

 
2,591

Foreign currency remeasurement loss
1,594

 
382

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
7,600

 
3,865

Inventories
(8,289
)
 
(24,191
)
Prepaid expenses and other current assets
(4,189
)
 
(2,286
)
Accounts payable
(10,485
)
 
17,133

Accrued liabilities
(12,428
)
 
1,421

Net cash (used in) provided by operating activities
(14,349
)
 
5,349

Investing activities
 
 
 
Purchase of property and equipment
(8,206
)
 
(5,766
)
Purchases of short-term investments

 
(15,000
)
Proceeds from sales of short-term investments
11,488

 

Net cash provided by (used in) investing activities
3,282

 
(20,766
)
Financing activities
 
 
 
Debt issuance costs

 
(5
)
Proceeds from exercise of stock options
359

 
1,777

Taxes paid related to net share settlement of equity awards
(462
)
 

Income tax benefit (detriment) from share based compensation
135

 
(394
)
Net cash provided by financing activities
32

 
1,378

Effect of exchange rate changes on cash and cash equivalents
(234
)
 
(78
)
Net decrease in cash and cash equivalents
(11,269
)
 
(14,117
)
Cash and cash equivalents, beginning of period
21,623

 
38,835

Cash and cash equivalents, end of period
$
10,354

 
$
24,718

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income tax
$
3,779

 
$
1,430

Supplemental non-cash activities:
 
 
 
Purchases of property and equipment financed through accounts payable
$
627

 
$

 
See Accompanying Notes to Condensed Consolidated Financial Statements

5


SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) Description of Business
Skullcandy, Inc., a Delaware corporation (the "Company"), is the original lifestyle and performance audio brand inspired by the creativity and irreverence of youth culture. The Company designs, markets and distributes audio and gaming headphones, earbuds, speakers and other accessories under the Skullcandy, Astro Gaming and 2XL brands. The Company launched in 2003 and quickly became an international audio brand by bringing innovation, bold color, character and performance to an otherwise monochromatic audio space. The Company's products are sold and distributed through a variety of channels in the U.S. and approximately 80 countries worldwide, including the Company's websites at www.skullcandy.com and www.astrogaming.com. The Company offers a wide array of styles and price points and is expanding into complementary audio products and categories such as sports performance, women's and wireless offerings, as well as partnerships with leading manufacturers to license the Skullcandy brand.
(2) Basis of Presentation
The accompanying condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014, condensed consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014, condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2015 and 2014, and condensed consolidated statements of cash flows for the nine months ended September 30, 2015 and 2014 are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments (all of which are considered of normal recurring nature) considered necessary to present fairly the Company’s financial position, results of operations for the three and nine months ended September 30, 2015 and 2014, and cash flows for the nine months ended September 30, 2015 and 2014. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. Historically, the Company has experienced greater net sales in the second half of the year than those in the first half due to a concentration of shopping during the fall and holiday seasons. The Company anticipates that this seasonal impact on net sales is likely to continue. Accordingly, the Company’s results of operations for any particular quarter are not indicative of the results the Company expects for the full year.
These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 13, 2015. The December 31, 2014 condensed consolidated balance sheet included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by GAAP for complete financial statements.
Certain prior period amounts have been reclassified to conform with current presentation.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries as well as the results of the Company's joint venture in Mexico. The Company entered into a joint venture in Mexico on September 19, 2011. The Company has the majority ownership and voting rights and controls the day-to-day operations of the entity. Accordingly, it has consolidated the results of the joint venture operations in its condensed consolidated financial statements. The noncontrolling interests, which reflect the portion of the earnings (losses) of operations which are applicable to the other noncontrolling partner, have been classified as non-controlling interests in the accompanying condensed consolidated financial statements. All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.
Recently Issued Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, "Revenue from Contracts with Customers." Under the new standard, revenue is recognized at the time a good or service is transferred to a customer for the amount of consideration received for that specific good or service. In July 2015, the FASB decided to defer the effective date of its new revenue standard by one year. It is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods, and early adoption is permitted with the originally proposed effective date for reporting periods beginning after December 15, 2016. Entities may use a full retrospective approach or report the cumulative effect as of

6

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

the date of adoption. The Company is currently evaluating the impact, if any, the adoption of this standard will have on the consolidated financial statements.
Consignment
        The Company sells products to certain customers through consignment arrangements and had approximately $620,000 and $634,000 of inventory consigned to others included in inventories, net at September 30, 2015 and December 31, 2014, respectively.


(3) Investments

In general, the majority of short-term investments have a maturity at the date of purchase within one year. Investments with maturities from one to five years may be classified, based on the Company’s determination, as short-term based on their highly liquid nature and because they represent the investment of cash that is available for current operations. Short-term investments classified as available-for-sale are recorded at fair value using the specific identification method with the unrealized gains and losses reflected in accumulated other comprehensive income (loss) until realized. Realized gains and losses from the sale of available-for-sale securities, if any, are determined on a specific identification basis and are recorded in interest (income) expense in the consolidated statements of operations. The Company periodically evaluates unrealized losses in its investment securities for other-than-temporary impairment, using both qualitative and quantitative criteria. In the event a security is deemed to be other-than-temporarily impaired, the Company recognizes the credit loss component in interest (income) expense in the consolidated statements of operations.

The short-term investments are primarily used to facilitate liquidity and for capital preservation. They consist predominantly of highly liquid investment-grade low risk income earning mutual funds, diversified among industries and individual issuers, that are predominantly U.S. dollar-denominated short-term debt securities.

As of September 30, 2015, the Company had the following available-for sale securities (in thousands):

 
 
Cost Basis
 
Unrealized gains (losses), net
 
Fair Value
Available-for-sale:
 
 
 
 
 
 
Debt mutual funds
 
$
3,552

 
$
(11
)
 
$
3,541


During the nine months ended September 30, 2015, the Company sold $11.5 million of its short-term investments and recognized an insignicificant amount of realized losses. The Company also did not recognize any other-than-temporary impairment, proceeds, or realized gains or losses as of September 30, 2015, and does not expect any significant other-than-temporary impairments in future periods.

At December 31, 2014 the Company had the following available-for sale securities (in thousands):

 
 
Cost Basis
 
Unrealized gains (losses), net
 
Fair Value
Available-for-sale:
 
 
 
 
 
 
Debt mutual funds
 
$
15,040

 
$
(30
)
 
$
15,010


(4) Financial Derivatives and Hedging Activities
As part of the Company’s overall risk management practices, the Company enters into financial derivatives primarily designed to either hedge foreign currency risks associated with forecasted international sales transactions – “cash flow hedges”; or to mitigate the impact that changes in currency exchange rates have on balance sheet monetary assets and liabilities – “foreign currency hedges.”

7

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

The Company records all derivatives on the condensed consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting, and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.

The effective portion of the gain or loss on derivative instruments designated and qualifying for hedge accounting is deferred in other comprehensive income. Any ineffectiveness in these designated hedging relationships is recognized in current period earnings. Similarly, the changes in fair value for all trades that are not designated for hedge accounting are recognized in current period earnings. Deferred gains or losses from designated hedging relationships are reclassified into earnings in the period that the hedged forecasted sales transactions effect earnings. The effectiveness of cash flow hedges is assessed at inception and quarterly thereafter. If the instrument were to no longer qualify for hedge accounting or it becomes probable that the originally-forecasted hedged transactions will not occur, then hedge accounting would cease and the related change in fair value of the derivative instrument would be reclassified from accumulated other comprehensive income (loss) and recognized in earnings. The Company does not offset fair value amounts recognized for derivative instruments.

