SKULLCANDY, INC. - FORM 10-Q

SKULLCANDY, INC. - FORM 10-Q - May 6, 2016

Attached files

Attached files

SKULLCANDY, INC. Reports

file	filename
EX-31.1 - EXHIBIT 31.1 - SKULLCANDY, INC.	exhibit-311x2016331.htm
EX-31.2 - EXHIBIT 31.2 - SKULLCANDY, INC.	exhibit-312x2016331.htm
EX-32.1 - EXHIBIT 32.1 - SKULLCANDY, INC.	exhibit-321x2016331.htm

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 March 31, 2016



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):

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 April 30, 2016 28,627,192 shares of the registrant’s common stock were outstanding, par value of $0.0001.

Table of Contents

SKULLCANDY, INC.

INDEX TO FORM 10-Q



		Page
PART I. FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets (Unaudited) as of March 31, 2016 and December 31, 2015	2
	Condensed Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2016 and 2015	3
	Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2016 and 2015 (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2016 and 2015	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.	Controls and Procedures	26
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 6.	Exhibits	27
Signatures		29

Table of Contents

PART I

Item 1. Condensed Consolidated Financial Statements

SKULLCANDY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands of dollars)

(unaudited)



	March 31, 2016			December 31, 2015
Assets
Current assets:
Cash and cash equivalents	$	29,208		$	23,030
Short-term investments	16,550			543
Total cash, cash equivalents, and short-term investments	45,758			23,573
Accounts receivable, net	46,834			84,909
Inventories, net	43,185			41,686
Prepaid expenses and other current assets	12,389			6,189
Current deferred tax assets	3,418			3,999
Total current assets	151,584			160,356
Property and equipment, net	14,477			14,830
Intangibles	7,088			7,433
Goodwill	13,867			13,867
Deferred financing fees	29			31
Non-current deferred tax assets	578			923
Other non-current assets	796			250
Total assets	$	188,419		$	197,690
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	12,856		$	13,216
Accrued liabilities	16,644			21,931
Current deferred tax liabilities	371			190
Total current liabilities	29,871			35,337
Non-current deferred tax liabilities	1,072			1,148
Other non-current liabilities	1,197			1,117
Total liabilities	32,140			37,602
Stockholders’ equity:
Preferred stock	—			—
Common stock	3			3
Treasury stock	(43,294		)	(43,294		)
Additional paid-in capital	138,679			137,535
Accumulated other comprehensive loss	(866		)	(818		)
Retained earnings	61,757			66,662
Total stockholders’ equity	156,279			160,088
Total liabilities and stockholders’ equity	$	188,419		$	197,690

See Accompanying Notes to Condensed Consolidated Financial Statements

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SKULLCANDY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands of dollars, except per share information)

(unaudited)



	Three months ended March 31,
	2016			2015
Net sales	$	46,286		$	45,642
Cost of goods sold	28,920			26,983
Gross profit	17,366			18,659
Selling, general and administrative expenses	24,140			22,307
Loss from operations	(6,774		)	(3,648		)
Other expense	180			995
Interest income	(12		)	(16		)
Loss before income taxes and noncontrolling interests	(6,942		)	(4,627		)
Income tax benefit	(2,037		)	(793		)
Net loss	(4,905		)	(3,834		)
Net loss attributable to noncontrolling interests	—			(103		)
Net loss attributable to Skullcandy, Inc.	$	(4,905	)	$	(3,731	)
Net loss per common share attributable to Skullcandy, Inc.
Basic	$	(0.17	)	$	(0.13	)
Diluted	$	(0.17	)	$	(0.13	)
Weighted average common shares outstanding
Basic	28,562			28,267
Diluted	28,562			28,267

See Accompanying Notes to Condensed Consolidated Financial Statements

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SKULLCANDY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands of dollars)

(unaudited)



	Three Months Ended March 31,
	2016			2015
Net loss	$	(4,905	)	$	(3,834	)
Unrealized (loss) gain on foreign currency cash flow hedges, net of tax (expense) benefit of $21 and ($132) for the three months ended March 31, 2016 and 2015, respectively	(41		)	264
Change in unrecognized actuarial loss, net of tax benefit of $4 and $0 for the three months ended March 31, 2016 and 2015, respectively	(38		)	—
Unrealized gain on available-for-sale securities, net of tax expense (benefit) of $0 for the three months ended March 31, 2016 and 2015, respectively	1			—
Foreign currency translation adjustment	30			(124		)
Comprehensive loss	(4,953		)	(3,694		)
Comprehensive loss attributable to noncontrolling interests	—			(103		)
Comprehensive loss attributable to Skullcandy, Inc.	$	(4,953	)	$	(3,591	)

