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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended October 31, 2002 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _______________ to
Commission File Number: 0-15827
SHARPER IMAGE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2493558
(State of Incorporation) (I.R.S. Employer
Identification No.)
650 Davis Street, San Francisco, California 94111
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 445-6000
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 (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
---
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
Common Stock, $0.01 par value, 12,634,752 shares as of December 12, 2002
1
SHARPER IMAGE CORPORATION
REPORT ON FORM 10-Q
FOR THE QUARTER ENDED OCTOBER 31, 2002
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements (Unaudited) 3
Condensed Balance Sheets
Condensed Statements of Operations
Condensed Statements of Cash Flows
Notes to Condensed Financial Statements
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk 31
Item 4. Controls and Procedures 32
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 33
SIGNATURES 34
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SHARPER IMAGE CORPORATION
CONDENSED BALANCE SHEETS
(Unaudited)
October 31, January 31, October 31,
2002 2002 2001
Dollars in thousands, except per share amounts (Note A)
---------- ---------- -----------
ASSETS
Current Assets:
Cash and equivalents $ 1,904 $ 40,417 $ 1,509
Accounts receivable, net of allowance for doubtful
accounts of $684, $1,082 and $734 12,335 8,098 11,794
Merchandise inventories 93,769 50,151 81,216
Deferred catalog costs 6,945 3,844 7,117
Prepaid expenses and other 12,347 10,648 14,447
---------- ---------- -----------
Total Current Assets 127,300 113,158 116,083
Property and equipment, net 51,333 44,862 44,106
Deferred taxes and other assets 4,836 4,318 6,341
---------- ---------- -----------
Total Assets $ 183,469 $ 162,338 $ 166,530
========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued expenses $ 59,899 $ 41,773 $ 54,872
Short term borrowings - - 7,625
Deferred revenue 17,737 16,982 13,370
Income taxes payable - 807 -
Current portion of notes payable 185 174 170
---------- ---------- -----------
Total Current Liabilities 77,821 59,736 76,037
Notes payable 1,893 2,033 2,077
Other liabilities 6,813 5,826 5,804
---------- ---------- -----------
Total Liabilities 86,527 67,595 83,918
---------- ---------- -----------
Commitments and contingencies - - -
Stockholders' Equity:
Preferred stock, $0.01 par value:
Authorized 3,000,000 shares: Issued and outstanding, none - - -
Common stock, $0.01 par value:
Authorized 25,000,000 shares: Issued and outstanding,
12,631,886, 11,970,684 and 11,897,857 shares 127 120 119
Additional paid-in capital 46,155 42,582 42,013
Retained earnings 50,660 52,041 40,480
---------- ---------- -----------
Total Stockholders' Equity 96,942 94,743 82,612
---------- ---------- -----------
Total Liabilities and Stockholders' Equity $ 183,469 $ 162,338 $ 166,530
========== ========== ===========
See notes to condensed financial statements.
3
SHARPER IMAGE CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
Dollars in thousands, except per share amounts October 31, October 31,
----------- -----------
2002 2001 2002 2001
---- ---- ---- ----
REVENUES:
Sales $ 116,863 $ 84,495 $ 330,834 $ 250,241
Less: returns and allowances 13,672 10,146 37,763 28,184
----------- ----------- ----------- -----------
Net Sales 103,191 74,349 293,071 222,057
Other revenue 2,918 2,655 8,282 7,503
----------- ----------- ----------- -----------
106,109 77,004 301,353 229,560
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Cost of products 48,218 38,084 132,655 110,949
Buying and occupancy 11,265 9,922 32,676 27,583
Advertising 20,027 12,667 61,357 43,114
General, selling, and administrative 27,361 22,338 77,034 65,132
----------- ----------- ----------- -----------
106,871 83,011 303,722 246,778
----------- ----------- ----------- -----------
OPERATING LOSS (762) (6,007) (2,369) (17,218)
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE):
Interest income 23 20 266 577
Interest expense (80) (90) (209) (227)
Other income (expense), net (16) (281) (27) (241)
----------- ----------- ----------- -----------
(73) (351) 30 109
----------- ----------- ----------- -----------
Loss before income tax benefit (835) (6,358) (2,339) (17,109)
Income tax benefit (342) (2,543) (958) (6,844)
----------- ----------- ----------- -----------
Net loss $ (493) $ (3,815) $ (1,381) $ (10,265)
============ =========== =========== ============
Net loss per share
- Basic $ (0.04) $ (0.32) $ (0.11) $ (0.86)
============ =========== =========== ===========
- Diluted $ (0.04) $ (0.32) $ (0.11) $ (0.86)
============ =========== =========== ===========
Weighted Average Number of Shares -
Basic 12,422,000 11,897,000 12,223,000 11,897,000
Diluted 12,422,000 11,897,000 12,223,000 11,897,000
4
SHARPER IMAGE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
October 31,
-----------
Dollars in thousands 2002 2001
---- ----
Cash was Provided by (Used for) Operating Activities:
Net loss $ (1,381) $ (10,265)
Adjustments to reconcile net loss to net cash used for operations:
Depreciation and amortization 10,782 7,580
Deferred rent expenses and landlord allowances 159 263
Loss on disposal of equipment 49 412
Changes in:
Merchandise inventories (43,618) (19,257)
Accounts receivable (4,237) (2,072)
Deferred catalog costs, prepaid expenses and other assets (4,462) (9,243)
Accounts payable and accrued expenses 18,126 (143)
Deferred revenue, income taxes payable and other liabilities (80) (8,982)
------------ -----------
Cash Used for Operating Activities (24,662) (41,707)
------------ -----------
Cash was Used for Investing Activities:
Property and equipment expenditures (17,302) (15,624)
------------ -----------
Cash Used for Investing Activities (17,302) (15,624)
------------ -----------
Cash was Provided by (Used for) Financing Activities:
Proceeds from issuance of common stock, including
stock options exercised 3,580 302
Repurchase of common stock - (987)
Proceeds from notes payable and revolving credit facility 5,000 10,475
Principal payments on notes payable revolving credit facility (5,129) (2,969)
------------ -----------
Cash Provided by Financing Activities 3,451 6,821
----------- ----------
Net Decrease in Cash and Equivalents (38,513) (50,510)
------------ -----------
Cash and Equivalents at Beginning of Period 40,417 52,019
----------- ----------
Cash and Equivalents at End of Period $ 1,904 $ 1,509
=========== ==========
Supplemental Disclosure of Cash Paid for:
Interest $ 195 $ 201
Income Taxes $ 707 $ 7,991
See notes to condensed financial statements.
5
SHARPER IMAGE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
Three-month and nine-month periods ended October 31, 2002 and 2001
(Unaudited)
NOTE A- Financial Statements
The accompanying unaudited condensed financial statements have been prepared
from the records of the Sharper Image Corporation (the "Company") without audit
and, in the opinion of management, include all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the financial position at
October 31, 2002 and 2001; the results of operations for the three and nine
months ended October 31, 2002 and 2001; and changes in cash flows for the nine
months ended October 31, 2002 and 2001. The balance sheet at January 31, 2002,
presented herein, has been derived from the audited financial statements of the
Company for the fiscal year then ended.