Credit risk related to derivative transactions reflects the risk that a party to the transaction could fail to meet its obligation under the derivative contracts. The Company’s derivative transactions are subject to master netting arrangements. Therefore, the Company’s exposure to the counterparty’s credit risk is generally limited to the amounts, if any, by which the counterparty’s obligations to the Company exceed the Company’s obligations to the counterparty. The Company’s policy is to enter into contracts only with financial institutions which meet certain minimum credit ratings to help mitigate counterparty credit risk.
As a result of the Company's hedging program, the Company recognized the following in the consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014, respectively (in thousands):
 
Three months ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Total impact on net sales
$
(211
)
 
$
201

 
$
(66
)
 
$
(56
)
Total impact on other income (expense)
880

 
129

 
985

 
127

 
$
669

 
$
330

 
$
919

 
$
71

Derivatives Designated as Hedging Instruments—Cash Flow Hedges
The Company uses currency forward contracts as cash flow hedges to manage its exposure to fluctuations in the Euro (EUR) to U.S. Dollar (USD) and Great British Pound (GBP) to U.S. Dollar exchange rates on a portion of forecasted international sales. Currency forward contracts involve fixing the exchange rate for delivery of a specified amount of foreign currency on a specified date.
The effective portion of changes in the fair value of derivatives designated as qualifying cash flow hedges of foreign exchange risk, is deferred as a component of accumulated other comprehensive income (loss) in the accompanying condensed consolidated balance sheets and is subsequently reclassified into earnings as net sales in the period in which the hedged forecasted sales transactions effect earnings. The ineffective portion, if any, of the changes in fair value of derivatives designated as cash flow hedges are recognized directly to earnings and reflected as net sales in the accompanying condensed consolidated statements of operations.
As of September 30, 2015, the Company had the following outstanding derivatives that were used to hedge foreign exchange risks associated with forecasted transactions and designated as hedging instruments (in thousands, except for the number of instruments):
 
Number of
Instruments
 
Sell
Notional Value
 
Buy
Notional Value
Sell EUR/Buy USD Forward Contract
15

 
3,949

 
$
4,354

Sell GBP/Buy USD Forward Contract
15

 
£
7,270

 
$
11,124

 
30

 
 
 
$
15,478

These contracts have maturities of 12 months or less.

8

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

The following table summarizes the amount of income recognized from derivative instruments for the periods indicated and the line items in the accompanying statements of operations where the results are recorded for cash flow hedges (in thousands):
 
Amount of Gain (Loss)
Recognized in
OCI on Derivative
(Effective Portion)
Three months ended
 
Location of Gain or Loss
Reclassified  from
Accumulated OCI
into Income
(Effective Portion)
 
Amount of Gain (Loss)
Reclassified from
Accumulated OCI
into Income
(Effective Portion)
Three months ended
 
Location of Gain or Loss
Recognized in
Income on Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)
 
Amount of Gain (Loss) 
Recognized in Income on
Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)
Three months ended
 
September 30, 
 2015
 
September 30, 
 2014
 
September 30, 
 2015
 
September 30, 
 2014
 
September 30, 
 2015
 
September 30, 
 2014
Sell EUR/Buy USD Forward Contract
$
(7
)
 
$
421

 
Net sales
 
$
(103
)
 
$
52

 
Net sales
 
$

 
$

Sell GBP/Buy USD Forward Contract
402

 
253

 
Net sales
 
(136
)
 
21

 
Net sales
 

 

 
$
395

 
$
674

 
 
 
$
(239
)
 
$
73

 
 
 
$

 
$

 
Amount of Gain (Loss)
Recognized in
OCI on Derivative
(Effective Portion)
Nine months ended
 
Location of Gain or Loss
Reclassified  from
Accumulated OCI
into Income
(Effective Portion)
 
Amount of Gain (Loss)
Reclassified from
Accumulated OCI
into Income
(Effective Portion)
Nine months ended
 
Location of Gain or Loss
Recognized in
Income on Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)
 
Amount of Gain (Loss) 
Recognized in Income on
Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)
Nine months ended
 
September 30, 
 2015
 
September 30, 
 2014
 
September 30, 
 2015
 
September 30, 
 2014
 
September 30, 
 2015
 
September 30, 
 2014
Sell EUR/Buy USD Forward Contract
$
(17
)
 
$
383

 
Net sales
 
$
77

 
$
(62
)
 
Net sales
 
$
(1
)
 
$

Sell GBP/Buy USD Forward Contract
(34
)
 
153

 
Net sales
 
(167
)
 
(126
)
 
Net sales
 
(2
)
 

 
$
(51
)
 
$
536

 
 
 
$
(90
)
 
$
(188
)
 
 
 
$
(3
)
 
$


The Company expects all of the amounts recorded as a component of accumulated other comprehensive income (loss) will be realized in the consolidated statements of operations over the next twelve months and the amount will vary depending on market rates.

9

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)


Derivatives Not Designated as Hedging Instruments—Foreign Currency Derivatives
The Company also enters into forward foreign exchange contracts to mitigate the impact changes in currency exchange rates have on balance sheet monetary assets and liabilities as well as certain other forecasted sales. None of these contracts are designated as hedges for accounting purposes and, accordingly, changes in value of the foreign exchange forward contracts, and in the offsetting underlying on-balance-sheet transactions (for derivatives hedging monetary assets and liabilities), are reflected in the accompanying consolidated statements of operations under the caption “Other (income) expense.” As of September 30, 2015, the Company had the following outstanding derivatives that were not designated as hedging instruments (in thousands, except for the number of instruments):
 
Number of
Instruments
 
Sell
Notional Value
 
Buy
Notional Value
Sell EUR/Buy USD Forward Contract
14

 
1,846

 
$
2,067

Sell GBP/Buy USD Forward Contract
2

 
£
2,184

 
$
3,313

Sell CAD/Buy USD Forward Contract
13

 
C$
10,812

 
$
8,264

Sell CHF/Buy USD Forward Contract
13

 
$
3,180

 
Fr.
3,026

Sell MXN/Buy USD Forward Contract
13

 
$
86,386

 
$
5,212

Sell JPY/Buy USD Forward Contract
1

 
¥
291,284

 
$
2,430

Sell CNY/Buy USD Forward Contract
1

 
¥
43,930

 
$
6,840

 
57

 
 
 

These contracts generally have maturities of within the next twelve months.
The following table summarizes the amount of income from derivative instruments recognized for the periods indicated and the accounts in the accompanying consolidated statements of operations where the results are recorded for economic foreign currency hedges (in thousands):
 
Location of Gain (Loss)
Recognized in
Income on
Derivative
 
Amount of Gain (Loss)
Recognized in Income
on Derivatives
 
Amount of Gain (Loss)
Recognized in Income
on Derivatives
 
 
Three months ended 
 September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Forecasted sales hedges
 
 
 
 
 
 
 
 
 
Sell EUR/Buy USD Forward Contract
Net sales
 
$
(19
)
 
$
73

 
$
80

 
$
95

Sell GBP/Buy USD Forward Contract
Net sales
 
47

 
55

 
(53
)
 
37

Sell CAD/Buy USD Forward Contract
Other income (expense)
 
269

 

 
200

 

Sell CHF/Buy USD Forward Contract
Other income (expense)
 
(138
)
 

 
(38
)
 

Sell MXN/Buy USD Forward Contract
Other income (expense)
 
154

 

 
214

 

Sell JPY/Buy USD Forward Contract
Other income (expense)
 

 

 

 

 
 
 
$
313

 
$
128

 
$
403

 
$
132

Monetary asset and liability hedges
 
 
 
 
 
 
 
 
 
Sell EUR/Buy USD Forward Contract
Other income (expense)
 
$
(33
)
 
$
76

 
$
44

 
$
92

Sell GBP/Buy USD Forward Contract
Other income (expense)
 
102

 
53

 
74

 
35

Sell CAD/Buy USD Forward Contract
Other income (expense)
 
284

 

 
252

 

Sell CHF/Buy USD Forward Contract
Other income (expense)
 

 

 

 

Sell MXN/Buy USD Forward Contract
Other income (expense)
 
198

 

 
224

 

