FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 Quarterly Report under Section 13 of the Securities Exchange Act of 1934 For the Quarter Ended September 30, 1998 Commission File No. 1-4290 K2 INC. (exact name of registrant as specified in its charter) DELAWARE 95-2077125 (State of Incorporation) (I.R.S. Employer Identification No.) 4900 South Eastern Avenue Los Angeles, California 90040 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (323) 724-2800 Former name, former address and former fiscal year, if changed since last report: Not applicable Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of October 31, 1998. Common Stock, par value $1 16,566,893 Shares FORM 10-Q QUARTERLY REPORT PART - 1 FINANCIAL INFORMATION Item 1. Financial Statements STATEMENTS OF CONSOLIDATED INCOME (condensed) (Dollars in thousands, except per share figures) THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30 ENDED SEPTEMBER 30 --------------------------------------------- 1998 1997 1998 1997 (Unaudited) Net sales $133,884 $121,255 $441,716 $417,509 Cost of products sold 101,657 83,028 320,371 289,920 -------- -------- -------- -------- Gross profit 32,227 38,227 121,345 127,589 Selling expenses 21,498 17,590 64,085 59,331 General and administrative expenses 20,181 13,846 45,439 38,048 -------- -------- -------- -------- Operating income (loss) (9,452) 6,791 11,821 30,210 Interest expense 2,833 2,574 9,147 7,772 Other expense (income), net (68) 120 (208) (106) -------- -------- -------- -------- Income (loss) before income taxes (12,217) 4,097 2,882 22,544 Provision (credit) for income taxes (4,308) 1,170 643 6,779 -------- -------- -------- -------- Income (loss) from continuing operations (7,909) 2,927 2,239 15,765 Discontinued operations, net of taxes (449) 140 627 1,851 -------- -------- -------- -------- Net income (loss) $ (8,358) $ 3,067 $ 2,866 $ 17,616 -------- -------- -------- -------- -------- -------- -------- -------- Basic earnings per share: Continuing operations $ (0.48) $ 0.18 $ 0.13 $ 0.95 Discontinued operations (0.03) 0.01 0.04 0.11 -------- -------- -------- -------- Net income (loss) (0.51) 0.19 0.17 1.06 -------- -------- -------- -------- -------- -------- -------- -------- Diluted earnings per share: Continuing operations $ (0.48) $ 0.17 $ 0.13 $ 0.94 Discontinued operations (0.03) 0.01 0.04 0.11 -------- -------- -------- -------- Net income (loss) (0.51) 0.18 0.17 1.05 -------- -------- -------- -------- -------- -------- -------- -------- Basic shares outstanding 16,547 16,545 16,551 16,543 Diluted shares outstanding 16,547 16,720 16,629 16,713 Cash dividend $ 0.11 $ 0.11 $ 0.33 $ 0.33 See notes to consolidated condensed financial statements. 1 ' CONSOLIDATED BALANCE SHEETS (condensed) (Dollars in thousands) SEPTEMBER 30 DECEMBER 31 1998 1997 ------------ ----------- (Unaudited) ASSETS Current Assets Cash and cash equivalents $ 4,972 $ 5,706 Accounts receivable, net 120,916 110,091 Inventories Finished goods 136,679 132,482 Work in process 10,089 18,872 Raw materials 32,535 27,727 ------------ ----------- 179,303 179,081 Less LIFO reserve 3,414 3,795 ------------ ----------- 175,889 175,286 Deferred taxes 9,255 9,236 Prepaid expenses and other current assets 5,817 6,081 ------------ ----------- Total current assets 316,849 306,400 Property, Plant and Equipment 151,365 136,420 Less allowance for depreciation and amortization 83,031 74,336 ------------ ----------- 68,334 62,084 Intangibles, principally goodwill 19,345 17,235 Net assets of discontinued operations 29,696 32,731 Other 3,912 3,152 ------------ ----------- Total Assets $ 438,136 $ 421,602 ------------ ----------- ------------ ----------- See notes to consolidated condensed financial statements. 2 CONSOLIDATED BALANCE SHEETS (condensed) (Dollars in thousands) SEPTEMBER 30 DECEMBER 31 1998 1997 ------------ ----------- (Unaudited) LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Bank loans $ 37,140 $ 48,967 Accounts payable 25,796 24,373 Accrued payroll and related 15,148 16,868 Other accruals 30,797 20,574 Current portion of long-term debt 4,444 4,445 ------------ ----------- Total current liabilities 113,325 115,227 Long-Term Debt 111,668 88,668 Deferred Taxes 11,376 14,822 Shareholders' Equity Preferred Stock $1 par value, authorized 12,500,000 shares, none issued Common Stock, $1 par value, authorized 40,000,000 shares, issued shares - 17,190,652 in 1998 and 17,160,080 in 1997 17,191 17,160 Additional paid-in capital 132,488 132,086 Retained earnings 67,072 69,668 Employee Stock Ownership Plan and stock option loans (2,092) (3,006) Treasury shares at cost, 623,759 shares in 1998 and in 1997 (8,106) (8,106) Cumulative translation adjustments (4,786) (4,917) ------------ ----------- Total Shareholders' Equity 201,767 202,885 Total Liabilities and Shareholders' Equity $ 438,136 $ 421,602 ------------ ----------- ------------ ----------- See notes to consolidated condensed financial statements. 