K2 Inc. Sees Synergy Boost in Q1 to Beat Street…

K2 Inc. managed to shrug off the increased raw material and labor expenses to exceed Wall Street estimates and internal guidance for both sales and earnings performance during the first quarter of 2006. The Team Sports business was the primary driver during the quarter with every significant segment – gloves, bats, balls, helmets, protective gear – increasing. The company managed to put some of the past difficulties behind it, with management stating that they don’t have any segment at this stage that’s struggling.

The increase in total sales for the quarter was due to increased sales in the Team Sports and Marine & Outdoor segments, offset by a decline in the Action Sports segment. Margins were flat during the first quarter at 32.3% due to product mix changes. K2’s Team Sports business had a little bit lower gross margin than Marine & Outdoor, so the increased sales in this segment flattened out the gross margin.

KTO is seeing three to five percent increases in raw material expenses, but the company has so far been able to absorb it and it does not have a negative effect on the shorter term plan. To offset the increased price of labor in China, K2 Inc. made a move starting two years ago, to move part of the higher-labor content products toward the Vietnam border in China, which is a lower cost area.

The Shakespeare and Stearns businesses, which make up the Marine & Outdoor group, generated a sales increase of 9.5% due to increased sales of fishing tackle, antennas, ski vests, and the addition of sales of Hodgman waders, which was acquired in the second quarter of 2005. K2 expects sales in the division to pick up through the season, driven by Ugly Stik combos and Plfuger reels. On the Stearns side, first quarter shipments were up 29% and Easter weekend sell-through resulted in a 20% retail sales growth.

Team Sports sales were up 22.4% from 2005. Operating profits were up 60.1% from the 2005 period. Sales growth in 2006 was driven primarily by Rawlings, Worth, and Miken baseball and softball products and Rawlings apparel product lines. The China bat manufacturing facility is now up and running and KTO is beginning to see the benefits of that cost reduction. However, the full benefits will not be realized until 2007, since roughly half of the product sold in 2006 will be manufactured in the Tennessee facility. Paintball products were shifted into the Team Sports segment this quarter and management said that the paintball business was profitable for the period compared to “a large loss” last year.

In Action Sports, sales of winter products and in-line skates fell 13.4% from 2005, partially due to licensing bikes to a third party in Q3 last year. This licensing impacted revenues by roughly $3 million, but had a positive impact on the bottom line. The operating loss was $10.9 million for Q1, a decrease in the loss of 6.1% from Q1 2005 loss of $11.6 million, primarily due to a decline in SG&A expenses.

Winter sports products’ pre-season sales were up three to five percent in North America and Japan. European pre-season sales are flat, but management expects the region to pick up closer to the season. K2 branded SnowSports pre-season is up over five percent.

The Apparel & Footwear group, which includes Earth Products, Ex Officio, and Marmot, saw sales increase due to an increase in sales of skateboard shoes and Marmot and Ex Officio products. The operating loss for Q1, which is a historically slow quarter, was $1.8 million compared to an operating profit of $900,000 in the first quarter of 2005.

The decrease in profit for the group was 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.

Earth Products’ core market continues at a three to five percent growth rate. K2 believes that the back to school business will be up over 20% this year.

K2 is also preparing to become more active on the acquisition front. After sitting on the sidelines and watching prices increase for over a year, Mr. Heckman said the market could expect to see some acquisitions this year. Mr. Heckman said that they looked at the Easton deal, but decided to pass on it due to some potential anti-trust issues in metal bats and some questions Mr. Easton had about transitioning to a public company.

For fiscal year 2006, K2 forecasts 2006 sales in the range of $1.33 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 82 cents to 86 cents. For the first six months of 2006, K2 forecasts net sales in the range of $635 million to $650 million, and GAAP diluted earnings per share in the range of 8 cents to 10 cents, and adjusted diluted earnings per share in the range of 13 cents to 16 cents.