Sell JPY/Buy USD Forward Contract
Other income (expense)
 
(48
)
 

 
(15
)
 

Sell CNY/Buy USD Forward Contract
Other income (expense)
 
92

 

 
30

 

 
 
 
$
595

 
$
129

 
$
609

 
$
127


10

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

The impact of monetary asset and liability hedges not designated as hedging instruments was substantially all offset by the remeasurement of the underlying balance sheet item.
The following table summarizes the fair values of derivative instruments as of the periods indicated and the line items in the accompanying consolidated balance sheets where the instruments are recorded (in thousands):
 
Derivative Assets
 
Derivative Liabilities
 
September 30, 2015
 
December 31, 2014
 
September 30, 2015
 
December 31, 2014
Derivatives designated as cash flow hedges
 
 
 
 
 
 
 
Balance Sheet Location
Prepaid expenses
and other current
assets
 
Prepaid expenses
and other current
assets
 
Accrued liabilities
 
Accrued liabilities
Sell EUR/Buy USD Forward Contract
$
2

 
$

 
$
72

 
$

Sell GBP/Buy USD Forward Contract
159

 

 
28

 

 
$
161

 
$

 
$
100

 
$

Derivatives not designated as hedging instruments
 
 
 
 
 
 
 
Balance Sheet Location
Prepaid expenses
and other current
assets
 
Prepaid expenses
and other current
assets
 
Accrued liabilities
 
Accrued liabilities
Sell EUR/Buy USD Forward Contract
$
7

 
$
50

 
$
29

 
$

Sell GBP/Buy USD Forward Contract
10

 
7

 
1

 
2

Sell CAD/Buy USD Forward Contract
177

 
 
 
12

 
 
Sell CHF/Buy USD Forward Contract

 
 
 
50

 
 
Sell MXN/Buy USD Forward Contract
155

 
 
 
18

 
 
Sell JPY/Buy USD Forward Contract
1

 

 

 

Sell CNY/Buy USD Forward Contract

 
 
 
49

 
 
 
$
350

 
$
57

 
$
159

 
$
2

The amounts set forth in the table above represent the gross asset or liability. These derivatives are subject to master netting agreements giving effect to rights of offset with each counterparty. Taking into consideration this right of offset, the derivatives are in a net asset position of $252,000 as of September 30, 2015 and a net asset position of $55,000 as of December 31, 2014.
(5) Fair Value Measurements
The fair value of the Company’s financial instruments reflects the amounts that the Company estimates to receive in connection with the sale of an asset or paid in connection with the transfer of a liability in an orderly transaction between market participants at the measurement date (exit price). The fair value hierarchy prioritizes the use of inputs used in valuation techniques into the following three levels:

Level 1—quoted prices in active markets for identical assets and liabilities.
Level 2— observable inputs other than quoted prices in active markets for identical assets and liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Some of the Company’s marketable securities primarily utilize broker quotes in a non-active market for valuation of these securities.
Level 3—unobservable inputs.

The majority of the Company’s financial instruments are valued using quoted prices in active markets or based on other observable inputs. The following table sets forth the fair value of the Company’s financial assets that are re-measured on a regular basis:


11

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

The fair value of these financial instruments was determined using the following levels of inputs as of September 30, 2015 (in thousands):

 
Fair Value Measurements at September 30, 2015
 
Quoted Prices in Active Markets for Identical Assets and Liabilities
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Derivative financial instruments
$

 
$
511

 
$

 
$
511

Cash equivalents - Money market funds
1,000

 

 

 
1,000

Debt mutual funds

 
3,541

 

 
3,541

Total assets
$
1,000

 
$
4,052

 
$

 
$
5,052

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments

 
259

 

 
259


There were no financial assets and liabilities measured on a recurring basis using significant unobservable inputs (Level 3) and there were no transfers in or out of Level 1, 2, or 3 during the three months ended September 30, 2015.
The fair values of the foreign exchange forward contracts are considered to be Level 2. Foreign currency forward contracts are valued using readily available foreign currency forward and interest rate curves. The fair value of each contract is determined by comparing the contract rate to the forward rate and discounting to the present value. Contracts in a gain position are recorded in the consolidated balance sheet under the caption “Prepaid expenses and other current assets” and the value of contracts in a loss position is recorded under the caption “Accrued liabilities.”
The fair value of these financial instruments was determined using the following levels of inputs as of December 31, 2014 (in thousands):
 
Fair Value Measurements at December 31, 2014
 
Quoted Prices in Active Markets for Identical Assets and Liabilities
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Derivative financial instruments
$

 
$
57

 
$

 
$
57

Cash equivalents - Money market funds
2,000

 

 

 
2,000

Debt mutual funds

 
15,010

 

 
15,010

Total assets
$
2,000

 
$
15,067

 
$

 
$
17,067

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
Derivative financial instruments

 
2

 

 
2




12

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

(6) Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and trade accounts receivable. The Company maintains its cash and short-term investments at various financial institutions. At times the balances may exceed federally insured limits or may not be federally insured. The Company has not experienced any permanent losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash.
Credit is extended to customers based on an evaluation of the customer’s financial condition and collateral is not required. One customer accounted for a significant portion of sales for the periods presented, which are as follows:
 
Three months ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Net sales to customer
18.5
%
 
17.4
%
 
16.4
%
 
15.2
%
The customer above accounted for 17% and 25% of the Company’s accounts receivable as of September 30, 2015 and December 31, 2014, respectively. No other customer accounted for greater than 10% of the Company's accounts receivable for the presented periods.

(7) Allowance for Doubtful Accounts and Sales Returns
The following is a roll forward of the allowance for doubtful accounts and for sales returns and allowances, which are classified as a reduction of accounts receivable and in accrued liabilities, respectively:
 
Doubtful
Accounts
 
Sales Returns
& Allowances
 
(in thousands)
Balance, December 31, 2014
$
1,935

 
$
7,168

Provision
304

 
19,145

Recoveries
247

 

Deductions
(925
)
 
(19,397
)
Balance, September 30, 2015
$
1,561

 
$
6,916

(8) Product Warranty Obligations
The Company provides for product warranties in accordance with the contract terms given to various customers and end users by accruing estimated warranty costs at the time of revenue recognition. Warranties are generally fulfilled by replacing defective products with new products.
Activity in the warranty accrual balance, which is included in accrued liabilities on the condensed consolidated balance sheets, was as follows:
 
Warranty
Accrual
 
(in thousands)
Balance at December 31, 2014
$
753

Warranty claims
(601
)
Warranty costs accrued
530

Balance at September 30, 2015
$
682


(9) Property and Equipment, Net
Property and equipment, net, consisted of the following:

13

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

 
September 30, 
 2015
 
December 31, 
 2014
 
(in thousands)
Cost:
 
 
 
Leasehold improvements
$
3,246

 
$
3,074

Furniture and fixtures
17,148

 
13,112

Other equipment
12,800

 
10,145

Computer equipment and software
8,903

 
7,596

Vehicles
206

 
253

 
42,303

 
34,180

Less accumulated depreciation
(27,679
)
 
(21,269
)
Property and equipment, net
$
14,624

 
$
12,911

(10) Net Income (Loss) per Share
Basic net income (loss) per common share is computed by dividing the net income (loss) attributable to Skullcandy, Inc. for the reporting period by the weighted average number of shares of common stock outstanding during the same period. Diluted net income (loss) per common share attributable to Skullcandy, Inc. reflects the effects of potentially dilutive securities, which consist of unvested restricted stock and stock options.
A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) per common share is as follows:
 
Three months ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Numerator
 
 
 
 
 
 
 
Net income (loss) attributable to Skullcandy, Inc.
$
2,301

 
$
2,106

 
$
(213
)
 
$
215

Denominator
 
 
 
 
 
 
 
Weighted average common stock outstanding for basic net income (loss) per common share
28,478

 
28,136

 
28,375

 
28,006

Effect of dilutive securities—unvested restricted stock and stock options
572

 
352

 

 
419

Weighted average common shares and dilutive securities outstanding
28,754

 
28,488

 
28,375

 
28,425

    
The following shares were excluded from the calculation of diluted shares outstanding as their effect would have been anti-dilutive (in thousands):
 
Three months ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Stock options and restricted stock awards
1,779

 
1,416

 
1,316

 
1,416

(11) Debt
Credit Facility
On August 19, 2013, the Company entered into a credit agreement and revolving line of credit, or the credit facility, with Wells Fargo Bank National Association which was subsequently amended on April 29, 2014, which provides a line of credit of up to $10,000,000. As a subfeature, the credit facility provided for letters of credit up to $5,000,000. The credit facility is secured with a first-priority lien against substantially all of the assets of the Company.


