K2 Inc. reported net sales for the fourth quarter ended December 31, 2004 of $338.9 million, an increase of 75% from $193.8 million in the prior year, and diluted earnings per share of 18 cents, a 157% increase over the fourth quarter of 2003. Operating income in the fourth quarter of 2004 was $21.5 million, a 294% increase from the 2003 comparable period, and net income was $8.8 million, a 310% increase from the fourth quarter of 2003.
Net sales for the twelve month period ended December 31, 2004 were $1.2 billion, an increase of 67% over the 2003 comparable period, and diluted earnings per share of 86 cents, an increase of 95% over the 2003 comparable period. Operating income for the twelve month period ended December 31, 2004 was $81.0 million, a 153% increase over the 2003 comparable period, and net income was $38.9 million, a 241% increase over the 2003 comparable period.
Richard Heckmann, Chairman and Chief Executive Officer, said, “2004 was an excellent year for K2 as evidenced by organic sales growth of approximately 9%, excluding the previously forecast decline in in-line skate sales, and dramatic growth in margins and profitability. Our acquisitions of Volkl and Marker have significantly strengthened our global winter products business, and Marmot and Ex Officio are the cornerstones of our technical apparel platform.
“For our 2005 guidance, comparability with the first and second quarters of 2004 is complicated by two key factors. The first is the timing of the acquisitions of Volkl, Marker and Marmot at mid-year. They are highly seasonal businesses and normally generate losses in the first six months of the year, which are not reflected in our full year 2004 GAAP financial figures. Secondly, we are incurring non-cash amortization charges related to recent acquisitions, non-cash stock compensation expense, and significant expenses associated with compliance under Section 404 of the Sarbanes-Oxley Act. While we believe we have just begun to realize the revenue and operational synergies available as a result of our recent transactions, we remain cautious about the timing of their impact. We have seen our EBITDA grow from $41.2 million in 2002 to $50.6 million in 2003 and $114.1 million in 2004, and we project over $120 million in 2005. Given the complexity of the industry’s seasonal business, we operate with particular attention to EBITDA and free cash flow. In 2004, K2 generated approximately $53 million in free cash flow, defined as net income plus non-cash taxes before acquisitions and growth in working capital.”
Share Repurchase Program
K2’s Board of Directors authorized the repurchase of the Company’s common stock as a means to enhance shareholder value. Depending on market conditions, K2 may repurchase up to $50 million of the Company’s common stock periodically in open market or privately negotiated transactions in accordance with applicable laws. The Company will use its available cash resources to fund the stock repurchase program.
Review of 2004 Fourth Quarter and Twelve Month Sales and Profit Results
Comparable Sales Trends
K2’s net sales in the fourth quarter of 2004 were $210.9 million, excluding the net sales from businesses acquired by K2 during 2004 and the incremental net sales from the Brass Eagle acquisition which closed at the end of the 2003 fourth quarter. K2’s net sales in the fourth quarter of 2003 were $193.8 million, which reflects a sales increase of 8.8% excluding the impact of acquisitions, for the 2004 fourth quarter.
Gross profit in the fourth quarter of 2004 increased to 34.5% of net sales, as compared to 29.8% in the comparable 2003 period. Gross profit for the twelve months ended December 31, 2004 increased to 33.3% of net sales, as compared to 30.6% for the 2003 comparable period. Gross profit as a percentage of net sales in the 2004 fourth quarter benefited from higher gross margins in the Action Sports and Apparel and Footwear segments.
Operating income as a percentage of net sales for the fourth quarter of 2004 increased to 6.3% compared to 2.8% in the comparable 2003 period. Operating income improved to 6.7% of net sales for the twelve months ended December 31, 2004 as compared to 4.5% for the 2003 comparable period. Selling, general and administrative expenses were 28.1% of net sales in the fourth quarter of 2004 as compared to 27.0% of net sales in the prior year. For the twelve months ended December 31, 2004, selling, general and administrative expenses increased slightly as a percentage of net sales to 26.6% as compared to 26.1% in the prior year.
Fourth Quarter Segment Review
Due to the acquisitions of Ex Officio and Marmot in the 2004 second and third quarters, respectively, K2 formed an Apparel and Footwear segment in the 2004 third quarter that also includes Earth Products. Earth Products was formerly included in the Action Sports segment.
Marine and Outdoor
Shakespeare fishing tackle and monofilament, and Stearns marine and outdoor products, generated sales of $62.2 million in the fourth quarter of 2004, 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.
Rawlings, Worth, and K2 Licensing & Promotions had total sales of $54.4 million in the 2004 fourth quarter, up 14.3% from the 2003 period. Growth was primarily driven by the acquisition of K2 Licensing & Promotions in January 2004.
Sales of skis, snowboards, in-line skates, bikes, snowshoes and paintball products totaled $178.4 million in the fourth quarter of 2004, an increase of 130.1% over the 2003 fourth quarter. Growth was driven by double digit increases in sales of K2 skis and snowshoes, improved sales of snowboards, and the acquisitions of Volkl and Marker at the beginning of the third quarter of 2004.
Apparel and Footwear
Earth Products, Ex Officio and Marmot had sales of $43.9 million in the fourth quarter of 2004, an increase of 437.4% over the 2003 period. The increase was due to 58.4% growth in technical skate footwear and apparel and the acquisitions of Ex Officio and Marmot in the second and third quarters, respectively, of 2004.