Certain information and disclosures normally included in the notes to the annual
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted from these interim
financial statements. Accordingly, these interim financial statements should be
read in conjunction with the financial statements and notes thereto included in
the Company's 2001 Annual Report.
The Company's business is highly seasonal, reflecting the general pattern
associated with the retail industry of peak sales and earnings during the
Holiday shopping season. A substantial portion of the Company's total revenues
and all or most of the Company's net earnings usually occurs in the fourth
quarter ending January 31. The Company, as is typical in the retail industry,
generally experiences lower revenues and net operating results during the other
quarters and has incurred and may continue to incur losses in these quarters.
The results of operations for interim periods are not necessarily indicative of
the results for the full fiscal year.
Certain reclassifications are made to prior periods' financial statements in
order to conform to current period presentations.
NOTE B- Revolving Loan and Notes Payable
The Company has a revolving secured credit facility (the "credit facility") with
an expiration date of September 2004. The credit facility allows the Company
borrowings and letters of credit up to a maximum of $33 million for the period
from October 1 through December 31, and $20 million for other times of the year
based on inventory levels. The credit facility is secured by the Company's
inventory, accounts receivable, general intangibles and certain other assets.
Borrowings under this facility bear interest at either the prime rate plus a
margin or at LIBOR plus a margin, based on the Company's financial performance.
The credit facility contains certain financial covenants pertaining to interest
coverage ratio and net worth and contains limitations on operating leases, other
borrowings, dividend payments and stock repurchases. At October 31, 2002, we had
no amounts outstanding on our credit facility and letter of credit commitments
outstanding under the credit facility were $7.0 million.
In addition, the credit facility provides for term loans for capital
expenditures ("Term Loans") up to $2.0 million. Amounts borrowed under the Term
Loans bear interest at a variable rate of either prime
6
rate plus a margin or at LIBOR plus a margin based on the Company's financial
performance. Each Term Loan is to be repaid in 36 equal monthly principal
installments. As of October 31, 2002, there were no outstanding Term Loans on
this facility.
NOTE C - Earnings (Loss) Per Share
Basic earnings per share is computed as net income available to common
stockholders divided by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution that
could occur from common shares to be issued through stock options.
Three Months Ended Nine Months Ended
October 31, October 31,
2002 2001 2002 2001
---- ---- ---- ----
Net loss $ (493,000) $ (3,815,000) $ (1,381,000) $ (10,265,000)
Average shares of common stock
outstanding during the period 12,422,000 11,897,000 12,223,000 11,897,000
============== ============== ============== ==============
Basic loss per share $ (0.04) $ (0.32) $ (0.11) $ (0.86)
============== ============== ============== ==============
Average shares of common stock
outstanding during the period 12,422,000 11,897,000 12,223,000 11,897,000
Add:
Incremental shares from assumed
Exercise of stock options - - - -
-------------- -------------- -------------- --------------
12,422,000 11,897,000 12,223,000 11,897,000
============== ============== ============== ==============
Diluted loss per share $ (0.04) $ (0.32) $ (0.11) $ (0.86)
============== ============== ============== ==============
The potential effects of stock options were excluded from the diluted earnings
per share for the three and nine-month periods ended October 31, 2002 and 2001
because their inclusion in net loss periods would be anti-dilutive to the
earnings per share calculation.
Options to purchase 2,713,794 and 2,517,043 shares of common stock were
outstanding as of October 31, 2002 and 2001, respectively. Of these options,
1,399,207 and 467,898 stock options for the three months ended October 31, 2002
and 2001, respectively, and 1,468,489 and 667,053 stock options for the nine
months ended October 31, 2002 and 2001, respectively, were excluded from
dilutive earnings per share calculation because the Company was in a net loss
position and their inclusion would have been anti-dilutive.
Had the Company been in a net income position, stock options of 27,400 and
1,363,582 for the three months ended October 31, 2002 and 2001, respectively and
stock options of 40,700 and 312,934 for the nine months ended October 31, 2002
and 2001, respectively, would have been excluded from the diluted earnings per
share calculation because the option exercise price exceeded the average stock
price for those periods.
7
NOTE D - Recent Accounting Standard
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal Activities, which
addresses accounting for restructuring and similar costs. SFAS No. 146
supersedes previous accounting guidance, principally Emerging Issues Task Force
Issue No. 94-3. The Company will adopt the provisions of SFAS No. 146 for
restructuring activities initiated after December 31, 2002. SFAS No. 146
requires that the liability for costs associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3, a
liability for an exit cost was recognized at the date of the Company's
commitment to an exit plan. SFAS No. 146 also establishes that the liability
should initially be measured and recorded at fair value. Accordingly, SFAS No.
146 may affect the timing of recognizing future restructuring costs as well as
the amounts recognized.
8
NOTE E - Segment Information
The Company classifies its business interests into three reportable segments:
retail stores, catalog and direct marketing, and Internet. The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies in Note A of the 2001 Annual Report. The Company
evaluates performance and allocates resources based on operating contribution,
which excludes unallocated corporate general and administrative costs and income
tax expense or benefit. The Company's reportable segments are strategic business
units that offer essentially the same products and utilize common merchandising,
distribution, and marketing functions, as well as common information systems and
corporate administration. The Company does not have intersegment sales, but the
segments are managed separately because each segment has different channels for
selling the product.
Financial information for the Company's business segments is as follows:
Three Months Ended Nine Months Ended
October 31, October 31,
----------- -----------
2002 2001 2002 2001
---- ---- ---- ----
Dollars in thousands
Revenues:
Stores $ 57,154 $ 41,826 $ 165,583 $ 130,131
Catalog and Direct Marketing 23,304 17,089 75,788 52,981
Internet 12,758 9,698 36,439 29,310
Other 12,893 8,391 23,543 17,138
----------- ----------- ------------ -----------
Total Revenues $ 106,109 $ 77,004 $ 301,353 $ 229,560
----------- ----------- ------------ -----------
Operating Contributions:
Stores $ 2,774 $ 190 $ 10,082 $ 2,916
Catalog and Direct Marketing 2,999 434 9,286 2,605
Internet 1,225 909 4,304 1,899
Unallocated (7,833) (7,891) (26,011) (24,529)
------------ ------------ ------------- ------------
Loss Before Income Tax Benefit $ (835) $ (6,358) $ (2,339) $ (17,109)
------------ ------------ ------------- ------------
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The condensed balance sheets of the Company as of October 31, 2002 and 2001, and
the related condensed statements of operations for the three-month and
nine-month periods, and statement of condensed cash flows for the nine-month
periods then ended have been reviewed by the Company's independent accountants,
Deloitte & Touche LLP, whose report covering their review of the financial
statements is presented herein.