14

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

The credit facility required the Company to be in compliance with specified affirmative financial covenants, including: (a) total liabilities divided by tangible net worth not greater than 1.0 to 1.0 as of the last day of each fiscal quarter; (b) current ratio not less than 2.00 to 1.00 as of the last day of each fiscal quarter; and (c) EBITDA coverage ratio of not less than 2.0 to 1.0 as of the last day of each fiscal quarter.

The Company’s credit facility was amended April 7, 2015 and contains certain financial covenants and other restrictions that limit the Company’s ability, among other things, to: (a) make fixed asset purchases greater than $19 million in aggregate for fiscal year 2015, $23 million for fiscal year 2016, and $15 million for any fiscal year thereafter; (b) incur operating lease expenses in any fiscal year greater than $3 million in aggregate; and (c) create, incur, assume or permit to exist any indebtedness or liabilities resulting from borrowings, loans or advances, whether secured or unsecured, matured or unmatured, liquidated or unliquidated, joint or several, except (1) the liabilities of the Company and each of its subsidiaries to Wells Fargo, (2) permitted investments, (3) uncapped permitted indebtedness, and (4) capped permitted indebtedness up to $2 million in the aggregate outstanding at any one time. Additional covenants and other restrictions exist that limit the Company’s ability, among other things, to: undergo a merger or consolidation, sell certain assets, create liens, guarantee certain obligations of third parties, make certain investments or acquisitions, and declare dividends or make distributions.

At September 30, 2015, the Company was in compliance with all applicable covenants in its credit facility.
(12) Segments
The Company manages its business in two operating segments which are comprised of Domestic and International. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Makers ("CODM") in deciding how to allocate resources and in assessing performance. The Company has determined that the CODM is the Chief Executive Officer and the Chief Financial Officer, collectively. The Company's operating segments and reporting segments are the same. The Domestic segment primarily consists of Skullcandy and Astro Gaming product sales to customers in the United States. The Domestic segment also includes the majority of general corporate overhead and related costs which are not allocated for segment reporting purposes, therefore the Company believes that the best metric for segment performance is gross profit. The International segment primarily includes Skullcandy product sales to customers in Europe, Asia, Canada, Mexico (through the Company’s joint venture), and all other geographic areas outside the United States that are served by the Company’s International operations. The Company primarily operates in the consumer products category in which the Company develops and distributes headphones and other audio products. All intercompany revenues, expenses, payables and receivables are eliminated in consolidation and are not reviewed when evaluating segment performance.
Information related to the Company’s segments is as follows:
 
Three months ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Net sales
 
 
 
 
 
 
 
Domestic
$
46,976

 
$
38,521

 
$
119,380

 
$
104,102

International
20,192

 
19,534

 
51,979

 
46,894

Consolidated net sales
$
67,168

 
$
58,055

 
$
171,359

 
$
150,996

Gross profit
 
 
 
 
 
 
 
Domestic
$
20,044

 
$
17,185

 
$
50,478

 
$
47,120

International
7,509

 
9,139

 
20,632

 
21,596

Consolidated gross profit
$
27,553

 
$
26,324

 
$
71,110

 
$
68,716

Income (loss) from operations
 
 
 
 
 
 
 
Domestic
$
1,388

 
$
397

 
$
(2,428
)
 
$
(2,559
)
International
1,694

 
3,186

 
2,887

 
3,526

Consolidated income from operations
$
3,082

 
$
3,583

 
$
459

 
$
967



15

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

 
September 30,
 
December 31,
 
2015
 
2014
 
(in thousands)
Identifiable assets
 
 
 
Domestic
$
117,229

 
$
140,176

International
74,099

 
71,990

Consolidated
$
191,328

 
$
212,166

Long-lived assets
 
 
 
Domestic
$
15,300

 
$
13,596

International
7,102

 
8,129

Consolidated
$
22,402

 
$
21,725

Goodwill
 
 
 
Domestic
$
6,805

 
$
6,805

International
7,062

 
7,062

Consolidated
$
13,867

 
$
13,867

(13) Stock-Based Compensation
The Company has an incentive award plan that provides for the grant of incentive and nonqualified options to purchase the Company’s common stock, performance-based restricted stock units (“PSUs”) and restricted stock units (“RSUs”) to selected officers, other key employees and directors. Options are granted at a price not less than the fair market value on the date of grant and generally become exercisable between one and four years after the date of grant in accordance with an applicable vesting schedule, and generally expire ten years from the date of grant. The Company has recorded stock-based compensation expense on its PSUs as the Company believes that it is probable that the performance criteria will be met for the outstanding awards.
RSUs granted to members of the Board of Directors vest annually subject to continued service on the Board.

Stock Options
The following table summarizes stock option activity under the Company’s stock option plans for the nine months ended September 30, 2015:
 
Options
Outstanding
 
Price Range
 
Weighted-
Average
Price
 
Weighted-
Average
Contractual Term
(in years)
 
Aggregate
Intrinsic Value  (1)
Balance at December 31, 2014
1,849,613

 
0.37 – 20.00
 
7.56

 

 
 
Granted
349,729

 
7.25 - 10.94
 
10.21

 

 
 
Exercised
(50,404
)
 
5.26 - 9.11
 
7.13

 

 
 
Canceled and forfeited
(20,557
)
 
5.33 - 11.99
 
7.64

 

 
 
Balance at September 30, 2015
2,128,381

 
0.37 – 20.00
 
8.00

 
7.65
 
584,425

Vested and Exercisable
898,313

 
0.37 – 20.00
 
8.53

 
6.57
 
428,769

Unvested
1,230,068

 
5.07 – 12.42
 
7.62

 
8.44
 
155,656

(1) The aggregate intrinsic value is equal to the difference between the exercise price of the underlying stock option awards and the fair value of the Company’s common stock as of September 30, 2015.
Performance-Based Restricted Stock Units
The following table summarizes PSU activity under the Company’s incentive award plan for the nine months ended September 30, 2015:

16

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

 
PSUs
Outstanding
 
Weighted-
Average
Grant Date
Fair Value
Balance at December 31, 2014
7,042

 
$
7.10

Granted
11,814

 
10.58

Vested

 

Forfeited

 

Balance at September 30, 2015
18,856

 
$
9.28

Restricted Stock Units
The following table summarizes RSU activity under the Company’s incentive award plan for the nine months ended September 30, 2015:
 
RSUs
Outstanding
 
Weighted-
Average
Grant Date
Fair Value
Balance at December 31, 2014
831,973

 
$
6.83

Granted
296,525

 
9.76

Vested
(285,156
)
 
6.69

Forfeited
(15,568
)
 
7.78

Balance at September 30, 2015
827,774

 
$
7.59

Summary of Share-Based Compensation
The Company recorded share-based compensation expense related to awards of $1.1 million and $1.2 million, and $3.2 million and $2.6 million for the three and nine months ended September 30, 2015 and 2014, respectively. Share-based compensation is recorded in selling, general and administrative expenses in the accompanying condensed consolidated statements of operations. The unrecognized compensation cost of share-based compensation as of September 30, 2015 was $6.1 million which is expected to be recognized over the weighted average remaining vesting period of 2.60 years.
(14) Income Taxes