See Accompanying Notes to Condensed Consolidated Financial Statements

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SKULLCANDY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands of dollars)

(unaudited)



	Three Months Ended March 31,
	2016			2015
Operating activities
Net loss	$	(4,905	)	$	(3,834	)
Adjustments to reconcile net loss to net cash provided (used in) by operating activities:
Depreciation of fixed assets and amortization of intangible assets	2,585			2,593
Loss on disposal of property and equipment and intangible assets	—			64
Provision for doubtful accounts	(162		)	(258		)
Deferred income taxes	1,061			1,604
Non-cash interest expense	2			2
Amortization of stock-based compensation expense	1,340			1,075
Foreign currency remeasurement (gain) loss	(563		)	550
Changes in operating assets and liabilities:
Accounts receivable	38,386			28,885
Inventories	(1,254		)	(9,261		)
Prepaid expenses and other assets	(6,192		)	(298		)
Accounts payable	(476		)	(5,568		)
Accrued liabilities	(5,834		)	(16,516		)
Net cash provided by (used in) provided by operating activities	23,988			(962		)
Investing activities
Purchase of property and equipment	(1,737		)	(1,265		)
Purchases of short-term investments	(16,009		)	(11		)
Net cash used in investing activities	(17,746		)	(1,276		)
Financing activities
Proceeds from exercise of stock options	—			292
Taxes paid related to net share settlement of equity awards	(132		)	(272		)
Income tax (detriment) benefit from share based compensation	(63		)	54
Net cash (used in) provided by financing activities	(195		)	74
Effect of exchange rate changes on cash and cash equivalents	131			(92		)
Net increase (decrease) in cash and cash equivalents	6,178			(2,256		)
Cash and cash equivalents, beginning of period	23,030			21,623
Cash and cash equivalents, end of period	$	29,208		$	19,367
Supplemental disclosure of cash flow information:
Cash paid for income tax	$	4,182		$	3,450
Supplemental non-cash activities:
Purchase of convertible note through accrued liabilities	$	500		$	—
Purchases of property and equipment financed through accounts payable	$	99		$	2,942

See Accompanying Notes to Condensed Consolidated Financial Statements

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1) Description of Business

Skullcandy, Inc. creates world-class audio experiences through its Skullcandy® and Astro Gaming® brands. Founded at the intersection of music, sports, technology and creative culture, Skullcandy brand creates world-class audio and gaming products for the risk takers, innovators, and pioneers who inspire us all to live life at full volume. From new innovations in the science of sound and human potential, to collaborations with up-and-coming musicians and athletes, Skullcandy lives by its mission to inspire life at full volume through forward-thinking technologies and ideas, and leading edge design and materialization. Astro Gaming creates premium video gaming equipment for professional gamers, leagues, and gaming enthusiasts. Astro Gaming was founded in the pits of competitive gaming and has become synonymous with pinnacle gaming experiences. Skullcandy and Astro Gaming products are sold and distributed through a variety of channels around the world from the Company’s global locations in Park City, San Francisco, London, Tokyo, Zurich, Mexico City, and Shanghai, as well as through partners in some of the most important culture, sports, and gaming hubs in the world. The Skullcandy brand website can be found at http://www.skullcandy.com. The Astro Gaming website can be found at http://www.astrogaming.com.

(2) Basis of Presentation

The accompanying condensed consolidated balance sheets as of March 31, 2016 and December 31, 2015, condensed consolidated statements of operations for the three months ended March 31, 2016 and 2015, condensed consolidated statements of comprehensive loss for the three months ended March 31, 2016 and 2015, and condensed consolidated statements of cash flows for the three months ended March 31, 2016 and 2015 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 as of March 31, 2016 and 2015, results of operations for the three months ended March 31, 2016 and 2015, and cash flows for the three months ended March 31, 2016 and 2015. The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. 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 4, 2016. The December 31, 2015 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.

Prior period amounts have been reclassified to correct for immaterial error corrections and conform with current presentation for certain reclassifications of certain gaming licenses, marketing development fees, and slotting fees between SG&A and costs of goods sold. These reclassifications in total reduced gross profit and operating expenses by $59,000 and did not result in any adjustment to operating loss, net income, or earnings per share.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The Company entered into a joint venture in Mexico on September 19, 2011. The Company had 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 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 financial statements for the 2015 period. On December 31, 2015, the Company acquired the minority interest in its Mexico joint venture to gain full control of the efforts in this market and now operates a wholly-owned subsidiary in this market. As the Company retained its controlling financial interest in the subsidiary, this transaction was accounted for as an equity transaction. The carrying amount of the noncontrolling interest was reduced to zero to reflect the purchase, and the difference between the price paid by the Company and the adjustment to the carrying value of the noncontrolling interest was recorded as an adjustment to equity attributable to the parent. All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)