9
INDEPENDENT ACCOUNTANTS' REPORT
Board of Directors
Sharper Image Corporation:
We have reviewed the accompanying condensed balance sheets of Sharper Image
Corporation as of October 31, 2002 and 2001, and the related condensed
statements of operations for the three-month and nine-month periods, and cash
flows for the nine-month periods then ended. These financial statements are the
responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the balance sheet of Sharper Image
Corporation as of January 31, 2002, and the related statements of operations,
stockholders' equity and cash flows for the year then ended (not presented
herein); and in our report dated March 25, 2002, we expressed an unqualified
opinion on those financial statements. In our opinion, the information set forth
in the accompanying condensed balance sheet as of January 31, 2002 is fairly
stated, in all material respects, in relation to the balance sheet from which it
has been derived.
/s/ Deloitte & Touche LLP
- -------------------------
San Francisco, CA
November 20, 2002
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
This report (including without limitation the statements contained in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations) contains forward-looking statements (within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934) regarding the Company and our business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this report.
Additionally, statements concerning future matters such as the development of
new products or enhancements, store expansions, possible changes in legislation
or economic conditions and other statements regarding matters that are not
historical are forward-looking statements.
The forward-looking statements in this report are based on current expectations,
estimates, forecasts and projections about the industry in which we operate and
the beliefs and assumptions of our management. Consequently, forward-looking
statements are inherently subject to risks and uncertainties, and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes include, but are not limited to those set
forth in the Management's Discussion and Analysis of Financial Condition and
Results of Operations and under the Factors Affecting Future Operating Results
as well as those discussed elsewhere in this report. Readers are urged not to
place undue reliance on these forward-looking statements, which speak only as of
the date of this report. We undertake no obligation to revise or update any
forward-looking statements in order to reflect any event or circumstance that
may arise after the date of the report.
The following information should be read in conjunction with the historical
financial information and the notes thereto included in Item 1 of this Quarterly
Report on Form 10-Q and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in our annual report on Form 10-K
for the fiscal year ended January 31, 2002 as filed with the Securities and
Exchange Commission.
11
RESULTS OF OPERATIONS
The following table sets forth the results of operations expressed as a
percentage of total revenues for the periods indicated.
Three Months Ended Nine Months Ended
October 31, October 31,
----------- -----------
Percentage of Total Revenues 2002 2001 2002 2001
- ---------------------------- ---- ---- ---- ----
Revenues:
Net store sales 53.9% 54.3% 54.9% 56.7%
Net catalog and direct marketing sales 22.0 22.2 25.1 23.1
Net Internet sales 12.0 12.6 12.1 12.8
Net wholesale sales 9.4 7.5 5.1 4.2
List rental and licensing 0.3 .5 0.3 .4
Delivery 2.4 2.9 2.5 2.8
-------- --------- -------- --------
Total Revenues 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Cost of products 45.4 49.5 44.0 48.3
Buying and occupancy 10.6 12.9 10.8 12.0
Advertising 18.9 16.4 20.4 18.8
General, selling and administrative 25.8 29.0 25.6 28.4
Other (Income) Expense 0.1 0.5 (0.0) (0.0)
-------- --------------------------- ---------
Loss Before Income Taxes (0.8) (8.3) (0.8) (7.5)
Income Tax Benefit (0.3) (3.3) (0.3) (3.0)
--------- ---------- --------- ---------
Net Loss (0.5)% (5.0)% (0.5)% (4.5)%
========= ========== ========= =========
The following table sets forth the components of total revenues for the periods
indicated.
Three Months Ended Nine Months Ended
October 31, October 31,
----------- -----------
2002 2001 2002 2001
---- ---- ---- ----
Revenues (dollars in thousands)
Net store sales $ 57,154 $ 41,826 $ 165,583 $ 130,131
Net catalog and direct marketing sales 23,304 17,089 75,788 52,981
Net Internet sales 12,758 9,698 36,439 29,310
Net wholesale sales 9,975 5,736 15,261 9,635
------------ ------------- ------------ -------------
Total Net Sales 103,191 74,349 293,071 222,057
List rental and licensing 360 389 806 870
Delivery 2,558 2,266 7,476 6,633
------------ ------------- ------------ -------------
Total Revenues $ 106,109 $ 77,004 $ 301,353 $ 229,560
============ ============= ============ =============
12
Revenues
Net sales for the third quarter increased $28,842,000, or 38.8%, from the
comparable three-month period of the prior year. Net sales for the nine-month
period ended October 31, 2002 increased $71,014,000, or 32.0%, from the
comparable period last year. Returns and allowances for the three and nine-month
periods ended October 31, 2002, were 11.7% and 11.4% of sales, as compared with
12.0% and 11.3% of sales for the comparable prior year periods. The increase in
net sales for the three and nine-month period ended October 31, 2002 compared to
the same periods last year was primarily attributable to increases in net sales
from stores of $15,328,000 and $35,452,000; catalog and direct marketing net
sales of $6,215,000 and $22,807,000; Internet operations of $3,060,000 and
$7,129,000; and wholesale of $4,239,000 and $5,626,000, respectively.
The popularity of our Sharper Image Design proprietary products and private
label products continues to be a key factor in the year over year increases in
net sales in all selling channels. We believe that the continued development and
introduction of new and popular products is a key strategic objective and
important to our future success. Sharper Image Design proprietary products and
private label products increased to 75% of net sales in the third quarter of
2002, from 73% in the same period in 2001, and increased to 75% of net sales for
the nine-month period ended October 31, 2002 from 70% in the same period in
2001. We believe the increased investment in our advertising initiatives in
fiscal 2001 and the first nine months of fiscal 2002 was another contributing
factor to the higher revenues in all selling channels. Our current initiatives
are also broadening our customer base, which we believe is an important factor
in our future revenue growth. There can be no assurances of the continued
success of our current or future advertising initiatives. This advertising
strategy, including the significant increase in television infomercial
advertising and single product mailers, highlighting selected Sharper Image
Design proprietary products contributed to improved sales in all sales channels.
Another factor contributing to the increase in net sales was the opening of 16
new stores since October 31, 2001.
For the three and nine-month periods ended October 31, 2002, as compared with
the same periods last year, net store sales increased $15,328,000, or 36.6%, and
$35,452,000, or 27.2%, while comparable store sales increased by 23.8% and
13.6%, respectively. The increase in net store sales for the three and
nine-month periods ended October 31, 2002 were primarily attributable to the
opening of 16 new stores since October 31, 2001, the popularity of Sharper Image
Design proprietary and private label products and the increased television
infomercial and single product mailer advertising. The increase was partially
offset by the closing of two stores at lease maturity since October 31, 2001.
The increase in net store sales for the three-month period ended October 31,
2002 reflects a 17.6% increase in total store transactions and a 13.1% increase
in average revenue per transaction, compared with the same period from the prior
year. Total store transactions increased 15.4% for the nine-months ended October
31, 2002, and average revenue per transaction increased by 9.3%, compared with
the same prior year period.
Comparable store sales is not a measure that has been defined under generally
accepted accounting principles. The Company defines comparable store sales as
sales from stores whose selling square feet did not change by more than 15% in
the previous 12 months and which have been open at least 12 full months. Stores
generally become comparable in their 13th full month of operation.