3 STATEMENTS OF CONSOLIDATED CASH FLOWS (condensed) (In thousands) NINE MONTHS ENDED SEPTEMBER 30 ---------------------- 1998 1997 ---------------------- (unaudited) Operating Activities Income from continuing operations $ 2,239 $ 15,765 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 10,368 8,063 Deferred taxes (3,700) (802) Changes in operating assets and liabilities: Accounts receivable (9,502) (6,057) Inventories 7,106 (23,509) Prepaid expenses and other current assets 658 (1,891) Accounts payable (10,431) (5,169) Payrolls and other accruals 7,576 10,063 -------- -------- Net cash provided by (used in) operating activities 4,314 (3,537) Investing Activities Property, plant & equipment expenditures (15,751) (12,857) Disposals of property, plant & equipment 313 441 Sale of investments 6,408 Other items, net 18 (3,789) -------- -------- Net cash used in investing activities (15,420) (9,797) Financing Activities Borrowings under long-term debt 40,500 24,667 Payments of long-term debt (18,201) (28,086) Net (decrease) increase in short-term bank loans (11,827) 24,211 Proceeds from (repurchase of) accounts receivable facility 700 (5,225) Dividends paid (5,462) (5,460) Repayment of loans by ESOP 1,000 3,000 -------- -------- Net cash provided by financing activities 6,710 13,107 -------- -------- Net decrease in cash and cash equivalents from continuing operations (4,396) (227) Discontinued operations Income from discontinued operations 627 1,851 Adjustments to reconcile income to net cash provided by (used in) discontinued operations: Depreciation and amortization 2,270 2,213 Capital expenditures (3,067) (3,966) Other items, net 3,832 (3,748) -------- -------- Cash provided by (used in) discontinued operations 3,662 (3,650) Net decrease in cash and cash equivalents (734) (3,877) Cash and cash equivalents at beginning of year 5,706 10,554 -------- -------- Cash and cash equivalents at end of period $ 4,972 $ 6,677 -------- -------- -------- -------- Supplemental disclosure of cash flow information: Interest paid $ 8,567 6,597 Income taxes paid 3,247 8,577 See notes to consolidated condensed financial statements. 4 K2 INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 NOTE 1 - BASIS OF PRESENTATION The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 1998, are not necessarily indicative of the results that may be expected for the year ended December 31, 1998. For further information, refer to the Consolidated Financial Statements and Notes to Financial Statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ACCOUNTS RECEIVABLE AND ALLOWANCES Accounts receivable are net of allowances for doubtful accounts of $5,831,000 at September 30, 1998 and $6,590,000 at December 31, 1997. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform with the current year presentation. NOTE 3 - BORROWINGS AND OTHER FINANCIAL INSTRUMENTS Covenants contained in the Company's $100 million credit line and accounts receivable financing arrangement, among other things, restrict amounts available for payment of cash dividends and stock repurchases by the Company. As of September 30, 1998, $8.6 million of retained earnings were free of such restrictions. At September 30, 1998, $49.3 million of accounts receivable were sold under the existing $50 million accounts receivable purchase facility. NOTE 4 - DISCONTINUED OPERATIONS On September 10, 1998, the Company adopted a plan to dispose of its Simplex building products division ("Division"). Accordingly, the Company reported the net operating results and net assets of the Division as a discontinued operation in the accompanying consolidated condensed financial statements. 5 K2 INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 NOTE 4 - DISCONTINUED OPERATIONS (CONTINUED) Net assets of discontinued operations have been segregated in the accompanying consolidated condensed balance sheets and consist primarily of accounts receivable, inventories and fixed assets offset by accounts payable, accrued payroll and related items and other accruals. Net sales of $20.2 million and $66.4 million for the three and nine month periods ended September 30, 1998, respectively, and net sales of $21.1 million and $67.9 million for the three and nine month periods ended September 30, 1997, respectively, were excluded from consolidated net sales in the accompanying condensed statements of consolidated income. NOTE 5 - CHARGE FOR RESERVES The Company recorded a charge for reserves in the third quarter of $14.5 million ($9.4 million after tax or $.57 per diluted share), which was included in earnings from continuing operations, to cover the