Jarden’s September 30 Quarter And the K2 Rolling Stones’ Limited Edition Ski Collection

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As you know, Jarden is a big, multi brand company that did $6 billion in its last complete year. They’ve got over 100 brands including Crock Pot, First Alert, Coleman, and Mr. Coffee. They also own K2, Ride, 5150, Planet Earth, and Volkl and that’s pretty much why we are interested in the company, though I think I’ve got a toaster oven one of their brands made.

The brands we care about are part of their Outdoor Solutions segment that did $707 million during the quarter (the whole company did $1.8 billion) and aren’t broken out from the rest of the brands in that segment. So we’re reduced to scouring footnotes and the conference call to see if we can find anything interesting.

Here’s the link to the 10Q. I’m not going to do my standard analysis of the income statement and balance sheet because the company’s pretty solid and I can’t really pull out any specifics that are relevant to action sports and youth culture.
 
Hiding in plain sight is the fact that Jarden is another big corporation that’s in our space and has been for some years now. Guess we should be used to it. That size and the extent of their operations gives them a perspective on the on the economy and business conditions that can highlights some things we are also thinking about.
 
One of those is China. Jarden management noted in the conference call that they expect Chinese wages and benefits will “…continue to rise by 15% to 20% annually as the Chinese economy becomes more consumer oriented and that the long-term trend in shipping and transportation costs will continue upwards.” As a result, they are bringing certain products back to the U.S. for manufacture. Time Magazine wrote about it as an example of an expanding trend. No snowboards or skis yet, according to the article.
 
A second is their focus on “achieving greater efficiencies from working capital.” That’s the stuff we’ve all been working on since the economy got tough; controlling inventories, being careful with credit, watching expenses. You know- all the operating stuff you do to try and bring a few more bucks to the bottom line when sales growth is a bit harder to come by.
 
With regards to the winter sports business, we did get a few pieces of information. They note that K2, Volkl and Marker have had strong early orders, especially in Europe. They think retailers are trying to replenish record low inventory positions.
 
There’s also a note about there being a Seattle K2 concept store that’s open on a seasonal basis. I haven’t seen it, but will have to track it down. Jarden has Rawlings and Coleman outlet stores. They say they are interested in doing more retail, but don’t offer any specifics.
 
I also found out that Jarden has an investment in Rossignol (size not specified) though they aren’t involved in running it.
 
Finally there are, in fact, going to be Rolling Stone limited edition skis from K2. I really don’t know whether or not I like this idea. I’d love to talk to the marketing guys about their rationale. I was relieved to see that it’s apparently not on any snowboards. Maybe it was the threat of putting Rolling Stones graphics on Ride that made Robert Marcovitch leave town.
 
As you know, Robert was the CEO of Ride and stayed with the company when it was acquired by K2 and when K2 was acquired by Jarden. He was running (very successfully I heard) the entire Jarden winter sports business until a bit more than two months ago, when he was promoted to CEO of Coleman and sent to their headquarter in Wichita, Kansas from Seattle.
 
Now the plot thickens. We learn in the conference call that, “…Robert and his senior team have been looking at Coleman on a global basis, looking at where our customers are, and how we need to be able to respond to a growing global presence…”
 
Out of this review came a decision for Coleman to put a facility in Denver“…that puts us closer to an international airport, puts us closer to people to work in the outdoor industries in our core consumer group and we think it’s a move that is going to kind of reinvigorate Coleman and put us on its next leg of growth over the next 10 years.”
 
Nice work Robert!! I don’t actually know any of this, but it just feels like he took the job, got to Wichita, and decided he needed to be back near the mountains. I’d love to see the Power Point he used to convince senior management.
 
On a serious note, I suspect that part of his new job is to get Coleman out of Wichita figuratively as well as, I guess, literally. This is a well-known brand that I think of as reliable, workmanlike, and venerable. In some ways it feels like a utility; it always works and it’s always there when you need it, but it’s definitely not cool. Robert has the background to make it cool and expand its market reach and I’ll bet that’s part of the plan. I think there’s a lot of potential there.
 
Should be fun to watch.

 

 

Jarden Corporation; Remember Them?

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Whenever VF comes out with its earnings, we all gather around to see if we can find anything about how Vans and Reef are doing. But when Jarden, who owns a winter lineup of brands that includes Atlas, Full Tilt, K2, Ride, Line, Little Bear, Madshus, Marker, Morrow, Tubbs, Volkl and 5150, we don’t even notice. Wonder why.