13
For the three and nine-month periods ended October 31, 2002, as compared with
the same period of the prior year, net catalog and direct marketing sales, which
includes sales generated from catalog mailings, single product mailers, print
advertising and television infomercials, increased $6,215,000, or 36.4%, and
$22,807,000, or 43.0%, respectively. The net sales increase from these direct
marketing activities for the three month period ended October 31, 2002, as
compared to the same period last year, was due primarily to a 56% increase in
television infomercial advertising, 457% increase in single product mailers
circulated, a 4% increase in the number of Sharper Image catalogs circulated and
a 8% increase in the number of Sharper Image catalog pages. For the three-month
period ended October 31, 2002, the increase in net catalog and direct marketing
sales reflects a 16.2% increase in transactions, and an increase of 19.3% in
average revenue per order. The net sales increase from these direct marketing
activities for the nine month period ended October 31, 2002, as compared to the
same period last year, was due primarily to a 47% increase in television
infomercial advertising, 257% increase in single product mailers circulated, a
3% increase in Sharper Image catalogs circulated and a 6% increase in Sharper
Image catalog pages. For the nine-month period ended October 31, 2002, the
increase in net catalog and direct marketing sales reflects a 18.3% increase in
transactions, and an increase of 20.1% in average revenue per order.
For the three and nine-month periods ended October 31, 2002, Internet sales from
our sharperimage.com website, which includes the Sharper Image auction site,
increased $3,060,000, or 31.6% and $7,129,000, or 24.3%, respectively, from the
same periods last year. The increase in Internet net sales for the three month
period ended October 31, 2002 was attributable to a 7.9% increase in average
revenue per transaction, and a 11.6% increase in transactions, as compared to
the same period last year. Excluding auction sales for this period, Internet
sales increased 50.9%, transactions increased 19.2% and average revenue per
transaction increased 26.6%. The Internet net sales increase for the nine months
ended October 31, 2002 was attributable to a 20.3% increase in average revenue
per transaction, and a 4.6% increase in Internet transactions, as compared to
the same period of the prior year. Excluding auction sales for this period,
Internet sales increased 43.7%, transactions increased 17.8% and average revenue
per transaction increased 21.9%.
We believe the variances between Internet net sales including auction sales, and
Internet net sales excluding auction sales, were primarily attributable to our
decision to raise bid prices and to reduce the number of products offered on our
auction site, which resulted in achieving the goal of improving the gross margin
rate and gross margin dollars from auctions, although we cannot be sure that
such improvements will continue. We continue to utilize the auction site to
increase our Internet business, broaden our customer base and manage
inventories, including closeouts, repackaged and refurbished items.
For the three and nine-month periods ended October 31, 2002, wholesale sales
increased $4,239,000, or 73.9%, and $5,626,000, or 58.4%, respectively, from the
same periods of the prior year. The increase is primarily attributable to a
strategic wholesale partnership with Circuit City Stores, which was entered into
during the three-month period ended October 31, 2002. The agreement with Circuit
City Stores allows for the display of over 20 Sharper Image proprietary and
private label products on a large dedicated fixture in all 600 Circuit City
Superstores. We believe that this will continue to strengthen our brand name and
broaden our customer base.
14
Cost of Products
Cost of products for the three and nine-month periods ended October 31, 2002
increased $10,134,000, or 26.6%, and $21,706,000, or 19.6%, from the comparable
prior year periods. The increase in cost of products for the three and
nine-month periods is due to the higher sales volume compared to the same
periods last year, and was partially offset by the lower cost of products
related to the increase in sales of Sharper Image Design proprietary and private
label products. The gross margin rate for the three and nine-month periods ended
October 31, 2002, was 54.4% and 55.9%, respectively, which was 4.1 and 4.4
percentage points higher than the comparable periods of the prior year. The
increase in gross margin rate was due to increased sales of Sharper Image Design
proprietary and private label products, which generally carry higher margins
than branded products. Sharper Image Design proprietary and private label
products percentage of net sales, exclusive of wholesale, increased to 75% from
70% for the nine-month period ended October 31, 2002, as compared to the same
prior year period.
Our gross margin rate fluctuates with the changes in our merchandise mix,
primarily Sharper Image Design proprietary and private label products, which is
affected by new items available in various categories or introduced by us. The
variation in merchandise mix from category to category from year to year
reflects the characteristic that we are driven by individual products as opposed
to general lines of merchandise. Additionally, the auction sites and other
selected promotional activities, such as free shipping offers, in part, tend to
offset the rate of increase in our gross margin rate.
While it is impossible to predict future gross margin rates accurately, our goal
is to continue to increase sales of Sharper Image Design proprietary products
and other exclusive private label products, as these products generally carry
higher margins than branded products and may be less susceptible to price
comparisons by customers. The popularity of these proprietary and private label
products contributed to the 4.1 and 4.4 percentage point increase in the gross
margin rate for the three and nine-month periods ended October 31, 2002,
respectively.
During the second quarter of fiscal 2002, the labor contract between the Pacific
Maritime Association (PMA) and the International Longshore and Warehouse Union
(ILWU), whose members are primarily responsible for the removal of cargo from
container loaded shipping vessels in West Coast U.S. ports, expired. Many of our
shipments from Asia move through these West Coast U.S. ports and may have been
affected by the 10-day lockout by the PMA in October 2002 and subsequent drop of
productivity since the ports re-opened. Though the ILWU and PMA reached a
tentative six-year contract agreement in late November 2002, the lockout and
subsequent drop in productivity at the ports have impacted the timely delivery
of several of our products, particularly for the critical Holiday season, and
may negatively impact our sales. During the second quarter of fiscal 2002, we
began a gradual buildup of merchandise inventory in anticipation of a possible
work stoppage by the ILWU and put into place contingency plans, which included
increased usage of airfreight transportation. The contingency plans, however,
cannot offset the impact the work stoppage may have on us. The increased usage
of airfreight transportation will have a negative impact on our gross margins
for the fourth quarter of 2002. Although we should continue to see gross margins
above that of the prior year fourth quarter, the increase will be somewhat
offset by the impact of the additional airfreight costs incurred.
We believe that the introduction of new proprietary and private label products
at gross margins that are anticipated to be in excess of the average of those
currently being realized should continue to have a positive impact on our gross
margin rate for 2002, but we cannot assure you that we will successfully
introduce those products, or that proprietary and private label products will
continue to have gross
15
margins in excess of the average gross margin. To the extent that the sales of
popular proprietary products continues to be a higher proportion of total sales,
this could have a positive impact on the gross margin rate for fiscal 2002 and
in the future, although we cannot assure you such increase in gross margin will
occur.
Buying and Occupancy
Buying and occupancy costs for the three and nine-month periods ended October
31, 2002 increased $1,343,000, or 13.5%, and $5,093,000, or 18.5% from the
comparable prior year periods. The increase reflects the occupancy costs
associated with the 16 new stores opened since October 31, 2001 and rent
increases associated with lease renewals, partially offset by the occupancy
costs of the two Sharper Image stores closed at lease maturity since October 31,
2001. Buying and occupancy costs as a percentage of total revenues decreased to
10.6% from 12.9% for the three-month period ended October 31, 2002, and
decreased to 10.8% from 12.0% for the nine-month period ended October 31, 2002.
