K2 Inc. Still Hitting on Most Cylinders as Company Focuses on the Fundamentals…

While KTO shares took a hit two weeks ago after the company issued a reduced outlook, the company rebounded a bit last week as fundamentals behind the company remain solid with expanding gross margins, flat SG&A expenses, and increases in the bottom line.

The GM improvement in the 2005 third quarter was attributable to higher gross margins in the winter products component of Action Sports and the Marine and Outdoor segments.

During a conference call with analysts and the media, K2 CEO Richard Heckmann said that the majority of K2’s brand portfolio is performing at or above expectations, with the exception of paintball. If the decline in the sale of paintball products is excluded from the Q2 results, K2's other product lines generated sales growth of 4.2% in the quarter.

In the Marine & Outdoor business, Shakespeare reported strong sales during their seasonally slow period with sales up 22%. Growth was driven by Pfleuger reels, kits, and combos. Stearns also was in the middle of their slow season, but sales were up 36% for the period. The flotation, dry wear, and hunting businesses were up in the single digits. Divisional operating profit increased 26.9% to $8.5 million.

The Team Sport group was also in a seasonally slow quarter, but Rawlings Q3 sales were up 14%. The 2005 sell-through was said to be “excellent,” and 2006 product listings are significantly above 2005. The company feels that the Rawlings integration in China is going better than expected. The division saw its operating loss improve to $4.9 million compared to $5.2 million in Q3 last year.

The Action Sports business, which includes snow sports, paintball, and bike, posted a 7.8% increase in operating profits despite the decline in sales for the period. Divisional operating profit was $25.0 million in Q3 compared to $23.2 million last year.

Management stated that the average worldwide pre-season for snow sports is down in the 10% to 15% range. K2 was said to be “down significantly less than that.” Sell-in orders to the retailers were on plan given that the company assumed a drop off after the slow snow year last year. K2 branded alpine ski products generated significant growth in the quarter. Sales of Volkl branded ski products were down in Q3 2005 versus 2004 due to softness in the premium end of the market.

Heckmann also said that the paintball retail market was down 25% to 30% overall, but down 10% since July, so they see the downward trend flattening. K2 is hoping to see a market share gain and has reduced overhead to match the present market conditions. Much of the decline was said to be due to larger retailers, like Wal-Mart, cutting their shelf space for paintball in half. Paintball is still a $100 million business for K2.

K2’s Action Sports division also saw a reduction in sales due to the licensing of the bike business in the third quarter. Heckmann said that the company’s bottom line went from “losing $1.5 million a year to making $0.5 million.” However, from a revenue standpoint, the decision resulted in a sales decline of roughly $10 million.

The Apparel and Footwear division, which includes Earth Products, Ex Officio, and Marmot, posted operating profit of $6.4 million for the period, up 4.9% compared to $6.1 million last year. The increase was driven by significant growth in Adio technical skate footwear and Marmot technical apparel and outerwear. Marmot and Ex Officio’s third quarter sales were up 17%. Summer bookings for Ex Officio are up double digits. On the design development side, the company is now offering K2 Freestyle, Volkl premium outerwear, and Marker Ski branded apparel.

K2 still sees a very competitive deal environment in the sporting goods world, but Heckmann might see a light at the end of the tunnel. Several analysts asked why the company has not re-purchased any stock, since the price is currently on the low side. He said that the minute the company spends cash on stock it loses the ability to grow, presumably through acquisitions. K2 is “working on a couple” of acquisitions right now, with a good chance of one going through because the price was said to be “where [they] want it.” Heckmann said he doesn’t see any “blockbusters out there” in the next quarter, but there are lots of “tuck-ins” the company can do relatively regularly.

>>> When asked by an analyst about increased competition from Quiksilver, Heckmann said, “…there is nothing about what's going on out there that keeps me up a minute at night.”