Recently Issued Accounting Pronouncements

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory ("ASU 2015-11"). Upon adoption by an entity, ASU 2015-11 will simplify the subsequent measurement of inventory by replacing the current lower of cost or market test with a lower of cost and net realizable value test. The new guidance applies only to inventories for which cost is determined by methods other than last-in-first-out (LIFO) and the retail inventory method. For inventory within the scope of ASU 2015-11, entities will be required to compare the cost of inventory to only one measure, its net realizable value, and not the three measures required by current guidance ("market," "subject to a floor," and a "ceiling"). When evidence exists that the net realizable value of inventory is less than its cost (due to damage, physical deterioration, obsolescence, changes in price levels or other causes), entities will recognize the difference as a loss in earnings in the period in which it occurs. ASU 2015-11 is effective for public entities for fiscal years beginning after December 15, 2016, and interim periods within the year of adoption. Early adoption is permitted. The Company expects to adopt the provisions of ASU 2015-11 at the beginning of fiscal 2017. The Company does not believe the adoption of ASU 2015-11 will have a material impact on its consolidated financial condition, results of operations, or cash flows, and is still evaluating the impact that this standard will have on the consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. The amendments in this ASU are effective for reporting periods beginning after December 15, 2016, with early adoption permitted. The Company is currently assessing the impact the adoption of ASU 2014-15 will have on its financial statements.

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes ("ASU 2015-17"). Current GAAP requires the deferred taxes for each tax jurisdiction (or tax-paying component of a jurisdiction) to be presented as a net current asset or liability and net noncurrent asset or liability. This requires a jurisdiction-by-jurisdiction analysis based on the classification of the assets and liabilities to which the underlying temporary differences relate based on the period in which the attribute is expected to be realized. Upon adoption of ASU 2015-17, all deferred tax assets and liabilities will be classified as noncurrent on an entity's balance sheet. As a result, each jurisdiction will have only one net noncurrent deferred tax asset or liability. ASU 2015-17 will not change the existing guidance that prohibits the offsetting of deferred tax liabilities of one jurisdiction against the deferred tax assets of another jurisdiction. ASU 2015-17 is effective for public entities in fiscal years beginning after December 15, 2016, including interim periods in the year of adoption. Early adoption is permitted, and adoption may be applied either prospectively or retrospectively. The Company plans to adopt ASU 2015-17 at the beginning of the first quarter of fiscal 2017. ASU 2015-17 will only involve classification of certain deferred tax assets and liabilities on the Company's consolidated balance sheet and will have no impact on the Company's results of operations or cash flows. The Company does not expect the adoption of ASU 2015-17 to be material to the Company's consolidated balance sheets.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This update requires an entity to recognize assets and liabilities for leases with lease terms of more than 12 months on the balance sheet. The Company plans to adopt this standard on January 1, 2019 and is still evaluating the impact that this standard will have on the consolidated financial statements.

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This update simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company plans to adopt this standard on January 1, 2017, and is still evaluating the impact that this standard will have on the consolidated financial statements.

In May 2014, the 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. It is effective for annual reporting periods beginning after December 15, 2016, including interim reporting periods. Entities may use a full retrospective approach or report the cumulative effect as of the date of adoption. The Company will adopt this standard on January 1, 2018. The Company has not yet determined the adoption approach and is currently evaluating the impact the adoption of this standard will have on the consolidated financial statements.

(3) Investments

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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 condensed 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 March 31, 2016, 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	$	16,552	$	(2	)	$	16,550

During the three months ended March 31, 2016, the Company did not sell any of its short-term investments, but made purchases of $16.0 million. The Company also did not recognize any other-than-temporary impairment, proceeds, or realized gains or losses as of March 31, 2016, and does not expect any significant other-than-temporary impairments in future periods.

At December 31, 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	$	543	$	(2	)	$	541

(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.”

The Company records all derivatives on the 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 ineffective portion 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.

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)

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 months ended March 31, 2016 and 2015, respectively (in thousands):



	Three Months Ended March 31,
	2016			2015
Total impact on net sales	$	124		$	131
Total impact on other income (expense)	(978		)	245
	$	(854	)	$	376

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 net sales expected to be realized over a maximum of twelve months. 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 and that qualify as cash flow hedges of foreign exchange risk is deferred as a component of accumulated other comprehensive income in the accompanying consolidated balance sheets and is subsequently reclassified into earnings in the period that the hedged forecasted sales transactions effect earnings. The ineffective portion of the changes in fair value of derivatives designated as cash flow hedges are recognized directly to earnings and reflected in the accompanying consolidated statements of operations.