We will have opened a total of 20 new stores for fiscal 2002, exceeding our goal
of a 10%-15% increase in the number of new stores opened on an annual basis. Our
goal will be to continue this new store growth into fiscal year 2003.
Advertising
Advertising for the three and nine-month periods ended October 31, 2002
increased $7,360,000, or 58.1%, and $18,243,000, or 42.3%, from the comparable
prior year periods. Advertising expenses as a percentage of total revenues
increased to 18.9% from 16.4% for three-month period ended October 31, 2002. The
increase in advertising expense for the three-month period ended October 31,
2002 was primarily attributable to a 56% increase in television infomercial
advertising, a 457% increase in the number of single-product mailers circulated,
a 8% increase in the number of Sharper Image catalog pages and a 4% increase in
the number of Sharper Image catalogs circulated. During the three-month period
ended October 31, 2002, we increased the circulation of our single-product
mailers and we will continue to monitor the effectiveness of this type of
advertising in order to get an appropriate return on investment. The increase in
advertising expense for the nine month period ended October 31, 2002 was
primarily attributable to a 47% increase in television infomercial advertising,
a 257% increase in the number of single-product mailers circulated, a 6%
increase in the number of Sharper Image catalog pages and a 3% increase in the
number of Sharper Image catalogs circulated. Advertising expenses as a
percentage of total revenues increased to 20.4% from 18.8% for nine-month period
ended October 31, 2002.
During the three and nine-month periods ended October 31, 2002, we continued our
other multimedia advertising initiatives, which included radio, television and
print advertising, among others. Although we believe they contributed to the
increase in sales in the stores, catalog and direct marketing and Internet
channels, there can be no assurance of the continued success of these
advertising initiatives.
During the three and nine-month periods ended October 31, 2002, we increased our
television media spending on infomercials highlighting selected Sharper Image
Design products. The broad appeal of our Sharper Image Design products in
conjunction with the higher gross margin rates allowed us to achieve our return
on investment goal, which represents a benchmark ratio of net sales to media
expense, on this type of advertising expenditure in the first nine months of
2002. Advertising expense as a percentage of total revenues, excluding
television infomercial net sales and expenses, was 14.1% and 12.3%,
respectively, for the three months ended October 31, 2002 and 2001, and 14.3%
and 13.3%, respectively, for the nine months ended October 31, 2002 and 2001.
16
We believe that the expansion of our multimedia advertising initiatives of
direct marketing, television and radio contributed to the sales increases for
the first nine months of fiscal 2002 and will continue be an important factor in
our future revenue growth. As a result, advertising costs, which include
television infomercial, catalog circulation, catalog pages, and other marketing
activities, are anticipated to be higher in the fourth quarter of fiscal 2002
and the fiscal year 2003. Additionally, the higher cost of postage on various
direct marketing mailers, including the catalog and single product mailers, has
contributed to advertising cost increases, which we believe may be partially
offset by anticipated savings from lower paper costs during fiscal 2002.
General, Selling and Administrative Expenses
General, selling and administrative (GS&A) expenses for the three and nine-month
periods ended October 31, 2002 increased $5,023,000, or 22.5%, and $11,902,000,
or 18.3%, from the comparable prior year periods. The increase was primarily due
to increases in variable expenses from increased net sales and overall selling
expenses related to the 16 new stores opened since October 31, 2001, partially
offset by the reduced selling expenses of two stores closed at lease maturity
since October 31, 2001. The increase was also due to our continued development
of Sharper Image Design proprietary products, technological system enhancements
made in operational areas of our Company and increases in Company-wide insurance
premiums. GS&A expenses for the three-month period ended October 31, 2002
decreased as a percentage of total revenues to 25.8% from 29.0%. For the
nine-month period ended October 31, 2002, GS&A expenses decreased as a
percentage of total revenues to 25.6% from 28.4%. The decline in the GS&A
percentage is the result of our continual review of GS&A expenses and
infrastructure combined with better leverage of fixed costs on an expanding
sales base.
Other Income (Expense)
Other expense for the three-month period ended October 31, 2002, decreased
$278,000 from the comparable prior year period, primarily due to the decrease in
the loss on disposal of equipment and a decrease in interest expense from a
reduction in the amount borrowed under our credit facility. Other income for the
nine-month period ended October 31, 2002 decreased $79,000 from the comparable
prior year period, primarily due to the decrease in interest income due to the
reduction in interest earned in invested balances and in the loss on disposal of
equipment.
Liquidity and Capital Resources
We met our short-term liquidity needs and our capital requirements in the
nine-month period ended October 31, 2002 with cash generated by operations,
trade credits borrowings under our credit facility and existing cash balances.
Net cash used for operating activities totaled $24,662,000 for the first nine
months of fiscal 2002, as compared to $41,707,000 for the first nine months of
fiscal 2001. The improvement in net cash used for operating activities of
$17,045,000 is primarily due to the decrease in the net loss and the timing of
vendor and tax payments. The improvement was partially offset by increased
merchandise inventory levels due to the 16 new stores opened since October 31,
2001 and to support the increased sales volume. The improvement was also
partially offset by the increase in accounts receivable balances due to the
increase in our wholesale sales and timing of collection from our third party
credit card processor.
Net cash used in investing activities, primarily capital expenditures for new
stores, design and tooling costs for Sharper Image proprietary products and
technological upgrades to our operational infrastructure, totaled $17,302,000 in
the first nine months of fiscal 2002 compared to $15,624,000 in
17
the same period of fiscal 2001. During the first nine months of fiscal 2002, we
opened 13 new stores and closed two stores at their lease maturity.
Net cash provided by financing activities totaled $3,451,000 during the first
nine months of fiscal 2002, which was the result of $3,580,000 in proceeds from
the issuance of common stock in connection with our stock option plan and
$5,000,000 borrowed under our credit facility, partially offset by $129,000
related to payments on our mortgage loan and a $5,000,000 paydown on our credit
facility.
We have a credit facility with an expiration date of September 2004. The credit
facility allows us borrowings and letters of credit up to a maximum of $33
million for the period from October 1 through December 31, and $20 million for
other times of the year based on inventory levels. The credit facility is
secured by our inventory, accounts receivable, general intangibles and certain
other assets. Borrowings under this facility bear interest at either the prime
rate plus a margin or at LIBOR plus a margin, based on our financial
performance. The credit facility contains certain financial covenants pertaining
to interest coverage ratio and net worth and contains limitations on operating
leases, other borrowings, dividend payments and stock repurchases. At October
31, 2002, we had no amounts outstanding on our credit facility and letter of
credit commitments outstanding under the credit facility were $7.0 million.
