K2 Inc. Profits Hurt by Goodwill Write-Down…

K2 Inc. reported healthy organic growth for the 2005 fourth quarter, but a large write-down related to the company’s goodwill and intangible assets negatively impacted earnings by $253.2 million for the quarter and the year. This charge resulted from the fact that K2’s book value significantly exceeded its market capitalization on the date of its annual impairment test. The company emphasized that this charge is non-cash, and does not have any impact on operations or any material effect on any debt agreement or material contract at the company.

According to K2 Inc. CEO Dick Heckman, the downward move in KTO shares as a result of the warning about paintball results in the fourth quarter of '05 is what triggered the write-down.

“We're taking the write-down and following the rules to the letter so as to ensure compliance,” said Heckman during a conference call with analysts. “We have now put the goodwill impairment issue behind us in all of our platforms but apparel, where it is not a problem.”

Net sales for the fourth quarter increased 4.3% to $353.5 million from $338.9 million in the prior year period. Gross margin improved 60 basis points to 35.1% of sales, while SG&A expenses inched up 20 basis points to 28.3% of sales. This brought net income for the fourth quarter, without the impairment charges, to $14.7 million, or 28 cents adjusted diluted earnings per share, compared to pro forma adjusted net income of $11.8 million, or 23 cents pro forma adjusted diluted earnings per share, for Q4 2004.

The paintball business that caused the majority of the impairment charge has been restructured. For fiscal '06, K2 has reduced personnel costs by $2.5 million, by closing their Mexican and U.S. manufacturing facilities. By the '06 winter selling season, K2 will have reduced manufacturing costs by an additional $3 million by moving production into their existing factory in China. The president, vice president of marketing, and vice president of manufacturing have been replaced. Mr. Heckman stated, “Sales are up 10% year-to-date in paintball. We lost over $1 million in the first quarter of '05. We will make money in paintball in the first quarter of '06.”

K2’s Action Sports segment, which includes winter products, in-line skates, and paintball products, reported Q4 sales of $173.8 million, a decrease of 2.5% from the 2004 fourth quarter, due primarily to the decline in paintball sales. SnowSports sales for the quarter were stronger than expected. K2 management said that the global market was slightly down for the year, but performed better than the high-single-digit decline they anticipated. Völkl finished the year flat, and K2 was “up considerably.” Management feels that both brands gained market share as a result. Geographically, California and New England weren’t as good as last year, but the central U.S. and Europe had an “outstanding” ski year. Japan, which has had “ten years of misery,” had the best ski season in ten plus years. Sell-through at retail was said to be “very good,” and retailers finished with much cleaner inventories.

Management said that the numbers at the end of April will give them a better picture of the SnowSports pre-season, but so far, their estimate is that pre-season will be up in the 3% to 5% range this year. In 2006, based on pre-season, the company believes the K2 ski brand will ship more skis into Europe than the United States for the first time in the history of the brand. This increase will be led by womenspecific skis, freeride skis, and twin-tip skis.

The Marine and Outdoor division, which includes Shakespeare and Stearns, generated sales of $70.3 million in the fourth quarter, an increase of 13.0% from the comparable quarter in 2004. Operating profit in the division increased 42.5% to $5.7 million due to a decline in SG&A expenses. Sales growth for the year was driven primarily by fishing tackle, antennas, children's flotation devices, ski vests, and Hodgman waders, which was acquired in second quarter 2005.

Team Sports, which includes Rawlings, Worth, and K2 Licensed Products, had total sales of $58.5 million in the 2005 fourth quarter, up 7.6% from the 2004 period. The division’s operating loss jumped from $2.7 million last year to $87.7 million this year due primarily to the non-cash intangible charges. Sales growth in 2005 was driven primarily by baseball and softball aluminum bats and Miken composite bats. The ongoing integration for the team sports division is coming to an end and the U.S. bat manufacturing facility, which has been running in tandem with the Chinese facility, will be closed shortly. K2 chose to run both facilities simultaneously in order to ensure against any delivery issues with their key accounts.

Apparel and Footwear, which includes the Earth Products, Ex Officio and Marmot brands, had sales of $50.9 million in the fourth quarter, an increase of 15.8% over the 2004 period. Operating profit in the division increased 92.9% to $5.4 million for the quarter. Sales growth was driven primarily by skate footwear and apparel, and winter and outdoor apparel. K2 management said that they have made “significant progress” at creating the new K2 apparel platform. Distribution of Völkl apparel for North America, Canada and the U.S., is now through the Marmot Group, and they have added a design center in Santa Rosa with specific individuals that are focused on the three brands – Marmot, Völkl, and K2. In addition, Marker did about $15 million in sales this year. From an EPS perspective, K2 Inc. does not see a significant impact in this coming year but there should be a “very solid impact” in 2007.

Going forward for 2006, K2 is forecasting a revenue increase of 5% without acquisitions. GAAP diluted EPS should be 73 cents to 76 cents and adjusted diluted EPS should be 82 cents to 86 cents. For 2006, the company forecast growth in both operating and net income in excess of 10% over 2005 levels, before charges.