As of March 31, 2016, 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	18	€	6,128	$	6,815
Sell GBP/Buy USD Forward Contract	18	£	8,198	$	12,222
	36			$	19,037

These contracts have maturities of 12 months or less.

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):

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)



	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
	March 31, 2016			March 31, 2015			March 31, 2016			March 31, 2015				March 31, 2016		March 31, 2015
Sell EUR/Buy USD Forward Contract	$	(220	)	$	264	Net sales	$	(1	)	$	49		Net sales	$	—	$	—
Sell GBP/Buy USD Forward Contract	270			163		Net sales	113			(19		)	Net sales	—		—
	$	50		$	427		$	112		$	30			$	—	$	—

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.

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 “Net Sales" and "Other (income) expense.” As of March 31, 2016, 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	11	€	2,668	$	2,971
Sell GBP/Buy USD Forward Contract	1	£	2,074	$	2,961
Sell CAD/Buy USD Forward Contract	25	C$	14,269	$	10,722
Sell CHF/Buy USD Forward Contract	18	$	3,427	Fr.	3,289
Sell MXN/Buy USD Forward Contract	18	$	98,518	$	5,630
Sell JPY/Buy USD Forward Contract	1	¥	275,198	$	2,430
Sell CNY/Buy USD Forward Contract	13	¥	33,644	$	5,072
	87

These contracts generally have maturities of within the next twelve months.

The following table summarizes the amount of income (loss) 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):

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)



	Location of Gain (Loss) Recognized in Income on Derivative	Amount of Gain (Loss) Recognized in Income on Derivatives
		Three months ended March 31,
		2016			2015
Forecasted sales hedges
Sell EUR/Buy USD Forward Contract	Net sales	$	(24	)	$	119
Sell GBP/Buy USD Forward Contract	Net sales	36			(17		)
Sell CAD/Buy USD Forward Contract	Other income (expense)	(404		)	1
Sell USD/Buy CHF Forward Contract	Other income (expense)	99			(1		)
Sell MXN/Buy USD Forward Contract	Other income (expense)	(31		)	(2		)
Sell JPY/Buy USD Forward Contract	Other income (expense)	—			—
Sell CNY/Buy USD Forward Contract	Other income (expense)	(72		)	—
		$	(396	)	$	100
Monetary asset and liability hedges
Sell EUR/Buy USD Forward Contract	Other income (expense)	$	(126	)	$	168
Sell GBP/Buy USD Forward Contract	Other income (expense)	232			113
Sell CAD/Buy USD Forward Contract	Other income (expense)	(249		)	21
Sell USD/Buy CHF Forward Contract	Other income (expense)	—			—
Sell MXN/Buy USD Forward Contract	Other income (expense)	(61		)	(40		)
Sell JPY/Buy USD Forward Contract	Other income (expense)	(179		)	(17		)
Sell CNY/Buy USD Forward Contract	Other income (expense)	(187		)	—
		$	(570	)	$	245

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):

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)



	Derivative Assets				Derivative Liabilities
	March 31, 2016		December 31, 2015		March 31, 2016		December 31, 2015
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	$	—	$	47	$	197	$	16
Sell GBP/Buy USD Forward Contract	452		273		21		—
	$	452	$	320	$	218	$	16
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	$	14	$	45	$	81	$	57
Sell GBP/Buy USD Forward Contract	—		27		20		—
Sell CAD/Buy USD Forward Contract	23		211		290		14
Sell CHF/Buy USD Forward Contract	42		3		21		116
Sell MXN/Buy USD Forward Contract	59		86		86		5
Sell JPY/Buy USD Forward Contract	—		—		17		1
Sell CNY/Buy USD Forward Contract	5		—		118		30
	$	143	$	372	$	633	$	223

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 liability position of $256,000 as of March 31, 2016 and a net asset position of $453,000 as of December 31, 2015.

(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:

The fair value of these financial instruments was determined using the following levels of inputs as of March 31, 2016 (in thousands):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)



	Fair Value Measurements at March 31, 2016
	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	$	—	$	595	$	—	$	595
Cash equivalents - Money market funds	2,401		—		—		2,401
Debt mutual funds	—		16,550		—		16,550
Total assets	$	2,401	$	17,145	$	—	$	19,546

Liabilities:
Derivative financial instruments	—		851		—		851

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 March 31, 2016.