In addition, the credit facility provides for term loans for capital
expenditures ("Term Loans") up to $2.0 million. Amounts borrowed under the Term
Loans bear interest at a variable rate of either prime rate plus a margin or at
LIBOR plus a margin based on the Company's financial performance. Each Term Loan
is to be repaid in 36 equal monthly principal installments. As of October 31,
2002, there were no outstanding Term Loans on this facility.
At October 31, 2002, notes payable included a mortgage loan collateralized by
our Little Rock distribution center. This note bears interest at a fixed rate of
8.40%, provides for monthly payments of principle and interest in the amount of
$29,367, and matures in January 2011. At October 31, 2002, the balance of this
note was $2.1 million.
During the nine-month period ended October 31, 2002, we opened 13 new stores
located at the Garden State Plaza in Paramus, New Jersey, Baybrook Mall in
Friendswood, Texas, Willowbrook Mall in Houston, Texas, Woodbury Common in
Central Valley, New York, in Downtown Los Gatos, California, Park Place in
Tucson, Arizona, Aspen Grove in Littleton, Colorado, Montgomery Mall in
Bethesda, Maryland, Marlton Square Shopping Center in Marlton, New Jersey, Town
Center Plaza in Leawood, Kansas, Dallas Galleria in Dallas, Texas, Mall at
Millenia in Orlando, Florida, and Dulles Town Center in Dulles, Virginia. We
closed two stores at their lease maturity. We will have opened a total of 20 new
stores for fiscal 2002, exceeding our goal of a 10%-15% increase in the number
of new stores opened on an annual basis. We have remodeled six stores at their
lease maturity. Total capital expenditures are estimated to be approximately $20
million to $23 million for fiscal 2002.
We believe we will be able to fund our cash needs for the remainder of fiscal
2002 and the fiscal year 2003 through existing cash balances, cash generated
from operations, trade credits and our credit facility.
Seasonality
Our business is highly seasonal, reflecting the general pattern associated with
the retail industry of peak sales and earnings during the Holiday shopping
season. In the past years, a substantial portion of our
18
total revenues and all or most of our net earnings occur in the fourth quarter
ending January 31. We, as is typical in the retail industry, generally
experience lower revenues and operating results during the other quarters and
have incurred and may continue to incur losses in these quarters. The results of
operations for these interim periods are not necessarily indicative of the
results for the full fiscal year.
19
Factors Affecting Future Operating Results
The following factors, in addition to the other information contained in this
report, should be considered carefully in evaluating our Company and our
prospects.
If we fail to offer merchandise that our customers find attractive, our business
and operating results will be harmed
In order to meet our strategic goals, we must successfully offer to our
customers new, innovative and high quality products. Our product offerings must
be affordable, useful to the customer, well made, distinctive in design, and not
widely available from other retailers. We cannot predict with certainty that we
will successfully offer products that meet these requirements in the future.
If other retailers, especially department stores or discount retailers,
offer the same products or products similar to those we sell, or if our products
become less popular with our customers, our sales may decline or we may decide
to offer our products at lower prices. If customers buy fewer of our products or
if we have to reduce our prices, our revenues and earnings will decline.
In addition, we must be able to deliver our merchandise in sufficient
quantities to meet the demands of our customers and deliver this merchandise to
customers in a timely manner. We must be able to maintain sufficient inventory
levels, particularly during peak selling seasons. Our future results would be
adversely affected if we are not successful in achieving these goals.
Our success depends on our ability to anticipate and respond to
changing product trends and consumer demands in a timely manner. Our products
must appeal to a broad range of consumers whose preferences we cannot predict
with certainty and may change between sales seasons. If we misjudge either the
market for our products or our customers' purchasing habits, our sales may
decline, our inventories may increase or we may be required to sell our products
at lower prices. This would have a negative effect on our business.
If sales of a significant product decrease, our stock price may be adversely
affected
During the first nine months of fiscal 2002, the sales of our air
purification line of product contributed significantly to our total revenue.
Although not as significant, the sales from our home and portable stereo
systems, and massage product lines also contributed a substantial portion to our
total revenues. We believe that sales from these product lines will continue to
constitute a significant portion of our sales during the remainder of fiscal
2002, and the fiscal year 2003, although we cannot assure you that sales of
these product lines will continue to increase or will continue at this level.
Our future growth will be substantially dependent on the continued
increase in growth of existing core and new products, while at the same time
maintaining or increasing our current gross margin rates. We cannot predict
whether we will be able to increase the growth of existing core and new products
or successfully introduce new products, increase our revenue level, or maintain
or increase our gross margin rate in future periods. Failure to do so may
adversely affect our stock price.
20
Poor economic conditions may hurt our business
Consumer spending patterns, particularly discretionary spending for
products such as ours, are affected by, among other things, prevailing economic
conditions, stock market volatility, threats of war, acts of terrorism, wage
rates, interest rates, inflation, taxation, consumer confidence and consumer
perception of economic conditions.
General economic, political and market conditions, such as recessions,
may adversely affect our business results and the market price of our common
stock. The terrorist attacks on New York City and Washington, D.C. on September
11, 2001, had a negative effect on an already slowing economy and on consumer
confidence. Our business has been and could continue to be negatively affected
by the poor economic conditions, and any related decline in consumer demand for
discretionary items such as our products. We face uncertainty in the degree to
which the continuing poor performance in the retail industry and the current
economic slowdown will negatively affect demand for our products from our
existing and potential customers. We may not be able to accurately anticipate
the magnitude of these effects on future quarterly results.
Our success depends in part on our ability to design and develop our proprietary
products
We are increasingly dependent on the success of the proprietary
products that we design and develop for our customers. Some of these products or
a group of related products, which are affected by customers' demands and the
level of our marketing and advertising efforts, can produce sales volume that is
significant to a particular reporting period's total sales volume. We must
design and develop products that meet the demands of our customers as well as
create customer demand for newly introduced products. If we are unable to
successfully design and develop these products, our operating results may be
adversely affected.
We rely on foreign sources of production
We must ensure that the products we design and develop are manufactured
cost-effectively. We rely solely on a select group of contract manufacturers,
most of whom are located in Asia (primarily China), to produce these products in
sufficient quantities to meet customer demand and to obtain and deliver these
products to our customers in a timely manner. These arrangements are subject to
the risks of relying on products manufactured outside the United States,
including political unrest and trade restrictions, local business practice and
political issues, including issues relating to compliance with domestic or
international labor standards, currency fluctuations, work stoppages, economic
uncertainties including inflation and government regulations, and other
uncertainties. If we are unable to successfully obtain and timely deliver
sufficient quantities of these products, our operating results may be adversely
affected.
We had a single supplier located in Asia that provided approximately
16% of the net merchandise purchases in fiscal 2001 and, 23% in the first nine
months of fiscal 2002 and is expected to be a comparable amount in the future.
If we were unable to obtain products from this supplier on a timely basis or on
commercially reasonable terms, our operating results may be adversely affected.