cost of several actions to enhance sales, streamline operations and reduce costs and to write down related assets. Approximately $7.7 million of the reserves relates to a write-down of certain bike and other sporting goods inventories. The balance of the reserve relates to implementing planned cost reduction programs at the winter sports and apparel operations and other non-cash items. These initiatives are expected to begin to benefit operations in early 1999. NOTE 6 - ACQUISITION OF BUSINESS On August 19, 1998, the Company purchased K2 Japan Corporation, a distributor of K2 branded products located in Japan. The purchase price of the acquisition was not material. The transaction was accounted for using the purchase method of accounting and the results of operations from this business have been included in the consolidated condensed statements of income from the date of acquisition. NOTE 7 - COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income". SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or shareholders' equity. SFAS No. 130 requires foreign currency translation adjustments, which prior to adoption were reported separately in shareholders' equity, to be included in other comprehensive income. During the three and nine months ended September 30, 1998, total comprehensive income (loss) amounted to ($7.7) million and $3.0 million, respectively. For the three and nine months ended September 30, 1997, total comprehensive income amounted to $2.6 million and $15.3 million, respectively. 6 ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations In September 1998, the Company adopted a plan to dispose of its Simplex building products division ("Division"). Accordingly, the Company reported the net operating results and net assets of the Division as a discontinued operation, and prior years' operations were similarly reclassified. (See Note 4 of Notes to Consolidated Condensed Financial Statements.) The discussion which follows focuses on the continuing operations of the Company. A. COMPARATIVE THIRD QUARTER RESULTS OF OPERATIONS Net sales from continuing operations for the three months ended September 30, 1998 increased to $133.9 million from $121.3 million in the year-earlier period. Income from continuing operations and prior to a $14.5 million ($9.4 million after tax or $.57 per diluted share) charge for reserves was $1.5 million, or $.09 per diluted share. This compares with income from continuing operations in the same quarter of the prior year of $4.5 million, or $.27 per diluted share, before a $2.4 million ($1.6 million after tax or $.09 per diluted share) restructuring charge. After the charge for reserves, there was a loss from continuing operations of $7.9 million, or $.48 per diluted share, and a net loss, including the discontinued operations of the Division, of $8.4 million, or $.51 per diluted share for the current year quarter. This compares with income from continuing operations of $2.9 million, or $.17 per diluted share, and net income of $3.1 million, or $.18 per diluted share, in the prior year quarter. NET SALES. In the sporting goods and other recreational products group, net sales increased 11.5% to $105.6 million from $94.7 million in the year-earlier period. This growth was primarily the result of an increase in worldwide skate sales. Sales also benefited from double-digit growth of new Shakespeare fishing tackle products recently introduced and from continued demand for its core products. Hilton active apparel reported an improvement in sales to the advertising specialty market. K2's lifestyles companies continued to progress, particularly due to sales of skateboard shoes. Shipments of snowboard products and Stearns sports equipment were comparable to the prior year. Offsetting these gains was a sales decline in the bicycle business. The decline in the high-end of the full-suspension bike market resulted in a 70% reduction in overall shipments as compared to the comparable prior year quarter. Ski shipments were impacted by cautious retail buying after a disappointing retail ski season which has resulted in an industry-wide decline in preseason orders. Sales of recreational products to the Japanese market also declined reflecting economic conditions in Asia. Net sales of the remaining two industrial products group, Shakespeare composites and electronics and Shakespeare monofilaments and specialty resins, rose 6.4% to $28.3 million from $26.6 million in the prior year's quarter. The increase reflects strong improvement in shipments of worldwide paperweaving monofilaments, an increase in specialty resin sales and higher cutting line business. 