K2’s balance sheet at December 31, 2004 reflects acquisitions and the related seasonal working capital requirements of the acquired businesses. At December 31, 2004, cash and accounts receivables increased to $395.5 million as compared to $246.1 million at December 31, 2003, and inventories at December 31, 2004 increased to $325.1 million from $237.2 million at December 31, 2003, in each case primarily as a result of the acquisitions that occurred after December 31, 2003.
The Company’s total debt increased to $415.9 million at December 31, 2004 from $216.1 million at December 31, 2003. The increase in debt as of December 31, 2004 is primarily the result of the Company’s acquisitions during 2004, including the related seasonal working capital requirements of the acquired businesses and the issuance of $200 million of senior notes in July 2004.
Primarily as the result of the acquisitions of K2 Licensing & Promotions in the 2004 first quarter, Marmot, Volkl and Marker in the 2004 third quarter, and the Company’s offering of common stock, the Company increased its number of shares of common stock outstanding by 1.0 million shares, 2.8 million shares, 1.8 million shares and 6.4 million shares, respectively, to 46.8 million shares outstanding at December 31, 2004 as compared to 33.4 million shares outstanding at December 31, 2003.
Sarbanes-Oxley Act of 2002
Section 404 of the Sarbanes-Oxley Act of 2002 requires K2, commencing with its 2004 Annual Report, to provide management’s annual report on its assessment of the effectiveness of its internal control over financial reporting and, in connection with such assessment, an attestation report from its independent registered public accountant, Ernst & Young LLP. In order to comply with the requirements of Section 404, K2 estimates that it incurred total expenses of approximately $2.5 million in 2004, and projects total expenses of approximately $3.1 million in 2005.
On June 30, 2004, K2 acquired Marmot, a premium manufacturer of technical performance apparel, and on July 7, 2004 acquired Volkl and Marker, premium manufacturers of alpine skis, bindings and snowboards. Due to the seasonality of their product lines, Volkl, Marker, and Marmot normally incur losses in the first and second quarters, and are profitable in the last two quarters of the year. As detailed in Table B, Pro Forma Adjusted diluted earnings per share for 2004 equals $0.65 assuming the acquisitions of Marmot, Volkl and Marker were completed on January 1, 2004. These results do not purport to be indicative of what would have occurred had the acquisitions been made as of those dates, or of results which may occur in the future. These adjustments also do not include the results of operations of certain other acquisitions completed by K2 during 2003 and 2004 because the effects of such acquisitions were not material on either an individual basis or in the aggregate to K2’s consolidated results of operations. Nonetheless, K2’s management believes the Pro Forma Adjusted financial measures for 2003 and 2004, although not indicative of future performance, are useful for comparison against K2’s operations in the future.
Outlook for 2005
For fiscal year 2005, K2 forecasts GAAP diluted earnings per share in the range of 75 to 79 cents and Adjusted diluted earnings per share in the range of 87 to 91 cents, in each case based on assumed fully diluted shares outstanding of 55.7 million. For the same period, K2 forecasts GAAP basic earnings per share in the range of 83 to 88 cents and Adjusted basic earnings per share in the range of 97 cents to $1.02, in each case based on assumed basic shares outstanding of 46.4 million.
For the first quarter of 2005, K2 forecasts GAAP diluted earnings per share in the range of 1 to 3 cents and Adjusted diluted earnings per share in the range of 4 to 6 cents, in each case based on assumed shares outstanding of 47.8 million. For the same period, K2 forecasts GAAP basic earnings per share in the range of 1 to 3 cents and Adjusted basic earnings per share in the range of 4 cents to 6 cents, in each case based on assumed shares outstanding of 46.2 million.
Although K2 is not providing a specific forecast at this time for the remaining quarters in 2005, from a seasonality standpoint the second quarter is anticipated to be the smallest in terms of sales and earnings per share, and the third quarter is forecast as the largest quarter followed by the fourth quarter.
K2 forecasts strong liquidity (cash and available capacity under K2’s revolving credit facility) in 2005, with total debt before acquisitions (if any) projected to decrease from current levels by the end of the second quarter.
K2 INC. STATEMENTS OF INCOME (in thousands, except for per share figures) FOURTH QUARTER TWELVE MONTHS ended December 31 ended December 31 ------------------------ ---------------------- 2004 2003 2004 2003 ----------- ----------- ----------- --------- (unaudited) (unaudited) (unaudited) (audited) Net sales $338,916 $193,785 $1,200,727 $718,539 Cost of products sold 222,051 136,096 800,678 498,620 ----------- ----------- ----------- --------- Gross profit 116,865 57,689 400,049 219,919 Selling expenses 56,785 33,395 197,134 116,509 General and administrative expenses 38,600 18,845 121,895 71,358 ----------- ----------- ----------- --------- Operating income 21,480 5,449 81,020 32,052 Interest expense 7,638 2,702 21,449 9,950 Debt extinguishment costs - - - 6,745 Other (income) expense, net (a) 358 (564) (246) (2,218) ----------- ----------- ----------- --------- Income before provision for income taxes 13,484 3,311 59,817 17,575 Provision for income taxes 4,659 1,159 20,876 6,151 ----------- ----------- ----------- --------- Net income $8,825 $2,152 $38,941 $11,424 =========== =========== =========== ========= Basic earnings per share: Net income 0.19 0.07 0.97 0.46 =========== =========== =========== ========= Diluted earnings per share: Net income $0.18 $0.07 $0.86 $0.44 =========== =========== =========== ========= Shares: Basic 46,077 29,238 40,285 24,958 Diluted 55,442 30,206 49,345 28,750 (a) The twelve month period ended December 31, 2003 includes a $2.2 million gain related to the sale of the utility and light pole assets during the 2003 second quarter.