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, 2015 (in thousands):



	Fair Value Measurements at December 31, 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	$	—	$	692	$	—	$	692
Cash equivalents - Money market funds	400		—		—		400
Debt mutual funds	—		541		—		541
Total assets	$	400	$	1,233	$	—	$	1,633

Liabilities:
Derivative financial instruments	—		239		—		239

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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. Two customer accounted for a significant portion of sales for the periods presented, which are as follows:



	Three Months Ended March 31,
	2016		2015
Customer A	20.9	%	17.8	%
Customer B	14.9	%	*
*Indicates less than 10% of net sales for the period

Customer A above accounted for 22% and 26% of the Company’s accounts receivable as of March 31, 2016 and December 31, 2015, respectively. Customer B above accounted for 10% and 8% as of March 31, 2016 and December 31, 2015, respectively. One other customer accounted for 10% of the Company's accounts receivable as of March 31, 2016, however this customer accounted for less than 10% of the Company's accounts receivable as of December 31, 2015.

(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, 2015	$	3,253		$	7,037
Provision	(162		)	7,633
Deductions	(90		)	(10,173		)
Balance, March 31, 2016	$	3,001		$	4,497

(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, 2015	$	792
Warranty claims	(190		)
Warranty costs accrued	148
Balance at March 31, 2016	$	750

(9) Property and Equipment, Net

Property and equipment, net, consisted of the following:

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)



	March 31, 2016			December 31, 2015
	(in thousands)
Cost:
Leasehold improvements	$	3,309		$	3,281
Furniture and fixtures	10,169			9,341
Other equipment	12,369			12,214
Computer equipment and software	7,899			6,998
Vehicles	212			212
Total cost:	33,958			32,046
Less accumulated depreciation	(19,481		)	(17,216		)
Property and equipment, net	$	14,477		$	14,830

(10) Net Loss per Share

Basic net loss per common share is computed by dividing the net 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 loss per share is computed using only the weighted-average number of common shares outstanding during the period, as any additional dilutive common shares would be anti-dilutive.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net loss per common share is as follows:



	Three Months Ended March 31,
	2016			2015
	(in thousands)
Numerator
Net loss attributable to Skullcandy, Inc.	$	(4,905	)	$	(3,731	)
Denominator
Weighted average common stock outstanding for basic net loss per common share	28,562			28,267
Effect of dilutive securities—unvested restricted stock and stock options	—			—
Weighted average common shares and dilutive securities outstanding	28,562			28,267

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 March 31,
	2016	2015
	(in thousands)
Stock options and restricted stock awards	4,184	1,102

(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 million, and expires on August 19, 2018. As a subfeature, the credit facility provided for letters of credit up to $5 million. The credit facility is secured with a first-priority lien against substantially all of the assets of the Company.

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

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)

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 also contains certain financial covenants and other restrictions that limit the Company’s ability, among other things, to: (a) make fixed asset purchases in any fiscal year 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 March 31, 2016, 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, 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 March 31,
	2016			2015
	(in thousands)
Net sales
Domestic	$	31,769		$	30,624
International	14,517			15,018
Consolidated net sales	$	46,286		$	45,642
Gross profit
Domestic	$	12,083		$	12,327
International	5,283			6,332
Consolidated gross profit	$	17,366		$	18,659
Income (loss) from operations
Domestic	$	(5,944	)	$	(4,826	)
International	(830		)	1,178
Consolidated loss from operations	$	(6,774	)	$	(3,648	)

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)



	March 31,		December 31,
	2016		2015
	(in thousands)
Identifiable assets
Domestic	$	126,767	$	129,102
International	61,652		68,588
Consolidated	$	188,419	$	197,690
Long-lived assets
Domestic	$	14,530	$	15,397
International	7,035		6,866
Consolidated	$	21,565	$	22,263
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.

Summary of Share-Based Compensation

The Company recorded share-based compensation expense related to awards of $1.3 million and $1.1 million for the three months ended March 31, 2016 and 2015, 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 March 31, 2016 was $6.8 million which is expected to be recognized over the weighted average remaining vesting period of 2.60 years.

Stock Options

The following table summarizes stock option activity under the Company’s stock option plans for the three months ended March 31, 2016 (share information in thousands):



	Options Outstanding		Price Range	Weighted- Average Price		Weighted- Average Contractual Term (in years)	Aggregate Intrinsic Value (1)
Balance at December 31, 2015	2,052		0.37 – 20.00	$	7.98
Granted	587		4.12	4.12
Exercised	—		—	—
Canceled and forfeited	(4	)	5.33	5.33
Balance at March 31, 2016	2,635		0.37 – 20.00	$	7.14	7.65	$	167
Vested	1,220		0.37 – 20.00	$	8.53	6.32	$	167
Unvested	1,415		4.12 – 12.42	$	6.18	8.80	$	—
Exercisable

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)

(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 March 31, 2016.

