K2 Inc. leveraged acquisitions and 9% internal organic growth to post a 74.9% increase in fourth quarter sales to $338.9 million, compared to $193.8 million last year. In spite of the strong growth rate, several analysts downgraded the companys stock. At issue is the SG&A expenses related to K2s Volkl, Marker and Marmot acquisitions late in the first half of 2004.
K2 acquired shortly after the majority of the SG&A expenses for the year were recorded. This helped make K2s fiscal 2004 look healthier and analysts were expecting similar profitability in 2005. Street EPS consensus estimates were at 27 cents for the 2005 first quarter and $1.03 for the year. In spite of the fact that K2 repeatedly stated that SG&A is front-loaded in its winter sports brands, Wall Street apparently thought the company could dodge these expenses again. KTO sees Q1 diluted EPS at a penny to three cents per share and fiscal 05 diluted EPS of 87 cents to 91 cents.
KTO shares were down 4.5% for the week to close at $13.90 on Friday.
In a conference call with analysts K2s chairman and CEO Richard Heckman, said, “It was a lot more painful when we bought Rawlings at the end of their cycle We had to tell everybody that there were going to be nine months of losses and you have to trust us that were going to see the revenues. With respect to Volkl, Marker, and Marmot, you dont have to trust us on the revenues. You can pretty much trust us on the expenses.” Heckman also emphasized the fact that the acquisitions were accretive to earnings on both a GAAP basis (without the H1 SG&A) and also on a pro-forma basis (with the H1 SG&A).
Fourth quarter sales broken down by division were primarily driven by acquisitions.
In the Action Sports group, sales of skis, snowboards, in-line skates, bikes, snowshoes and paintball products totaled $178.4 million in Q4, an increase of 130.1% over the 2003 quarter. Growth was driven by double-digit sales increases of K2 skis, snowshoes, improved sales of snowboards, and the acquisitions of Volkl and Marker in Q3 2004.
In the Apparel/Footwear group, Earth Products, Ex Officio and Marmot had Q4 sales of $43.9 million or an increase of 437.4% over the 2003 period. The increase was due in part to 58.4% growth in technical skate footwear and apparel, but was primarily driven by acquisitions of Ex Officio and Marmot in the second and third quarters of 2004.
In the Marine & Outdoor group, Shakespeare fishing tackle & monofilament and Stearns marine & outdoor products generated sales of $62.2 million in Q4, an increase of 2.8% from the comparable quarter in 2003. Sales increases were driven by growth in children's flotation devices and the addition of All-Star rods and ATV accessory product lines during 2004.
In Team Sports, Rawlings, Worth, and K2 Licensing & Promotions had total sales of $54.4 million in Q4, up 14.3% from the 2003 period. Growth was primarily driven by the acquisition of K2 Licensing & Promotions in January 2004.
Looking into the current operations, K2 admitted that the winter market has been very difficult this year, with the Northwest and the Mid-Atlantic both down due to weather. Europe also had a tough start to the season with January sales down 30%, but since then it has bounced back somewhat. Heckman said that the overall SnowSports business will be down roughly 10% or more this year, but that K2 has fared well and sales will actually be up for the companys various brands.
K2s most recent inventory check was said to be, “significantly better that we were afraid it was going to be.” K2 estimates that between its three different ski brands it holds 50% of the U.S. womens market and 37% of all skis sold in the U.S. The company sold 100,000 pairs of ski poles in 2004 compared to zero the year before.
K2 is also on track to launch multiple brands of apparel in 2005, using Marmots sourcing and design expertise. Retailers will more than likely get their first look at next years winter shows.
The company is also keeping a close eye on the paintball market. The main reason for this concern is that K2 has invested heavily in the sector, and several competitors have recently been acquired by different financial firms. “Were taking this opportunity to go after market share, and were going after it hard,” said Heckman.
Manufacturing for the Brass Eagle branded product has begun its move to K2s China facility, and the company expects to see synergies from that move in late 2005.
Heckman said that the fishing market will be up in the “low single digits” over last year, with early order of premium products “way above last years levels.” K2 expects a 10% market share in fishing by the end of 2005.
Stearns, Marine and Outdoor division is “slightly ahead of last year,” with spring orders up in the “low-single digits.” K2 is entering the hunting boot market with its new Mad Dog brand, which is expected to ship 200,000 pair in 2005.
K2s fourth quarter gross margin increased 470 basis points to 34.5% of sales, as compared to 29.8% in 2003. The company is expecting even better margins as integration into its Chinese manufacturing facility progresses. Each percentage point of margin improvement equals roughly 15 cents added to the bottom line EPS. SG&A expenses were 28.1% of sales in the fourth quarter, compared to 27.0% of net sales in the prior year. Net income during the fourth quarter was $8.8 million, a 310% increase over $2.2 million in 2003. Diluted EPS was 18 cents compared to 7 cents last year with roughly 25,000 additional outstanding shares.