7 GROSS PROFIT. Gross profit for the third quarter of 1998 declined to $32.2 million, or 24.1% of net sales as compared with $38.2 million, or 31.5% of net sales in the year ago quarter. Excluding the effect of the charge for reserves, gross profit for the 1998 quarter was $39.9 million, or 29.8% of net sales. The decline in the gross profit percentage was due to shipments of closeout bikes at no margin and lower margin from sales at reduced prices of certain skate models. COSTS AND EXPENSES. In the third quarter of 1998, selling expenses increased to $21.5 million, or 16.1% of net sales from $17.6 million, or 14.5% of net sales in the prior year's quarter. The increase was due to expanded marketing of the various brands and products throughout the Company. General and administrative expenses, before the $6.8 million relating to the charge for reserves, increased to $13.4 million, or 10.0% of net sales, from $11.4 million, or 9.4% of net sales, before the restructuring charge of $2.4 million, included in the year-earlier period. The dollar increase is attributable to continued investment in new product development and other items related to timing. After the charges, general and administrative expenses in the third quarter of 1998 increased to $20.2 million, or 15.1% of net sales from $13.8 million, or 11.4% of net sales in the same 1997 quarter. OPERATING INCOME. Operating income for the third quarter before the charge for reserves declined to $5.0 million, or 3.7% of net sales, as compared to operating income of $9.2 million before the restructuring charge, or 7.6% of net sales, a year ago. The decline is mainly due to the lower gross profit margin from closeout sales and higher selling, general and administrative expenses. The operating loss after the charge for reserves was $9.5 million, or 7.1% of net sales, versus operating income, after the restructuring charge, of $6.8 million, or 5.6% of net sales, a year ago. INTEREST EXPENSE. Interest expense increased $259,000 to $2.8 million in the third quarter of 1998 compared to $2.6 million the year-earlier period. Higher average borrowings incurred to support the growth in sales increased interest expense by $651,000, which was offset by a reduction of $392,000 of interest due to lower interest rates. B. COMPARATIVE NINE-MONTH RESULTS OF OPERATIONS Net sales from continuing operations for the nine months ended September 30, 1998 increased to $441.7 million from $417.5 million in the corresponding prior-year period. Income from continuing operations before the charge for reserves was $11.7 million, or $.70 per diluted share. This compares with earnings from continuing operations, and before the after-tax restructuring charge of $17.3 million, or $1.03 per diluted share for the same period in the prior year. Including the charge for reserves, earnings from continuing operations was $2.2 million, or $.13 per diluted share and net income was $2.9 million, or $.17 per diluted share. This compares with income from continuing operations of $15.8 million, or $.94 per diluted share, and net income of $17.6 million, or $1.05 per diluted share, for the year-ago period. 8 NET SALES. In the sporting goods and other recreational products group, net sales increased to $343.8 million from $330.5 million in the 1997 period. Shakespeare fishing tackle products grew at a strong double digit rate due to the introduction of new Shakespeare branded products and continued gains in core fishing tackle products. Shipments of snowboard products increased due to strong demand for performance boards and Clicker step-in bindings and boots. Worldwide sales of in-line skates recovered in the third quarter. Stearns sports equipment contributed to sales growth as a result of new products as well as continued strength of core products. The new lifestyle companies also contributed to the sales increase. Offsetting these gains were lower shipments of full-suspension bikes due to the decline in the high-end of the full-suspension bike market. Sales of skis also declined due to a disappointing retail season industry-wide. The industrial products group reported a 12.5% increase in sales, to $97.9 million from $87.0 million. The improvement was primarily due to increased sales of paperweaving product and cutting line in the Shakespeare monofilament business. GROSS PROFIT. Gross profit for the first nine months of 1998 declined to $121.3 million, or 27.5% of net sales, from $127.6 million, or 30.6% of net sales, in the same 1997 period. Excluding the effect of the charge for reserves, gross profit was $129.0 million, or 29.2% of net sales, in the first nine months of 1998. The reduction in the gross profit percentage reflects closeout sales of certain bike inventories at no margin, higher sales of certain skate inventories at reduced margins and higher manufacturing costs in the industrial products group. COST AND EXPENSES. Selling expenses for the