Performance-Based Restricted Stock Units

The following table summarizes PSU activity under the Company’s incentive award plan for the three months ended March 31, 2016 (share information in thousands):



	PSUs Outstanding	Weighted- Average Grant Date Fair Value
Balance at December 31, 2015	19	$	9.28
Granted	232	4.12
Vested	—	—
Forfeited	—	—
Balance at March 31, 2016	251	$	4.51

Restricted Stock Units

The following table summarizes RSU activity under the Company’s incentive award plan for the three months ended March 31, 2016 (share information in thousands):



	RSUs Outstanding		Weighted- Average Grant Date Fair Value
Balance at December 31, 2015	1,011		$	7.03
Granted	592		4.11
Vested	(131	)	9.20
Forfeited	(38	)	6.09
Balance at March 31, 2016	1,435		$	5.66

(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 benefit for the three months ended March 31, 2016 and 2015 was $2,037,000 and $793,000, respectively, or approximately 29.3% and 17.1% of pre-tax loss. The increase in the Company’s effective tax rate for the three months ended March 31, 2016 reflects a reduction in taxable income in low tax rate jurisdictions. The Company's effective tax rate for the three months ended March 31, 2016 differs from the United States Federal Statutory rate of 35%, due to a few discrete items and income derived from jurisdictions with different tax rates than the U.S.

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 March 31, 2016 and December 31, 2015, the Company had uncertain tax liabilities of $441,000 and $384,000, 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.

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SKULLCANDY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(CONTINUED)

(unaudited)

(15) Commitments and Contingencies

On November 5, 2015, Peter Kravitz, as Liquidating Trustee of the RSH Liquidating Trust, filed a complaint against the Company in the U.S. States Bankruptcy Court for the District Court of Delaware alleging payments received by the Company were preferential payments and seeking the return of approximately $4.0 million in payments. The Company operated under a consignment relationship with the former Radio Shack entity. Therefore, the Company believes the payments received are not considered preferential and intends to vigorously defend this action.

The Company is also subject to other various claims, complaints and legal actions in the normal course of business. The Company does not believe it has any currently pending litigation of which the outcome will have a material adverse effect on its operations or financial position.

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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 (unaudited) and the related notes (unaudited) 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, 2015 filed with the Securities and Exchange Commission on March 4, 2016.

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, 2015 filed with the Securities and Exchange Commission on March 4, 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 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.

Basis of Presentation

Our net sales are derived primarily from the sale of headphones and audio accessories under the Skullcandy and Astro Gaming brand names. Amounts billed to retailers for shipping and handling are included in net sales. Sales are reported net of estimated product returns and pricing adjustments. The Domestic segment primarily consists of Skullcandy and Astro Gaming product sales to customers in the United States. The international segment primarily includes product sales to customers outside the United States.

Gross profit is influenced by cost of goods sold, which consists primarily of product costs, packaging, freight, duties and warehousing. We are experiencing higher product costs due to increasing labor and other costs in China. If we are unable to pass along these costs to our retailers and distributors or shift our sales mix to higher margin products, our gross profit as a percentage of net sales, or gross margin, may decrease.

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Our selling, general and administrative expenses consist primarily of marketing and advertising expenses, wages, related payroll and employee benefit expenses, including stock-based compensation, commissions to outside sales representatives, legal and professional fees, travel expenses, utilities, other facility related costs, such as rent and depreciation, amortization of intangible assets and consulting expenses. The primary components of our marketing and advertising expenses include in-store advertising and maintenance of in-store assets, brand building fixtures, content creation, sponsorship of trade shows and events, promotional products and sponsorships for athletes, musicians and artists.

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 Europe, Asia, Canada, Mexico, and all other geographic areas outside the United States that are served by our International operations. We operate primarily in the consumer products category in which we develop and distribute 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 March 31,
	2016			2015
	(in thousands)
Net sales
Domestic	$	31,769		$	30,624
International	14,517			15,018
Consolidated net sales	$	46,286		$	45,642
Gross profit
Domestic	$	12,083		$	12,327
International	5,283			6,332
Consolidated gross profit	$	17,366		$	18,659
Income (loss) from operations
Domestic	$	(5,944	)	$	(4,826	)
International	(830		)	1,178
Consolidated loss from operations	$	(6,774	)	$	(3,648	)

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	March 31,		December 31,
	2016		2015
	(in thousands)
Identifiable assets
Domestic	$	126,767	$	129,102
International	61,652		68,588
Consolidated	$	188,419	$	197,690
Long-lived assets
Domestic	$	14,530	$	15,397
International	7,035		6,866
Consolidated	$	21,565	$	22,263
Goodwill
Domestic	$	6,805	$	6,805
International	7,062		7,062
Consolidated	$	13,867	$	13,867