In order to determine the quarterly provision for income taxes, the Company uses an estimated annual effective tax rate, which is based on expected annual income and statutory tax rates in the various jurisdictions in which the Company operates. To the extent that application of the estimated annual effective tax rate is not representative of the quarterly portion of actual tax expense expected to be recorded for the year, the Company determines the quarterly provision for income taxes based on actual year-to-date income (loss). Certain significant or unusual items are separately recognized in the quarter during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

Income tax expense for the three months ended September 30, 2015 and 2014 was $697,000 and $507,000, respectively, or approximately 24.7% and 19.1% of pre-tax income. The effective tax rate increased for the three months ended September 30, 2015 primarily due to proportionately lower levels of income in countries with lower statutory tax rates and losses in our joint-venture entity that are excluded from income tax expense due to a valuation allowance that was in effect for the current period. The Company’s effective tax rate for the three months ended September 30, 2015 differs from the United States Federal Statutory rate of 35%, due to permanent items and different tax rates associated with earnings from the Company's operations in Switzerland and other foreign jurisdictions. All earnings at foreign locations are considered to be permanently reinvested for tax purposes.

Income tax benefit for the nine months ended September 30, 2015 and 2014 was $116,000 and $284,000, respectively, or approximately (17.2%) and (516.4%) of pre-tax income (loss). The Company’s effective tax rate for the nine months ended September 30, 2015 differs from the United States Federal Statutory rate of 35%, due to an increased benefit and loss in 2015, favorable discrete items for a completed research and development study, as well as a higher estimated annual effective tax rate in 2015 than in 2014 due to greater projected income in higher tax jurisdictions.


17

SKULLCANDY, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)
(unaudited)

The Company is subject to income taxes in the United States and various foreign jurisdictions and to continual examination by tax authorities. Significant judgment is required in evaluating the Company’s uncertain tax positions and determining its provision for income taxes. As of September 30, 2015 and December 31, 2014, the Company had uncertain tax liabilities of $301,000 and $352,000, respectively. The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. The Company did not incur any material interest or penalties related to income taxes in any of the periods presented. The Company does not anticipate any significant events or circumstances that would cause a material change to these uncertainties during the ensuing year.

The Company files U.S., state and foreign income tax returns in jurisdictions with various statutes of limitations. The Company’s consolidated federal tax return and any significant state or foreign tax returns are not currently under examination.
(15) Commitments and Contingencies
The Company is subject to various claims, complaints and legal actions in the normal course of business from time to time. The Company does not believe it has any currently pending litigation for which the outcome could have a material adverse effect on its operations or financial position.


18


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of the financial condition and results of our operations should be read together with our condensed consolidated financial statements and the related notes included in Part I of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the year ended December 31, 2014 filed with the Securities and Exchange Commission on March 13, 2015.
Cautionary Statement Regarding Forward-Looking Statements
This quarterly report contains forward-looking statements. The words “may,” “will,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions that are predictions of or indicate future events and trends and that do not relate to historical matters identify forward-looking statements. Although forward-looking statements reflect our current views, reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements speak only as of the date the statements are made. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise. These forward-looking statements are subject to numerous risks and uncertainties, including the risks and uncertainties described under “Risk Factors” in Part II of this quarterly report and in our Annual Report on Form 10-K for the year ended December 31, 2014 filed with the Securities and Exchange Commission on March 13, 2015 and Form 10-Q for the quarter ended March 31, 2015 filed with the SEC on May 7, 2015. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement. We qualify all of our forward-looking statements by these cautionary statements.
Overview
We are the original lifestyle and performance audio brand inspired by the creativity and irreverence of youth culture. We design, market and distribute audio and gaming headphones, earbuds, speakers and other accessories under the Skullcandy, Astro Gaming and 2XL brands. We launched in 2003 and quickly became an international audio brand by bringing innovation, bold color, character and performance to an otherwise monochromatic audio space. Our products are sold and distributed through a variety of channels in the U.S. and approximately 80 countries worldwide. We offer a wide array of styles and price points and are expanding into complementary audio products and categories such as sports performance, women's and wireless offerings, as well as partnerships with leading manufacturers to license our brand.
We pioneered the distribution of headphones and audio products in specialty retailers focused on action sports and youth culture with hundreds of independent snow, skate and surf retailers. Through this channel we reach consumer influencers, individuals who help establish and maintain the credibility and authenticity of our brand. Building on this foundation, we have successfully expanded our distribution to leading consumer electronics, sporting goods, mobile phone and big box retailers such as Best Buy, Dick’s Sporting Goods, AT&T Wireless, Target and Wal-Mart.
We also produce and market gaming headphones. We acquired Astro Gaming in April 2011 as part of our strategy to position ourselves in the premium end of the gaming category with a leading, authentic brand. Astro Gaming is based in San Francisco, California and develops and markets high-performance, feature-rich products to dedicated gamers, through both the direct-to-consumer channel and through an expected growing global network of retailers and distributors.
We were incorporated in Delaware in 2003. Our principal executive offices are located at 1441 West Ute Boulevard, Suite 250, Park City, Utah 84098, and our telephone number is (435) 940-1545. Our principal website address is www.skullcandy.com. Information contained on our website does not constitute part of, and is not incorporated by reference into, this report.
Segment Information
We manage our business in two operating segments which are comprised of Domestic and International. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Makers ("CODM") in deciding how to allocate resources and in assessing performance. We determined that the CODM is the Chief Executive Officer and the Chief Financial Officer, collectively. Our operating segments and reporting segments are the same. The Domestic segment primarily consists of Skullcandy and Astro Gaming product sales to customers in the United States. The Domestic segment also includes the majority of general corporate overhead and related costs which are not allocated to the International segment, therefore we believe that the best metric for segment performance is gross profit. The International segment primarily includes Skullcandy product sales to customers in

19


Europe, Asia, Canada, Mexico (through the Company’s joint venture), and all other geographic areas outside the United States that are served by the Company’s International operations. We operate exclusively in the consumer products category in which the Company develops and distributes headphones and other audio products. All intercompany revenues, expenses, payables and receivables are eliminated in consolidation and are not reviewed when evaluating segment performance.
Information related to our segments is as follows:
 
Three months ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Net sales
 
 
 
 
 
 
 
Domestic
$
46,976

 
$
38,521

 
$
119,380

 
$
104,102

International
20,192

 
19,534

 
51,979

 
46,894

Consolidated net sales
$
67,168

 
$
58,055

 
$
171,359

 
$
150,996

Gross profit
 
 
 
 
 
 
 
Domestic
$
20,044

 
$
17,185

 
$
50,478

 
$
47,120

International
7,509

 
9,139

 
20,632

 
21,596

Consolidated gross profit
$
27,553

 
$
26,324

 
$
71,110

 
$
68,716

Income (loss) from operations
 
 
 
 
 
 
 
Domestic
$
1,388

 
$
397

 
$
(2,428
)
 
$
(2,559
)
International
1,694

 
3,186

 
2,887

 
3,526

Consolidated income from operations
$
3,082

 
$
3,583

 
$
459

 
$
967

 
September 30,
 
December 31,
 
2015
 
2014
 
(in thousands)
Identifiable assets
 
 
 
Domestic
$
117,229

 
$
140,176

International
74,099

 
71,990

Consolidated
$
191,328

 
$
212,166

Long-lived assets
 
 
 
Domestic
$
15,300

 
$
13,596

International
7,102

 
8,129

Consolidated
$
22,402

 
$
21,725

Goodwill
 
 
 
Domestic
$
6,805

 
$
6,805

International
7,062

 
7,062

Consolidated
$
13,867

 
$
13,867


Basis of Presentation
Our net sales are derived primarily from the sale of audio and gaming headphones and other accessory related products under the Skullcandy, Astro Gaming and 2XL brands.
Amounts billed to retailers and distributors for shipping and handling are included in net sales. Sales are reported net of estimated product returns and pricing adjustments.
Gross profit is influenced by cost of goods sold, which consists primarily of product costs, packaging, freight, duties warehousing, warranty costs and depreciation on tooling assets held at our contract manufacturers.