Jarden is another large company with $6 billion in revenue. Its Outdoor Solutions Group, of which the winter sports brands listed above are a part, represented $2.5 billion, or 42% of total revenues in the year ended December 31, 2010.

The catch of course, like with VF, is that they don’t tell us anything specific about brand performance. But if you listen carefully to the conference call, you can pick up a few things.
 
The Outdoor Solutions Group grew 17% during the year. Of that, 13% was organic (not the result of acquisitions). They tell us that growth was led by the winter sports brands. They view winter sports sales as a barometer for consumer confidence. Performance for winter sports was “exceptionally strong” and produced record sales and EBITDA. They say that their winter performance was a lot stronger than many of their competitors due to certain technical improvements they made in the product.
 
Well, it ain’t much information, but it’s better than nothing. We probably can’t afford to ignore $6 billion companies that play in our back yard.
 
Jarden’s winter business is run by Robert Marcovitch and judging from the smile on his face in Denver, things are going just as well as management indicated in the conference call. I wonder if those guys saw Ride’s booth. I was really disappointed when “Our customers come first” came off the sign on the booth entrance after the first day of the show. Sorry I missed seeing the booth in Europe.      

 

 

K2’s 2006 Annual Report

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      For the longest time, I thought about K2 as a ski and snowboard company. But that’s ancient history. They call themselves a “premier branded consumer products company” and divide their business into four segments: Marine and Outdoors ($407.6-million in 2006 sales), Action Sports ($421.4-million), Team Sports ($383.4-million), and Apparel and Footwear ($182.3-million). That’s a bit over $1.3-billion in total 2006 revenues.

      Snowboarding, obviously, is included in the action-sports segment. And now, going directly to the discussion of that segment, I’m going to tell you exactly how each of their four snowboard brands are doing, right?
      Not hardly. They don’t provide a breakdown beyond those four segments. The only piece of information I was able to find was in footnote thirteen of the financial statements on page 92 of their 10K where they note that one-third of the action-sports segment (around $140-million) was snowboarding. They also note that one-third of the apparel and footwear segment revenue ($61-million) was skateboard shoes, apparel, and accessories.
      If only fifteen percent of K2’s 2006 revenues were in what we would all call action sports, why am I writing about them? Two reasons. First, $200-million still isn’t small potatoes in the action-sports industry as it has traditionally been defined. Second, in discussing their business, they say a number of insightful things about their strategy and the industry’s evolution that are worth highlighting.
      Let’s start by remembering what K2’s product lines include. Snowboarding and skate we’ve already mentioned, and we all know about their ski business. But they are also selling snowshoes, paintball products, baseballs and gloves, softballs, fishing kits and combos, fishing rods, personal flotation devices, hunting accessories, all-terrain vehicle accessories, inline skates, Nordic skis, and snowshoes. I think that covers it.
      K2’s management thinks that “the growing influence of large format sporting goods retailers and retailer buying groups, as well as the consolidation of certain sporting-goods retailers worldwide, is leading to a consolidation of sporting-goods suppliers.” As a result, they expect retailers to buy increasingly from fewer larger suppliers. This, according to K2, will allow those retailers to operate more efficiently and cut their costs. Those few larger suppliers will be “those with greater financial and other resources, including those with the ability to produce or source high-quality, low-cost products and deliver these products on a timely basis to invest in product development projects and to access distribution channels with a broad array of products and brands.”
      In its market, including the action-sports business but obviously going far beyond it, K2 thinks size matters. Their general strategy of improving operating efficiency, maximizing how they utilize their distribution channels, leveraging existing operations and “complementing and diversifying its product offerings” reflects this. 
      The second part of this strategy is making acquisitions “of other sporting-goods companies with well-established brands and with complementary distribution channels.” So far, they have made two in 2007. There were three in 2006 and two others in 2005. They note that much of their revenue growth in 2006 came from acquisitions made in 2003–2006.
      There are two things they don’t talk about—opening retail stores and expanding into the fashion/apparel business. K2 is largely a hardgoods (I think a baseball glove is a hardgood) company that believes an increasing percent of its sales and profits will come from large retailers and that those retailers will control more and more of the market. Fifteen percent of its sales were to Wal-Mart in 2005 and 2006. Given their strategy and analysis of how the market is evolving, that makes perfect sense.
      And now, three weeks later, after this story is long gone to the editors and basically out of my memory, but about one day before it was too late to do anything about it, K2 goes and sells itself to Jarden , who had revenues of $3.8 billion in 2006 (see the related story in this issue). Jarden is a “leading provider of niche consumer products used in and around the home.” They have a huge stable of brands, many of which we all recognize.  They divide their business into three segments- branded consumables, consumer solutions and outdoor solutions. K2 will become part of their outdoor solutions and snowboarding will become an even smaller piece of the whole pie. Jarden’s growth strategy “is based on introducing new products, as well as on expanding existing product categories which is supplemented through acquiring businesses with highly recognized brands, innovative products and multi-channel distribution” Go back and review K2’s strategy and market analysis and you’ll see why the two companies thought it made sense to get together.
 