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 March 31,
	2016					2015
Net sales	$	46,286		100.0	%	$	45,642		100.0	%
Cost of goods sold	28,920			62.5	%	26,983			59.1	%
Gross profit	17,366			37.5	%	18,659			40.9	%
Selling, general and administrative expenses	24,140			52.2	%	22,307			48.9	%
Loss from operations	(6,774		)	(14.6	)%	(3,648		)	(8.0	)%
Other expense	180			0.4	%	995			2.2	%
Interest income	(12		)	—	%	(16		)	—	%
Loss before income taxes and noncontrolling interests	(6,942		)	(15.0	)%	(4,627		)	(10.1	)%
Benefit for income taxes	(2,037		)	(4.4	)%	(793		)	(1.7	)%
Net loss	(4,905		)	(10.6	)%	(3,834		)	(8.4	)%
Net loss attributable to noncontrolling interests	—			—	%	(103		)	(0.2	)%
Net loss attributable to Skullcandy, Inc.	$	(4,905	)	(10.6	)%	$	(3,731	)	(8.2	)%

Three Months Ended March 31, 2016 Compared to Three Months Ended March 31, 2015

Net sales

The following table reflects our net sales for three months ended March 31, 2016 and 2015 (in thousands):



	Three Months Ended March 31,
	2016		2015		$ Change			% Change
Net sales
Domestic	$	31,769	$	30,624	$	1,145		3.7	%
International	14,517		15,018		(501		)	(3.3	)%
Total net sales	$	46,286	$	45,642	$	644		1.4	%

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Total net sales increased 1.4%. Domestic (U.S.) net sales increased 4% to $31.8 million from $30.6 million in the same quarter a year ago, primarily due to strong holiday sell through that resulted in post-holiday replenishment sales of audio and wireless products. International (Non U.S.) net sales decreased 3% to $14.5 million from $15.0 million in the same quarter a year ago, primarily due to decreased sales in China, partially offset by strong sales in Europe, Canada, Japan and Mexico.

Gross profit and gross margin

The following table reflects our gross profit and gross margin for the three months ended March 31, 2016 and 2015 (in thousands):



	Three Months Ended March 31,
	2016			2015			$ Change			% Change
Gross profit
Domestic	$	12,083		$	12,327		$	(244	)	(2.0	)%
International	5,283			6,332			(1,049		)	(16.6	)%
Total gross profit	$	17,366		$	18,659		$	(1,293	)	(6.9	)%

	Three Months Ended March 31,
	2016			2015			Basis Point Change
Gross margin %
Domestic %	38.0		%	40.3		%	(230		)
International %	36.4		%	42.2		%	(580		)
Total gross margin %	37.5		%	40.9		%	(340		)

Total gross margin decreased across both segments. This decrease reflects product mix shifts to lower margin audio wireless products as percentage of net sales, increased warehousing costs as a percentage of net sales, together with higher retailer promotional credits and returns in the U.S. and China. Wireless products typically have lower margins which are partially driven by higher third party technology and licensing costs.

Selling, general and administrative expenses

The following table reflects our selling, general and administrative expenses for the three months ended March 31, 2016 and 2015 (in thousands):



	Three Months Ended March 31,
	2016			2015			$ Change		% Change
Selling, general and administrative expenses	$	24,140		$	22,307		$	1,833	8.2	%
Selling, general and administrative expenses as a percent of net sales	52.2		%	48.9		%

The increase in SG&A expenses is primarily due to increases in personnel related expenses, specifically in our Astro brand, demand creation and research and innovation expenses, partially offset by decreases in information technology related expenses.

Other Expense

Other expense was $180,000 and $995,000 for the three months ended March 31, 2016 and 2015, respectively, which includes net expenses related to our hedging program and foreign currency activities and general currency fluctuations compared to the U.S. dollar.

Interest Income

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Interest income was $12,000 and $16,000 for the three months ended March 31, 2016 and 2015, 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 benefit was $2,037,000 and $793,000 for the three months ended March 31, 2016 and 2015, respectively. Our effective tax rate for the three months ended March 31, 2016 and 2015 was (29.3%) and (17.1)%, respectively. The increase in rate in between periods is due to a higher estimated annual effective rate in 2016 as a result of less forecasted income in our low tax rate jurisdictions.