20


Our selling, general and administrative expenses consist primarily of employee related payroll and benefit expenses, commissions to outside sales representatives, marketing and demand creation expense, research and development expenses, information technology expenses, third party professional fees, and other facility and operational related costs, including depreciation and amortization. The primary components of our marketing and demand creation expenses include in-store advertising, point of sale fixtures, sponsorship of trade shows and events, promotional products and relationships with athletes, DJs, musicians and artists.
There are references to the impact of foreign currency fluctuations in the discussion of our results of operations. Currency fluctuations impact our financial position, operating results and cash flows. In the discussion that follows, results excluding this impact are referred to as being on a “currency neutral basis,” which assume, for certain items, the foreign exchange rates in effect for the three months ended September 30, 2015 were in effect for the three months ended September 30, 2014.
Results of Operations
The following table sets forth selected items in our statements of operations in dollars and as a percentage of net sales for the periods presented (in thousands):
 
 
Three months ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Net sales
 
$
67,168

 
100.0
 %
 
$
58,055

 
100.0
 %
 
$
171,359

 
100.0
 %
 
$
150,996

 
100.0
 %
Cost of goods sold
 
39,615

 
59.0
 %
 
31,731

 
54.7
 %
 
100,249

 
58.5
 %
 
82,280

 
54.5
 %
Gross profit
 
27,553

 
41.0
 %
 
26,324

 
45.3
 %
 
71,110

 
41.5
 %
 
68,716

 
45.5
 %
Selling, general and administrative expenses
 
24,471

 
36.4
 %
 
22,741

 
39.2
 %
 
70,651

 
41.2
 %
 
67,749

 
44.9
 %
Income from operations
 
3,082

 
4.6
 %
 
3,583

 
6.2
 %
 
459

 
0.3
 %
 
967

 
0.6
 %
Other expense
 
261

 
0.4
 %
 
934

 
1.6
 %
 
1,144

 
0.7
 %
 
729

 
0.5
 %
Interest (income) expense
 
(1
)
 
 %
 
(9
)
 
 %
 
(12
)
 
 %
 
183

 
0.1
 %
Income (loss) before income taxes and noncontrolling interests
 
2,822

 
4.2
 %
 
2,658

 
4.6
 %
 
(673
)
 
(0.4
)%
 
55

 
 %
Provision (benefit) for income taxes
 
697

 
1.0
 %
 
507

 
0.9
 %
 
(116
)
 
(0.1
)%
 
(284
)
 
(0.2
)%
Net income (loss)
 
2,125

 
3.2
 %
 
2,151

 
3.7
 %
 
(557
)
 
(0.3
)%
 
339

 
0.2
 %
Net income (loss) attributable to noncontrolling interests
 
(176
)
 
(0.3
)%
 
45

 
0.1
 %
 
(344
)
 
(0.2
)%
 
124

 
0.1
 %
Net income (loss) attributable to Skullcandy, Inc.
 
$
2,301

 
3.4
 %
 
$
2,106

 
3.6
 %
 
$
(213
)
 
(0.1
)%
 
$
215

 
0.1
 %


Three Months Ended September 30, 2015 Compared to Three Months Ended September 30, 2014
Net sales
The following table reflects our net sales for three months ended September 30, 2015 and 2014 (in thousands):
 
Three months ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
Net sales
 
 
 
 
 
 
 
Domestic
$
46,976

 
$
38,521

 
$
8,455

 
21.9
%
International
20,192

 
19,534

 
658

 
3.4
%
Total net sales
$
67,168

 
$
58,055

 
$
9,113

 
15.7
%
Total net sales increased 15.7%, or 19.5% on a currency neutral basis, primarily due to increased sales of audio, gaming and wireless products across both segments. International net sales also increased primarily due to increased sales in India, Australia, and China, partially offset by declines in Europe and Canada.

21


Gross profit and gross margin
The following table reflects our gross profit and gross margin for the three months ended September 30, 2015 and 2014 (in thousands):
 
Three months ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
Gross profit
 
 
 
 
 
 
 
Domestic
$
20,044

 
$
17,185

 
$
2,859

 
16.6
 %
International
7,509

 
9,139

 
(1,630
)
 
(17.8
)%
Total gross profit
$
27,553

 
$
26,324

 
$
1,229

 
4.7
 %
 
 
 
 
 
 
 
 
 
Three months ended September 30,
 
 
 
 
 
2015
 
2014
 
Basis Point Change
 
 
Gross margin %
 
 
 
 
 
 
 
Domestic %
42.7
%
 
44.6
%
 
(190
)
 
 
International %
37.2
%
 
46.8
%
 
(960
)
 
 
Total gross margin %
41.0
%
 
45.3
%
 
(430
)
 
 
Total gross margin decreased across both segments primarily due to product mix shift to lower margin wireless products, the continued increase of gaming products sales, significant declines in foreign currencies in our International segment, and increased sales of aged inventory at our International segment. Gaming products typically have lower margins which are partially driven by higher third party licensing and royalty costs.
Selling, general and administrative expenses
The following table reflects our selling, general and administrative expenses for the three months ended September 30, 2015 and 2014 (in thousands):
 
Three months ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
Selling, general and administrative expenses
$
24,471

 
$
22,741

 
$
1,730

 
7.6
%
Selling, general and administrative expenses as a percent of net sales
36.4
%
 
39.2
%
 
 
 
 

The increase in SG&A expenses is primarily due to increases in personnel expenses, demand creation and research and innovation expenses, and in-store display depreciation. SG&A expenses decreased as a percentage of net sales due to higher increased sales and a continued focus on cost control efforts and lower proportional amounts of payroll.
We expect to continue to make critical investments in the business to support long-term growth. In particular, we intend to continue to invest in marketing and demand creation efforts at the same level or higher compared to the same quarter of the prior year; while also continuing to invest in increased amounts for research and development efforts.
Other Expense (Income)
Other expense (income) was $261,000 and $934,000 for the three months ended September 30, 2015 and 2014, respectively, which includes net expenses related to our hedging program and foreign currency expense activities and general currency fluctuations compared to the U.S. dollar.

22


Interest Income
Interest income was $1,000 and $9,000 for the three months ended September 30, 2015 and 2014, respectively, which primarily includes income earned through short-term investments, partially offset by the amortization of deferred financing fees, and unused line fees associated with our credit facility.
Income Taxes
The income tax expense was $697,000 and $507,000 for the three months ended September 30, 2015 and 2014, respectively. Our effective tax rate for the three months ended September 30, 2015 and 2014 was 24.7% and 19.1%, respectively. The effective tax rate increased for the three months ended September 30, 2015 primarily due to proportionately lower levels of income in countries with lower statutory tax rates and losses in our joint-venture entity that are excluded from income tax expense due to a valuation allowance that was in effect for the current period.
Our effective tax rate may fluctuate significantly on a quarterly basis due to a variety of factors including our levels of taxable income in the countries with lower statutory tax rates versus countries with higher statutory tax rates, which is difficult to predict.
Noncontrolling Interest
We have a joint venture in Mexico to facilitate distribution and marketing of our products in Mexico. We own a majority of the joint venture and the voting rights and control the day-to-day operations.
Noncontrolling interest for the three months ended September 30, 2015 and 2014 consists of income (losses) of $(176,000) and $45,000, respectively, from our Mexico joint venture that is attributable to the other partner in the joint venture.