Also, the arrangement with this supplier is subject to the risks of products
manufactured outside the United States. Some of our smaller vendors have limited
resources, limited production capacities and limited operating histories. We
have no long-term purchase contracts or other contracts that provide continued
supply, pricing or access to new products and any vendor or distributor could
discontinue
21
selling to us at any time. We cannot assure you that we will be able to acquire
the products we desire in sufficient quantities or on terms that are acceptable
to us in the future. In addition, we cannot assure you that our vendors will
make and deliver high quality products in a cost-effective, timely manner. We
may also be unable to develop relationships with new vendors.
We depend on our vendors' ability to timely deliver sufficient quantities of
products
All products we purchase from our vendors in Asia must be shipped to
our distribution centers by freight carriers and we cannot assure you that we
will be able to obtain sufficient freight capacity on a timely basis and at
favorable rates. Our inability to acquire suitable products in a cost-effective,
timely manner or the loss of one or more key vendors or freight carriers could
have a negative effect on our business.
On July 1, 2002, the labor contract between the Pacific Maritime
Association (PMA) and the International Longshore and Warehouse Union (ILWU),
whose members are primarily responsible for the removal of cargo from container
loaded shipping vessels in West Coast U.S. ports, expired. Many of our shipments
from Asia move through these West Coast U.S. ports and may have been affected by
the 10-day lockout by the PMA in October 2002 and subsequent drop of
productivity since the ports re-opened. Though the ILWU and PMA reached a
tentative six-year contract agreement in late November 2002, the lockout and
subsequent drop in productivity at the ports have impacted the timely delivery
of several of our products, particularly for the critical Holiday season, and
may negatively impact our sales. During the second quarter of fiscal 2002, we
began a gradual buildup of merchandise inventory in anticipation of a possible
work stoppage by the ILWU and put into place contingency plans, which included
increased usage of airfreight transportation. The contingency plans, however,
cannot offset the impact the work stoppage may have on us. The increased usage
of airfreight transportation will have a negative impact on our gross margins
for the fourth quarter of 2002.
Our ability to protect our proprietary technology, which is vital to our
business, is uncertain
Our success, competitive position and amount of potential future income
will depend in part on our ability to obtain patent protection relating to the
technologies and products we are currently developing and that we may develop in
the future. Our policy is to seek patent protection and enforce the intellectual
property rights we own and license. We cannot assure you that patent
applications we submit and have submitted will result in patents being issued.
We cannot assure you that a third party will not infringe upon or design around
any patent issued or licensed to us or that these patents will otherwise be
commercially viable. Litigation to establish the validity of patents, to defend
against patent infringement claims of others and to assert patent infringement
claims against others can be expensive and time-consuming even if the outcome is
favorable to us. If the outcome is unfavorable to us, this could have a material
adverse effect on our business. We have taken and may, in the future, take steps
to enhance our patent protection, but we cannot assure you that these steps will
be successful or that, if unsuccessful, our patent protection will be adequate.
We also rely upon trade secrets, know-how, continuing technological
innovations and licensing opportunities to develop and maintain our competitive
position. We attempt to protect our proprietary technology in large part by
confidentiality agreements with our employees, consultants and other
contractors. We cannot assure you, however, that these agreements will not be
breached, that we would have adequate remedies for any breach or that
competitors will not know of or independently discover our trade secrets.
22
We are subject to inquiries from regulatory agencies
In the normal course of business, our products are the subject of
inquiries from regulatory agencies. We cannot predict the occurrence or outcome
of any such inquiries and the outcome of such inquiry or review could have a
material adverse affect on sales and may reduce our profitability. Furthermore,
our success in developing Sharper Image Design proprietary products may increase
these inquiries, as we are solely responsible for handling regulatory compliance
issues with our proprietary products.
Our quarterly operating results are subject to significant fluctuations and
seasonality
Our business is seasonal, reflecting the general pattern of peak sales
and earnings for the retail industry during the Holiday shopping season.
Typically, a substantial portion of our total revenues and all or most of our
net earnings occur during our fourth quarter ending on January 31. During our
2001 and 2000 fiscal years, our total revenues for the fourth quarter ending
January 31 accounted for more than 40% of total revenues for the full fiscal
year. We cannot predict with certainty whether the fourth quarter of 2002 will
account for such a large percentage of our total revenues. In anticipation of
increased sales activity during the fourth quarter, we incur significant
additional expenses, including significantly higher inventory costs and the
costs of hiring a substantial number of temporary employees to supplement our
regular store staff. If for any reason our sales were to be substantially below
those normally expected during the fourth quarter, our annual operating results
would be adversely affected. Due to this seasonality, our operating results for
any one period may not be indicative of our operating results for the full
fiscal year.
We generally experience lower revenues and net operating results during
the other quarters and have historically and may continue to experience losses
in these quarters. Our quarterly results of operations may fluctuate
significantly as a result of a variety of factors, including, among other
things, the timing of new store openings, net sales contributed by new stores,
increases or decreases in comparable store sales, changes in our merchandise mix
and net catalog sales.
In addition, similar to other retailers, we typically make
merchandising and purchasing decisions well in advance of the Holiday shopping
season. As a result, poor economic conditions or differences from projected
customer demand for our products during the fourth quarter could result in lower
revenues and earnings.
Our vital computer and communications hardware and software systems are
vulnerable to damage and interruption which could harm our business
Our success, in particular our ability to successfully receive and
fulfill Internet orders and provide high-quality customer service, largely
depends upon the efficient and uninterrupted operation of our computer and
communications hardware and software systems. We use internally managed systems
for our website and some aspects of transaction processing, including customer
information and order verifications. Our systems and operations are vulnerable
to damage or interruption from earthquake, fire, flood and other natural
disasters, terrorist attacks, power loss, computer systems failures, Internet
and telecommunications or data network failure, operator negligence, improper
operation by or supervision of employees, physical and electronic loss of data
23
or security breaches, misappropriation and similar events, fluctuations and
failures in the business of Internet service providers on which we rely, and
computer viruses.
In addition, we maintain our servers at the site of a third party
located in Santa Clara, California. We cannot control the maintenance and
operation of this site, which is also susceptible to similar disasters and
problems. We also cannot control the business or operations of Internet service
providers, which are susceptible to failure as a result of industry-wide
business fluctuations. Because our strategies depend in part on maintaining our
reputation for superior levels of customer service, any system failure that
causes an interruption in our service or a decrease in responsiveness could harm
our relationships with our customers and result in reduced revenues.
We are dependent on the success of our advertising and marketing efforts
Our revenues depend in part on our ability to effectively market and
advertise our products through The Sharper Image catalog and other advertising
vehicles. Increases in advertising, paper or postage costs may limit our ability
to advertise without reducing our profitability. If we decrease our advertising
efforts due to increased advertising costs, restrictions placed by regulatory
agencies, or for any other reason, our future operating results may be
materially adversely affected. We are also utilizing and constantly testing
other advertising media, such as television infomercials, radio, and single
product mailings, and significantly increased our advertising expenditures in
fiscal years 2001 and 2002. While we believe that increased expenditures on
these and other media have resulted in increasing revenues during the first nine
months of fiscal 2002, we cannot assure you that this trend will continue in the
future. We expect to continue to spend on advertising and marketing at increased
levels in the future, but may not continue to produce a sufficient level of
sales to cover such expenditures, which would reduce our profitability.