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):



	Three Months Ended March 31,
	2016			2015
Cash and cash equivalents at beginning of period	$	23,030		$	21,623
Net cash provided by (used in) operating activities	23,988			(962		)
Net cash used in investing activities	(17,746		)	(1,276		)
Net cash (used in) provided by financing activities	(195		)	74
Effect of exchange rate changes on cash and cash equivalents	131			(92		)
Cash and cash equivalents at end of period	$	29,208		$	19,367

Net Cash Provided by (Used in) Operating Activities. Cash from operating activities consists primarily of net 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 three months ended March 31, 2016, net cash provided by operating activities was $24.0 million and consisted of a net loss of $4.9 million, less $24.6 million of working capital and other activities, offset by increases of $4.8 million of non-cash items. Working capital and other activities consisted primarily of a decrease in accounts receivable of $38.4 million, decreases in accounts payable of $0.5 million and accrued liabilities of $5.8 million, offset by increases in prepaid expenses and other current assets of $6.2 million, and increase in inventory of $1.3 million.

For the three months ended March 31, 2015, net cash used in operating activities was $(1.0) million and consisted of a net loss of $3.8 million, less $2.2 million of working capital and other activities, offset by increases of$5.1 million of non-cash items. Working capital and other activities consisted primarily of a decrease in accounts receivable of $28.9 million, decreases in accounts payable of $5.0 million and accrued liabilities of $16.5 million, offset by increases in prepaid expenses and other current assets of $0.3 million, and increases in inventory of $9.3 million.

Net Cash Used in Investing Activities. Net cash used in investing activities was $17.7 million and $1.3 million for the three months ended March 31, 2016 and 2015, respectively. Net cash used in investing activities relates to capital expenditures for in-store displays and purchases of short-term investments.

Net Cash (Used in) Provided by Financing Activities. Net cash used in financing activities primarily related to taxes paid related to net share settlement of equity awards for the three months ended March 31, 2016. Net cash provided by (used in) 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 three months ended March 31, 2015.

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.

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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 million, and expires on August 19, 2018. As a subfeature, the credit facility provided for letters of credit up to $5 million. 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 million 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 March 31, 2016, we were in compliance with all applicable covenants in our credit facility.

Contractual obligations

In the three months ended March 31, 2016, 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, 2015.

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, 2015.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

At March 31, 2016, 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 March 31, 2016, 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 March 31, 2016, 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.

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. 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

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effect on our reported results from our European operation because it takes more profits in Euro to generate the same amount of profits in stronger U.S. dollars. We do not enter into foreign currency exchange contracts to hedge the translation of operating results and financial position of our international subsidiaries, therefore we are subject to foreign currency impacts.

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. On the date we enter into a derivative contract, we 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 or are no longer deemed effective to qualify for hedge accounting but are used by management to mitigate exposure to currency risks are marked to fair value with corresponding gains or losses recorded in earnings. We enter into forward exchange and other derivative contracts with major banks and are exposed to foreign currency 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.

The net fair value of foreign currency forward contracts (including adjustments for credit risk) as of March 31, 2016 and December 31, 2015 was a net liability of $256,000 and a net asset of $453,000, 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 not have a material effect on our results of operations or financial condition.

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 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 March 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

Item 1. Legal Proceedings.

On February 12, 2016, an alleged shareholder filed a putative securities class action complaint against the Company and certain Company officers and directors in the United States District Court for the District of Utah, captioned Davis v. Skullcandy, Inc., et al., No. 2:16-cv-00121-RJS. The complaint purports to be brought on behalf of shareholders who purchased common stock between August 7, 2015 and January 11, 2016. It asserts that the Company and certain officers and directors violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by making allegedly false or misleading statements concerning positioning and expectations for future growth. The complaint seeks damages in an unspecified amount and equitable relief against the defendants. On March 28, 2016, an alleged shareholder filed a substantially similar putative securities class action complaint in the United States District Court for the District of Utah, captioned Oswald v. Skullcandy, Inc., et al., No. 2:16-cv-00246-CW. The Oswald Complaint purports to be brought on behalf of shareholders who purchased common stock between May 5, 2015 and January 11, 2016. Plaintiffs have requested that the court consolidate the two complaints. The Company believes these lawsuits are without merit and intends to vigorously defend them.

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, 2015 filed with the SEC on March 4, 2016. There have been no significant changes to the risks discussed in our 2015 10-K.

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.

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Exhibit No.	Description of Exhibit

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 March 31, 2016, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Comprehensive Loss (iv) Condensed Consolidated Statements of Cash Flows; and (v) Notes to Condensed Consolidated Financial Statements.

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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: May 6, 2016	By:	/s/ JASON HODELL
		Jason Hodell
		Chief Financial Officer and Chief Operating Officer
		(Principal Financial Officer and Duly Authorized Signatory)

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