K2 Inc. Sees Integration Upside for Q2…

K2 Inc. has been busy integrating acquisitions over the last year and a half and the results are trickling down to the bottom line through a 100 point gross margin gain to a 47.4% increase in net income. However, without any new acquisitions to integrate, many are wondering how much longer this increase in margins and earnings can last.

K2 has been holding back on the acquisition front over the last several quarters, with the exception of relatively small tuck-in acquisitions, because the deal-making environment has been too expensive. During a conference call with analysts and the media, K2 Chairman and CEO Richard Heckman said that this has recently changed, and prices are coming down to be more in-line with K2’s requirements.

“We’ve paid down a fair amount of debt, so we are very comfortable with our capital structure now with respect to transactions. We also are far enough along with our integration process that we wouldnt be over loading anybody,” Heckman said. “We are actively involved at pretty late stage on one (acquisition) and reasonably along on another… I would say that there are a couple (of deals) that we like that are bigger than tuck-ins…”

In K2’s ongoing business activity, the fundamentals are consistently improving. The second quarter showed a slight $400,000 sales decline, but this was due to $4.2 million in lost revenue from K2’s bike business, which is now licensed to a third party. Removing the bike sales from last year’s numbers, K2’s sales would have increased 1.3%.

Team Sports sales increased 8.2% for the quarter with operating profits more than quadrupling thanks to the re-structuring and return to profitability of the paintball business. Paintball is also seeing a bit of a turn-around, with sales growth in the Team Sports division driven primarily by Rawlings, Miken, and paintball products. In addition, as of June of this year the integration of Rawlings, Worth, Miken, and ABC Helmets is essentially complete. Rawlings production has been moved to other facilities including China. Rawlings and Worth operations and management have been consolidated and moved into new facilities in St. Louis. Worth, specifically the bat business, is now 100% in China with a building in Tennessee sold and vacated.

Marine and Outdoor sales were negatively impacted by slow sales in cutting line, marine antennas, and ski vests. This was partially offset by increased sales of fishing kits and combos, children’s flotation devices, and Hodgman waders.

Action Sports sales, which include in-line skates and winter sports hardgoods, fell 14.5% during the quarter, mainly due to licensing bikes to a third party in the third quarter of 2005. K2, Volkl, and Marker products sales were up “3 to 5%” in North America. The 2006 pre-season finished up in the strong single digits over 2005 with the U.S. being “a little more bullish” than Europe. K2 management estimates that the entire U.S. snowsports pre-season market was up 3- 5% with K2’s pre-season book up “substantially more than that.” K2 skis, Ride snowboards and K2 snowboards and bindings were said to have been “especially strong this year.”

By September 1st, K2 Sports staff will move from Vashon Island to Seattle. The main reason for the move is to eliminate the ferry ride from K2 employees’ commute every day and to attract more talent. “With the exception of the people who do live on Vashon, it is universally hailed as good news by the people at K2,” said Heckman. “Robert Marcovitch, our President up there said he’s even getting e-mails from wives and husbands of the employees saying thank God” K2 is also well on its way to integrating Line Skis and Karhu into the Washington-based organization. Heckman said that the K2 factory in China made the fist pair of Line skis on the day they announced the acquisition, well behind schedule.

“We havent counted on anything, to be blunt, with the Line acquisition this year. If we have to air freight the product, we will air freight it,” said Heckman. “Today, we are in a terrible manufacturing situation and we have really been recognized as coming to the rescue of the retailers that ordered the product.”

Apparel and Footwear net sales increased 1.8% driven by growth in skateboard shoes, Ex Officio, and Marmot combination.

Operating profit for Q2 decreased due to start up expenses associated with the opening of a new distribution center in Reno, Nev., and integration expenses for combining design, development, and sourcing for several apparel brands. Marmot and Ex Officio posted “5 to 6%” sales increases.

In November, ExOfficio will be opening their second retail store in Bellevue, Wash. Marmot, ExOfficio, K2, Ride, Marker, Adio, and other K2 apparel and footwear products are currently moving their distribution into the new 200,000 square foot facility in Reno. The apparel design functions are now coordinated through the offices in Santa Rosa, California. Heckman said that this year’s second half will show the “very, very early stages of these efforts of the integration.”

For the back half, K2 forecasts net sales in the range of $710 million to $730 million, and GAAP diluted earnings per share in the range of 59 cents to 62 cents, and adjusted diluted earnings per share in the range of 64 cents to 67 cents. For fiscal year 2006, K2 forecasts net sales in the range of $1.36 to $1.38 billion, GAAP diluted earnings per share in the range of 73 cents to 76 cents and adjusted diluted earnings per share in the range of 83 cents to 86 cents. Heckman said that, “without any huge emergency with snow,” K2 will hit the high end of this guidance.

>>> Mr. Heckman sounded very interested in an opportunity to look at the Spalding and the Huffy basketball backboard businesses that Berkshire Hathaway will pick up in the Russell Corp. acquisition…

>>> Love to be a fly on the wall for that negotiation…