Nine Months Ended September 30, 2015 Compared to Nine Months Ended September 30, 2014
Net sales
The following table reflects our net sales for nine months ended September 30, 2015 and 2014 (in thousands):
 
Nine Months Ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
Net sales
 
 
 
 
 
 
 
Domestic
$
119,380

 
$
104,102

 
$
15,278

 
14.7
%
International
51,979

 
46,894

 
5,085

 
10.8
%
Total net sales
$
171,359

 
$
150,996

 
$
20,363

 
13.5
%
Total net sales increased 13.5%, or 16.4% on a currency neutral basis, primarily due to increased sales of audio, wireless, and gaming products across both segments. International net sales also increased primarily due to increased sales in China and Australia, and to a lesser extent, India and Japan.

23


Gross profit and gross margin
The following table reflects our gross profit and gross margin for the nine months ended September 30, 2015 and 2014 (in thousands):
 
Nine Months Ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
Gross profit
 
 
 
 
 
 
 
Domestic
$
50,478

 
$
47,120

 
$
3,358

 
7.1
 %
International
20,632

 
21,596

 
(964
)
 
(4.5
)%
Total gross profit
$
71,110

 
$
68,716

 
$
2,394

 
3.5
 %
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
 
2015
 
2014
 
Basis Point Change
 
 
Gross margin %
 
 
 
 
 
 
 
Domestic %
42.3
%
 
45.3
%
 
(300
)
 
 
International %
39.7
%
 
46.1
%
 
(640
)
 
 
Total gross margin %
41.5
%
 
45.5
%
 
(400
)
 
 
Total gross margin decreased across both segments primarily due to increased air-freight and warehousing expense to overcome West Coast port slowdowns, product mix shift to lower margin wireless products, and the continued increase of gaming products sales and significant declines in foreign currencies in our International segment. Gaming products typically have lower margins which are partially driven by higher third party licensing and royalty costs.
Selling, general and administrative expenses
The following table reflects our selling, general and administrative expenses for the nine months ended September 30, 2015 and 2014 (in thousands):
 
Nine Months Ended September 30,
 
 
 
 
 
2015
 
2014
 
$ Change
 
% Change
Selling, general and administrative expenses
$
70,651

 
$
67,749

 
$
2,902

 
4.3
%
Selling, general and administrative expenses as a percent of net sales
41.2
%
 
44.9
%
 
 
 
 

The increase in SG&A expenses is primarily due to increases in demand creation and research and innovation expenses, in-store display depreciation, partially offset by decreases in bad debt. SG&A expenses decreased as a percentage of net sales due to increased sales and a continued focus on cost control efforts and lower proportional amounts of payroll and bad debt.
Other Expense (Income)
Other expense (income) was $1.1 million and $729,000 for the nine months ended September 30, 2015 and 2014, respectively, which includes net expenses related to our hedging program and foreign currency expense activities and general currency fluctuations compared to the U.S. dollar.
Interest (Income) Expense

24


Interest (income) expense was $(12,000) and $183,000 for the nine months ended September 30, 2015 and 2014, respectively, which primarily includes income earned through short-term investments, partially offset by the amortization of deferred financing fees, and unused line fees associated with our credit facility. The increase in interest (income) was due to write downs of deferred financing fees in conjunction with debt modifications that occurred during the nine months ended September 30, 2014.
Income Taxes
The income tax benefit was $116,000 and $284,000 for the nine months ended September 30, 2015 and 2014, respectively. Our effective tax rate for the nine months ended September 30, 2015 and 2014 was 17.2% and 516.4%, respectively. The decrease in rate in 2015 is due to an increased benefit and loss in 2015, favorable discrete items for a completed research and development study, as well as a higher estimated annual effective tax rate in 2015 than in 2014.
Noncontrolling Interest
We have a joint venture in Mexico to facilitate distribution and marketing of our products in Mexico. We own a majority of the joint venture and the voting rights and control the day-to-day operations.
Noncontrolling interest for the nine months ended September 30, 2015 and 2014 consists of income (losses) of $(344,000) and $124,000, respectively, from our Mexico joint venture that is attributable to the other partner in the joint venture.

Liquidity and Capital Resources
Our primary cash needs are working capital, including inventory purchases, and capital expenditures. Historically, we have generally funded these needs with operating cash flows. This source of liquidity may be impacted by fluctuations in demand for our products, ongoing investments in our infrastructure and expenditures on marketing and advertising.
The following table sets forth, for the periods indicated, our beginning balance of cash, net cash flows provided by and used in operating, investing and financing activities and our ending balance of cash (in thousands):
 
Nine Months Ended September 30,
 
2015
 
2014
Cash and cash equivalents at beginning of period
$
21,623

 
$
38,835

Net cash provided by (used in) operating activities
(14,349
)
 
5,349

Net cash provided by (used in) investing activities
3,282

 
(20,766
)
Net cash provided by financing activities
32

 
1,378

Effect of exchange rate changes on cash and cash equivalents
(234
)
 
(78
)
Cash and cash equivalents at end of period
$
10,354

 
$
24,718

Net Cash Provided by (Used in) Operating Activities. Cash from operating activities consists primarily of net income (loss) adjusted for certain non-cash items including depreciation and amortization expense, loss on disposal of property and equipment, provision for doubtful accounts, deferred income taxes, non-cash interest expense, amortization of stock-based compensation expense and the effect of changes in working capital and other activities.
For the nine months ended September 30, 2015, net cash used in operating activities was $(14.3) million and consisted of a net loss of $0.6 million, less $27.8 million of working capital and other activities, offset by increases of $12.4 million of non-cash items. Working capital and other activities consisted primarily of a decrease in accounts receivable of $7.6 million, decreases in accounts payable of $10.5 million and accrued liabilities of $12.4 million, offset by increases in prepaid expenses and other current assets of $4.2 million, and increase in inventory of $8.3 million. The increase in cash used in operating activities is primarily due to the implementation of accelerated payment programs with certain contract manufacturers. As a result, for example, our accounts payable decreased significantly. We expect to realize product cost discounts and gross margin benefits in the future as a result of such accelerated payment programs. This is an optional program and can be discontinued at our discretion. Our accounts payable, accrued liabilities, and inventories were at increased levels at December 31, 2014 due to West Coast Port delays and contingency planning.


25


For the nine months ended September 30, 2014, net cash provided by operating activities was $5.3 million and consisted of a net income of $339,000, offset by $8.7 million of non-cash items, less $3.7 million of working capital and other activities. Working capital and other activities consisted primarily of a decrease in accounts receivable of $3.9 million, an increase in prepaid expenses and other current assets of $2.3 million, offset by an increase in inventory of $24.2 million and an increase in accounts payable of $17.5 million and accrued liabilities of $1.4 million.
Net Cash Provided by (Used in) Investing Activities. Net cash provided by (used in) investing activities relates to capital expenditures for in-store displays and proceeds from sale of our short-term investments. Net cash provided by (used in) investing activities was $3.3 million and $(20.8) million for the nine months ended September 30, 2015 and 2014, respectively.
Net Cash Provided by Financing Activities. Net cash provided by financing activities primarily related to proceeds from the exercise of stock options and taxes paid related to net share settlement of equity awards for the nine months ended September 30, 2015. Net cash provided by financing activities primarily related to proceeds from exercise of stock options for the nine months ended September 30, 2014.
We believe that our cash, cash equivalents, short-term investments and available borrowings under our credit facility will be sufficient to meet our capital requirements for at least the next twelve months.
Indebtedness
On August 19, 2013, we entered into a credit agreement and revolving line of credit, or the credit facility, with Wells Fargo Bank National Association which was subsequently amended on April 29, 2014, which provides a line of credit of up to $10,000,000. As a subfeature, the credit facility provided for letters of credit up to $5,000,000. The credit facility is secured with a first-priority lien against substantially all of our assets.

The credit facility required us to be in compliance with specified affirmative financial covenants, including (a) total liabilities divided by tangible net worth not greater than 1.0 to 1.0 as of the last day of each fiscal quarter; (b) current ratio not less than 2.00 to 1.00 as of the last day of each fiscal quarter; (c) and EBITDA coverage ratio of not less than 2.0 to 1.0 as of the last day of each fiscal.