first nine months of the year increased to $64.1 million, or 14.5% of net sales, from $59.3 million, or 14.2% of net sales, in the comparable 1997 period. The increase was due to expanded marketing efforts of new products. General and administrative expenses, before the charge for reserves, increased to $38.6 million from $35.6 million, before a restructuring charge in the prior-year period. These expenses remained comparable from year to year as a percentage of net sales. After the charges, general and administrative expenses in the first three quarters of 1998 increased to $45.4 million, or 10.3% of net sales, from $38.0 million, or 9.1% of net sales, in the prior year period. OPERATING INCOME. Operating income before the charge for reserves declined to $26.3 million, or 6.0% of net sales, from $32.6 million, or 7.8% of net sales, before the restructuring charge in the prior-year period. The decline was mainly attributable to the effect of the lower gross profit percentage and higher selling, general and administrative expenses. After the charges, operating income was $11.8 million, or 2.7% of net sales, compared with $30.2 million, or 7.2% of net sales, in the prior year period. INTEREST EXPENSE. Interest expense increased $1.3 million to $9.1 million in the first nine months of 1998 compared to $7.8 million in the year-earlier period. Higher average borrowings incurred to support the growth in sales and new product development increased interest expense by $2.1 million, which was offset by a reduction of $800,000 of interest due to lower interest rates. 9 C. FINANCIAL CONDITION The Company's continuing operating activities provided $4.3 million of cash during the nine months ended September 30, 1998, as compared with $3.5 million of cash used during the nine- month period a year ago. The year to year improvement in cash was largely due to lower inventory levels in the current period offset in part by lower income from continuing operations. Net cash used for investing activities was $15.4 million in the current nine-month period compared to $9.8 million in the corresponding 1997 period. The 1997 period has been reduced by $6.4 million in connection with a one-time sale of investments. Excluding the one-time sale, net cash used in investing activities is consistent from year to year. There were no material commitments for capital expenditures at September 30, 1998. Net cash provided by financing activities was $6.7 million in the 1998 nine-month period as compared with $13.1 million in the corresponding year-ago period. The year to year reduction of $6.4 million in cash from financing activities was due to a net reduction in borrowings for the period. The Company anticipates its remaining cash needs in 1998 will be provided from operations and borrowings under existing credit lines. D. OTHER MATTERS The Company is currently working to resolve the potential impact of the Year 2000 on the processing of date-sensitive information by the Company's computerized information systems. The year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Any of the Company's programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000, which could result in miscalculation or system failures. Based on a preliminary study, the Company's management believes that most of the Company's information systems are Year 2000 compliant. Those systems that are not Year 2000 compliant will be either upgraded or replaced by the end of 1998 to ensure compliance. The total anticipated cost of compliance is not expected to be material. 10 STATEMENT REGARDING FORWARD-LOOKING DISCLOSURE This Form 10-Q contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including, but not limited to, the following: statements regarding sales and earnings, market conditions, market positioning, product acceptance and demand, restructuring efforts, market trends regarding bicycles, softboot in-line skates and skis, inventory levels at retail and overall market trends which involve substantial risks and uncertainties. The Company cautions that these statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements, including, but not limited to, economic conditions, product demand, competitive pricing and products, and other risks described in the Company's Annual Report on Form 10-K filing with the Securities and Exchange Commission. 11 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27 Financial Data Schedule (b) Reports on Form 8-K filed in the third quarter ended September 30, 1998 None 12 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. K2 INC. (registrant) Date: November 12, 1998 /S/ RICHARD M. RODSTEIN Richard M. Rodstein President and Chief Executive Officer Date: November 12, 1998 /S/ JOHN J. RANGEL John J. Rangel Senior Vice President - Finance 13