      I’m not sure our comfortable little action-sports niche is still little, or comfortable, or a niche, but sitting in it we have tended to make fun of in-line skates, team sports and, not very long ago, skis. K2 doesn’t care. They’ve just looked at where they think the industry is going and have devised a strategy to respond to that evolution—which, as far as I know, is what management at any company is suppose to do.
      Okay, you’re not K2. There is no sale of fishing poles in your future. But if you think their analysis of the broader sporting-goods market and its retailers is valid, what does it mean for your brand? Snowboards, skateboards, and surf boards are, I’m afraid, sporting goods. They are not isolated from these trends.

 

 

Fat Lady Sings. K2 Buys Ride

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K2’s purchase of Ride, announced on July 22 and expected to close within 100 days, is as close as we’ll ever get to a capstone on consolidation.

We all were intellectually aware of consolidation, but this makes you aware in your gut. Burton and K2 now control what I’d estimate to be 65 percent of the U. S. snowboard hard goods market. Add Salomon and Rossignol and the number jumps to north of 75 percent. The number two, independent, snowboard only brand in North America is now Sims
Three questions:
 
·         What the deal?
·         What does it mean for the industry?
·         How is K2 going to manage it?
 
The Deal
 
The only info we’ve got on the deal comes from the press release and Ride’s 8K filing with the Securities and Exchange Commission. K2 is buying the common stock of Ride. That is, it’s buying the whole company- not the assets like in the Morrow deal and so many other snowboard deals.
 
So K2 gets all the assets and all the liabilities, known and unknown. If a two-year-old Ride binding blows up, somebody is hurt, and Ride is sued, K2 will be responsible. In an asset deal, they typically would not be- which is one reason asset deals are often popular.
 
Ride’s stock will be acquired in exchange for K2 common stock. Ride shareholders will receive K2 shares “with an approximate value of $1.00 for each share of Ride stock owned.” Given the number of Ride shares outstanding, that means a purchase price of around $14.3 million. Both boards of directors have approved the deal. One of the reasons it will take so long to close is that Ride shareholders have to approve the deal as well.
 
The deal is being structured so it’s tax free to Ride’s shareholders. Ride’s directors have already agreed to vote their shares in favor of the deal.
 
To get Ride from the July 22 agreement date to closing, K2 has agreed to extend $2 million in interim financing to Ride in exchange of a promissory note that can be converted into Ride stock. The note’s initial interest rate is eight percent. That rate increases one percent every 180 days up to a maximum of eighteen percent on the unpaid portion of the note and any accrued interest, however the notes is payable in full on November 19, 1999.
 
The note is convertible by K2 at any time into Ride’s cumulative convertible preferred stock and is automatically converted under certain circumstances if the merger agreement between K2 and Ride is terminated. K2 would get one share of the convertible preferred stock for each dollar that is still owed from the principal and unpaid interest of the note.
If somebody else buys Ride, or agrees to buy ride, before the note is repaid or converted, K2 can demand to be paid in cash for up to a year based on the price of Ride’s stock (which could go up if a better deal comes along).
 
Ride, as a public company, has an obligation to consider any better offers that come along. This note is structured not only to give Ride working capital to get it through the period until closing, but to make it less likely that any such deal will come along. If the deal with K2 closes, there’s nothing but intercompany debt that gets eliminated in consolidation and doesn’t much matter.
 
As another step in keeping Ride operational until the deal closes, the two companies have agreed that K2 will acquire Ride bindings with an approximate cost of $700,000 and assume Ride’s obligations to ship Ride customer orders of approximately $8.4 million in bindings and apparel. K2 will purchase approximately $4 million in inventory from Ride’s vendors to fill these orders.
 
What’s it all mean? The two companies are getting so far into bed with each other before the deal closes that it’s unlikely it won’t close or that another buyer will come along.  
 
The transaction will be accounted for as a purchase rather than a pooling, and now I’ve put my foot in it because I have to explain the difference.
 