Our credit facility was amended April 7, 2015 and contains certain financial covenants and other restrictions that limit the our ability, among other things, to: (a) make fixed asset purchases greater than $19 million in aggregate for fiscal year 2015, $23 million for fiscal year 2016, and $15 million for any fiscal year thereafter; (b) incur operating lease expenses in any fiscal year greater than $3 million in aggregate; and (c) create, incur, assume or permit to exist any indebtedness or liabilities resulting from borrowings, loans or advances, whether secured or unsecured, matured or unmatured, liquidated or unliquidated, joint or several, except (1) the liabilities of the Company and each of its subsidiaries to Wells Fargo, (2) permitted investments, (3) uncapped permitted indebtedness, and (4) capped permitted indebtedness up to $2,000,000 in the aggregate outstanding at any one time. Additional covenants and other restrictions exist that limit our ability, among other things, to: undergo a merger or consolidation, sell certain assets, create liens, guarantee certain obligations of third parties, make certain investments or acquisitions, and declare dividends or make distributions.

At September 30, 2015, we were in compliance with all applicable covenants in our credit facility.
Contractual obligations
In the three and nine months ended September 30, 2015, there were no material changes to our contractual obligations as discussed in our annual report on Form 10-K for the year ended December 31, 2014.
Off-Balance Sheet Arrangements
We currently do not have any off-balance sheet arrangements or financing activities with special-purpose entities.
Critical Accounting Policies and Estimates
Critical accounting policies are those policies which are both important to the presentation of a company’s financial condition and results and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. No significant changes to our accounting policies took place during the period. For a further discussion of our critical accounting policies, see our Annual Report on Form 10-K for the fiscal year ended December 31, 2014.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
At September 30, 2015, we maintained a credit facility which was amended during the period and provided for revolving loans of a line of credit of up to $10 million. As a subfeature, the credit facility provided for letters of credit up to $5 million. At September 30, 2015, there were no borrowings outstanding. We currently do not engage in any interest rate hedging activity. Based on the average interest rate on the credit facility during the three months ended September 30, 2015, and to the extent that borrowings were outstanding, we do not believe that a 10% change in the interest rate would have a material effect on our results of operations or financial condition.

26


Foreign Currency Risk
In the normal course of business, we are exposed to foreign currency exchange rate risks that could impact our results of operations. We are exposed to gains and losses resulting from fluctuations in foreign currency exchange rates relating to certain sales and expenses of our international subsidiaries that are denominated in currencies other than their functional currencies. Currency exchange rates fluctuations may also disrupt the business of the contract manufacturers and independent distributors. We are exposed to gains and losses resulting from the effect that fluctuations in foreign currency exchange rates have on the reported results in our consolidated financial statements due to the translation of the operating results and financial position of our international subsidiaries. Changes in foreign currency rates affect our consolidated statement of operations and distort comparisons between periods. For example, when the U.S. dollar strengthens compared to the Euro, there is a negative effect on our reported results from our Europe business because it takes more profits in Euro to generate the same amount of profits in stronger U.S. dollars.
We use various foreign currency exchange contracts as part of our overall strategy to manage the level of exposure to the risk of fluctuations in foreign currency exchange rates. For those derivative contracts that can qualify for hedge accounting, we may elect to designate the derivative as a hedge of the identified exposure. We formally document all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for entering into various hedge transactions. We identify in this documentation the asset, liability, firm commitment, or forecasted transaction that has been designated as a hedged item and indicate how the hedging instrument is expected to hedge the risks related to the hedged item. We formally measure effectiveness of our hedging relationships both at the hedge inception and on a quarterly basis in accordance with our risk management policy. Derivatives that do not qualify for hedge accounting but are used by management to mitigate exposure to currency risks are recorded at fair value with corresponding gains or losses recognized in earnings. We enter into forward exchange and other derivative contracts with major banks and are exposed to foreign currency credit losses in the event of nonperformance by these banks. We anticipate, however, that these banks will be able to fully satisfy their obligations under the contracts. Accordingly, we do not obtain collateral or other security to support the contracts.
During 2015, the Company has focused its foreign currency risk hedging program on:
a portion of certain forecasted net sales denominated in GBP, EUR, CAD, and MXN;
certain monetary assets and liabilities of its foreign domiciled subsidiaries; and
a portion of its exposure to CHF denominated forecasted operating expenses estimated to be incurred by its Skullcandy International GmbH subsidiary.
From a U.S. GAAP accounting perspective, the Company has elected to: (i) apply hedge accounting treatment to hedging instruments entered into in connection with certain forecasted net sales denominated in GBP and EUR; and (ii) not apply hedge accounting to all other aforementioned hedging instruments, but rather mark changes in value related to those hedging instruments through earnings.
The net fair value of foreign currency forward contracts (including adjustments for credit risk) as of September 30, 2015 and December 31, 2014 was a net asset of $252,000 and a net asset of $55,000, respectively. The potential decrease in fair value of foreign currency forward contracts (excluding adjustments for credit risk), assuming a 10% adverse change in the underlying foreign currency exchange rates versus the U.S. Dollar, would be $70,000 as of September 30, 2015, and immaterial as of December 31, 2014. If adjustments for credit risk were to be included, the decrease would be smaller. Furthermore, a 10% change in U.S. dollar exchange rates in effect at September 30, 2015, would cause a translation adjustment change in consolidated net assets of approximately $385,000.
Inflation
Inflationary factors, such as increases in the cost of our product and overhead costs, may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of net sales if the selling prices of our products do not increase with these increased costs.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file pursuant to the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to

27


allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures were effective to provide reasonable assurance at the end of the period.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent or detect all error and all fraud. While our disclosure controls and procedures are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Skullcandy, Inc. have been detected.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II
Item 1. Legal Proceedings.
We are subject to various claims, complaints and legal actions in the normal course of business from time to time. We do not believe we have any currently pending litigation for which the outcome could have a material adverse effect on our operations or financial position.
Item 1A. Risk Factors.
We operate in a rapidly changing environment that involves a number of risks that could materially and adversely affect our business, financial condition, prospects, operating results or cash flows. For a detailed discussion of the risks that affect our business, please refer to the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2014 filed with the SEC on March 13, 2015 and Form 10-Q for the quarter ended March 31, 2015 filed with the SEC on May 7, 2015. There have been no significant changes to the risks discussed in our 2014 10-K or our Form 10-Q for the quarter ended March 31, 2015.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.
 

28


 
 
Exhibit No.
Description of Exhibit
 
 
10.1
Form of Lease Agreement dated as of August 19, 2015 between Boyer Snyderville 2, L.C. and Skullcandy, Inc.
 
 
10.2
Form of Expansion Space Agreement dated as of August 19, 2015 between Boyer Snyderville Junction L.C. and Skullcandy, Inc.
 
 
10.3
Form of Work Letter dated as of August 19, 2015 between Boyer Synderville 2, L.C. and Skullcandy, Inc.
 
 
10.4
Lease Addendum No.8 between Cottonwood Newpark One, L.C. and Skullcandy, Inc.
 
 
10.5
Lease Addendum No.9 between Cottonwood Newpark One, L.C. and Skullcandy, Inc.
 
 
10.6
Form of Lease Agreement dated September 29, 2015 between 140 Partners, L.P. and Skullcandy, Inc.
 
 
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
 
 
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
101
The following materials from Skullcandy, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2015, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Comprehensive Income (iv) Condensed Consolidated Statements of Cash Flows; and (v) Notes to Condensed Consolidated Financial Statements.


29


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
Skullcandy, Inc.
 
 
 
Date: November 6, 2015
By:
/s/    JASON HODELL       
 
 
Jason Hodell
 
 
Chief Financial Officer
 
 
(Principal Financial Officer and Duly Authorized Signatory)

30