First, if you buy assets, you assign values to the assets based on what they are really worth. So is you’re buying accounts receivable for $100,000, but know that only 85 percent are collectible you’d “allocate” $85,000 of the purchase price to those receivables. After you’ve allocated as much of the purchase price as you can to the assets, the rest is allocated to goodwill. Goodwill sits on your balance sheet and has to be amortized (taken as an expense some at a time) over a period of many years, but isn’t deductible for tax purposes.   In addition, no bank ever thinks good will is worth anything when considering whether or not to lend you money.
 
Allocation of purchase price in an asset deal also has a major impact on who pays what tax when the deal closes, but since this isn’t an asset deal and I hate it when readers fall asleep, we’ll skip that. You’re welcome.
 
A pooling is a straight exchange of stock where the values on the two company’s balance sheets are added up. No goodwill is created. No assets are written up or down and there’s no allocation of purchase price. The only adjustments are the netting out of any inter-company debts (amounts the two companies owe each other).
 
K2 is buying Ride’s stock with its stock, but it’s not a pooling because Ride shareholders are getting a certain value per share- not just K2 shares with a value completely dependent on the market. It’s a purchase. That’s what the Financial Accounting Standards Board says, so that’s the way it is.
 
Once K2 knows exactly how many shares it’s exchanging for Ride, and the market price of those shares at closing, it will know how many dollars it paid for Ride by multiplying the market price of each share by the number of shares they are giving Ride shareholders. The accounting interpretation of the deal is that K2 is buying Ride’s equity, a balance sheet number. At March 31, that number was 16.1 million dollars. I’m sure it’s lower now. I wouldn’t be surprised if it’s around 14.3 million dollars.
 
To the extent that the purchase price is higher or lower than Ride’s actual equity at closing, other balance sheet items will be adjusted to reflect fair market values. For example, if the purchase price is $100,000 higher than the value of Ride’s equity at closing, the value of other Ride assets will have to be increased, to a maximum of $100,00 if what they are really worth justified such an increase. To the extent that those adjustments don’t account for the difference between Ride’s equity and K2’s purchase price, goodwill is adjusted. It looks in this case like the purchase price will end up being somewhere close to Ride’s equity, so adjustments should be minor.
 
That’s enough of that. This article is in serious danger of turning into a lecture on acquisition accounting.
 
So what’s the deal worth anyway? The easy answer is that it’s worth the approximately $14.3 million in K2 stock Ride shareholders are receiving. That’s not a bad answer, but let’s go a little further, keeping in mind that there’s rarely a right answer when you value companies.
 
Ride’s March 31 balance sheet showed thirty two million dollars in assets and sixteen million dollars in liabilities. K2 gets all those as part of the purchase. The assets include $8.5 million in goodwill and $5.4 million in net plant and equipment. If I were K2 trying to figure out the value of Ride, I’d call the goodwill zero. I’d write down the plant and equipment. How much would depend on what use I was going to make of the factory. Let’s say they cut it in half, making the realizable value of the Ride assets around $20 million. The liabilities, as usual, are all real.
 
Let’s say that K2 could liquidate the assets for $20 and pay off the liabilities for $16 million. It doesn’t work that way of course, but if it did K2 would have $4 million in the bank. So they would have paid stock worth $14.3 million less $4 million in net assets, or $10.3 million basically for Ride’s trade name and order book.
 
But you can’t realize the value of that trade name and order book unless you operate the business. To do that, you have to invest a certain amount of permanent working capital. Ride didn’t have the working capital it needed. In a nutshell, that’s why it had to sell. My guesstimate, depending on the expense reductions K2 can find to reduce overall operating costs, is that K2 is going to have to invest maybe more than$10 million in Ride in additional to the $4 million in net assets that’s already in there. My guess is that Ride’s bank (owed $8.5 million at March 31) is going to want to be paid off and certain unsecured creditors who have been waiting a long time for their money will also have to be paid. 
 
K2, therefore, may look at it’s cost to buy Ride as not only the value of the equity it gave up, but as the additional capital they have to invest to normalize the balance sheet- $24 million in total or maybe higher. If Ride had been capitalized normally, that whole amount, and probably more, would have accrued to Ride’s shareholders. But K2’s offer was based on what it would cost them not only to buy but to operate Ride regardless of whether it went to the shareholders or not.
 
Good deal or bad deal? K2 got a good deal. Did Ride shareholders get screwed? Not given the alternative. My sense is that Ride’s management found the buyer to whom Ride has the most value. Furthermore, Ride’s balance sheet and recent public information suggest that cash flow issues were severe enough that scenarios where shareholders got less than one dollar per share were possible. Like a whole lot less. Like the big goose egg.
 
All of the web whiners who are bitching and moaning about this deal ought to give Ride employees credit for performing some operational miracles under impossibly difficult circumstances not of their making.
 
If you want to blame somebody, check out the nearest mirror. The person you’re looking at bought an over priced stock in an industry facing an inevitable and predictable consolidation. 
 
Industry Impact
 
Ride and Morrow are gone as independent snowboard companies. Atlantis, Division 23 and Type A are, in my judgment, unlikely to resurface as strong specialty brands. To Forum, Sims, Palmer, Never Summer, Option and maybe a couple of other brands this could be an opportunity depending on retailers’ perception of the deal. One brand I’ve talked with is already getting calls from retailers who were prepared to buy Ride but are reluctant to buy “another K2 brand.”
 
The strategic line between the niche players and the big companies are as clearly drawn as you could ever expect to see. If any single action can be said to mark the end of snowboarding’s consolidation phase, this deal is it.
 
Specialty brands can exist in their niches and maybe grow a little. But it’s financially unlikely that anybody will start another one. Those niche brands that exist don’t have the economies of scale, distribution leverage, and marketing dollars they need to chase the big players. And as independent companies, they probably never will.
 
Then there’s Burton with something like forty five percent of the U.S. market. They are left standing alone with the cache of a niche brand, but on an international scale, and the leverage of a large company. Ain’t nothing to analyze there. My guess is that they are thrilled with this deal.
 
As I indicated, some retailers may have some resistance to putting more eggs in the K2 basket. But if the consumer wants Ride boards, and K2 offers good terms, prices, service, quality and promotion, the retailers will pretty much get over it. They have before.
 
I would expect the complete programs from Morrow and Ride to improve as a result of being part of a larger, financially stable organization. And the production of boards in China is going to produce some price points that retailers aren’t going to be able to live without.
 
Sean- I don’t really want to add here what you added. I think I ask and answer the question you raise in the next section.
 
K2’s Decisions
 
What I think was the opportunistic purchase of Morrow (it was too good a deal to turn down) seems to have transformed itself into a strategy with the purchase of Ride. Of course, we don’t know exactly what that strategy is yet. K2 now has five snowboard brands, with K2, Morrow, Ride, Liquid and 5150. How do they get positioned against each other? How many of those brands can you imagine one retailer buying? If I were doing it, I’d make K2 the ski shop brand. I’d retain Brad Steward (between movies, of course) to consult on repositioning Morrow as the quirky brand it use to be. Liquid would be for the mass-market channel, and Ride for specialty shops, but with a more mainstream profile and higher volume than Morrow. I’m fresh out of market positions and have no idea what I’d do with 5150. Whatever the positioning decisions are, I’ll be interested to see if all five are retained. I wonder what Cass would pay for Liquid? I’d really like to leave this in. Let’s talk.
 
Even excluding the distribution issues, managing five brands against each other in the same organization is tough. I’m reminded that one of Bob Hall’s first pronouncements on becoming CEO of Ride was that the company had too many brands.
 
Of course, some of the brands he eliminated didn’t have enough volume to justify the required advertising and promotional expenditures, and I don’t think K2 faces that. Still, there are some obvious conflicts as K2 works to restructure its organization to manage the five brands.
 
For instance, you just know that the financial guys at K2 are sharpening their knives to slice expenses and walking around muttering stuff about synergies. And certainly K2doesn’t need two warehouses, credit departments, computer systems, purchasing departments, etc.
 
Maybe they don’t need two factories. Yet maintaining brand integrity means keeping sales and marketing separate. Will they have separate customer service departments with people dedicated to brands or will the temptation to have one group that answers the phone “snowboard customer service!” win out? Will all the invoices the retailers receive look the same except for the brand name?   How many brands will be made in the same factory? Will the T-shirts and beanies all be the same but with different logos? In a thousand ways, none of which, by itself, probably matters, the identity of the brands can be subverted in the perfectly reasonable pursuit of operational efficiencies.
 
I’m not saying it will happen, but making sure it doesn’t is a hell of a challenge. It’s not easy to be passionate about five brands at once.
 
SIDEBAR
 
Things to Watch
 
1)             Who’s going to run what brands?
2)             What will happen to Ride’s factory?
3)             What will be the fate of the Device step-in system and the lawsuit with Vans (Switch)?
4)             How will be product development be managed among the different brands?
5)             I’m sure we’ll figure out some more to add.