We face risks associated with our growth strategy
Our growth strategy primarily includes the following components:
o increase Sharper Image Design product offerings;
o broaden customer base;
o open new stores; and
o broaden sales and marketing channels.
Our growth strategy involves various risks. Any failure on our part to
successfully implement any or all of our growth strategies would likely have a
material adverse effect on our financial condition, results of operations and
cash flows. We believe our past growth has been attributable in large part of
our success in meeting the merchandise, timing and service demands of an
expanding customer base with changing demographics characteristics, but there is
no assurance that we will be able to continue to have such success.
We face risks associated with the expansion of our store operations
We plan to increase our number of stores by 10-15% annually. We may not
be able to attain our target new store openings, and any of our new stores that
we open may not be profitable, either of which could have an adverse impact on
our financial results. Our ability to expand by opening new stores will depend
in part on the following factors:
24
o the availability of attractive store locations;
o our ability to negotiate favorable lease terms;
o our ability to identify customer demand in different geographic areas;
o general economic conditions;
o and the availability of sufficient funds for expansion.
As we continue to expand, we continue to become concentrated in limited
geographic areas. This could increase our exposure to customer demand, weather,
competition, distribution problems, and poor economic conditions in these
regions. In addition, our catalog sales, Internet sales, or existing store sales
in a specific region may decrease as a result of new store openings.
In order to continue our expansion of stores, we will need to hire
additional management and staff for our corporate offices and employees for each
new store. We must also expand our management information systems and
distribution systems to serve these new stores. If we are unable to hire
necessary personnel or grow our existing systems, our expansion efforts may not
succeed and our operations may suffer.
Some of our expenses will increase with the opening of these and other
new stores. If store sales are inadequate to support these new costs, our
profitability will decrease. For example, inventory costs will increase as we
increase inventory levels to supply additional stores. We may not be able to
manage this increased inventory without decreasing our profitability. We may
need additional financing in excess of our current credit facility, or an
amendment to such facility. Furthermore, our current credit facility has various
loan covenants we must comply with in order to maintain the credit facility. We
cannot predict whether we will be successful in obtaining additional funds or
new credit facilities on favorable terms or at all.
We rely on our catalog operations
Our success depends in part on the success of our catalog operations.
We believe that the success of our catalog operations depends on the following
factors:
o our ability to achieve adequate response rates to our mailings;
o our ability to continue to offer a merchandise mix that is attractive to
our mail order customers;
o our ability to cost-effectively add new customers;
o our ability to cost-effectively design and produce appealing catalogs;
and
o timely delivery of catalog mailings to our customers.
Catalog production and mailings entail substantial paper, postage,
merchandise acquisition and human resource costs, including costs associated
with catalog development and increased inventories. We incur nearly all of these
costs prior to the mailing of each catalog. As a result, we are not able to
adjust the costs being incurred in connection with a particular mailing to
reflect the actual performance of the catalog. If we were to experience a
significant shortfall in anticipated revenue from a particular mailing, and
thereby not recover the costs associated with that mailing, our future results
would be adversely affected. In addition, response rates to our mailings and, as
a result, revenues generated by each mailing are affected by factors such as
consumer preferences, economic conditions, the timing and mix of catalog
mailings, the timely delivery by the postal system of our catalog mailings and
changes in our merchandise mix, several or all of which may be outside our
control. Further, we have historically
25
experienced fluctuations in the response rates to our catalog mailings. If we
are unable to accurately target the appropriate segment of the consumer catalog
market or to achieve adequate response rates, we could experience lower sales,
significant markdowns or write-offs of inventory and lower margins, which would
adversely affect our future results. During the third quarter of fiscal 2001, we
experienced delays and non-delivery of several catalog mailings due to the post
office closures and mail interruptions that occurred after the September 11,
2001 terrorist attacks which had a material negative impact on sales during this
period.
Increase in costs of mailing, paper or printing may impact our business
Historically, a significant portion of our revenues has been generated
from purchases made by customers driven by The Sharper Image catalog. Increases
in the costs of producing and distributing the catalog may reduce the
profitability of our catalog, store and Internet sales. Specifically, we may
experience increases in postage, paper or shipping costs due to factors beyond
our control. As a result, our future results may be adversely affected.
Effective June 30, 2002, the U.S. Postal Service increased its rates. This
increase has impacted the cost of mailing catalogs and single product mailers to
our customers, and to the extent that we use the U.S. Postal Service for the
fulfillment of orders, our delivery expense will also increase. In addition,
postal rates increases may result in competitive increases by other delivery
services, which we may use from time to time. Furthermore, both the U.S. Postal
Service and other delivery services may raise their rates further in the future.
Though we currently have medium-term contracts for the supply of paper
or printing services, future paper, printing and postal rate increases would
adversely impact our earnings if we were unable to pass such increases directly
on to our customers or offset such increases by raising prices or by
implementing more efficient printing, mailing, delivery and order fulfillment
systems.
The terrorist attacks on September 11, 2001 adversely impacted our business
The terrorist attacks that took place in the United States on September
11, 2001 and the mail service interruption and post office closures that
commenced in September 2001 are unprecedented events that have created many
economic and political uncertainties, some of which have harmed and may continue
to harm our business and prospects.
The national and global responses to these terrorist attacks and the
mail service interruption and post office closures materially adversely affected
us and may continue to adversely affect us in ways we cannot predict at present.
Some of the possible material adverse impacts to our business from these events
include, but are not limited to:
o reduced activity in the retail industry;
o fears of or the occurrence of future terrorist attacks;
o possible delays in delivery of and failures to deliver our catalogs;
o increased postage expense for delivery of our catalogs; and
o increased insurance expenses.
We face certain risks relating to customer service
Our ability to provide customer service depends, to a large degree, on
the efficient and uninterrupted operation of our call centers, our contracting
services with third party call centers and our
26
sharperimage.com website. Any material disruption or slowdown in our order
processing systems resulting from labor disputes, telephone or Internet down
times, electrical and service outages, mechanical problems, human error or
accidents, fire, earthquakes, natural disasters, or other events could cause
delays in our ability to receive orders by telephone or over the Internet and
distribute orders, and may cause orders to be lost or to be shipped or delivered
late. As a result, customers may be unable to place orders, cancel orders or
refuse to receive goods on account of late shipments, which would result in a
reduction of net sales and could mean increased administrative and shipping
costs. We cannot assure you that telephone call volumes will not exceed our
present telephone system capacity. If this occurs, we could experience telephone
answer delays and delays in placing orders. Because our strategies depend in
part on maintaining our reputation for superior levels of customer service, any
impairment of our customer service reputation could have an adverse effect on
our business.
We face risks associated with our distribution and fulfillment operations
We conduct the majority of our distribution operations and all of our
catalog and Internet order processing fulfillment functions from our owned
facility in Little Rock, Arkansas, a leased facility in Little Rock, Arkansas
and a leased facility in Ontario, California. We also use contract fulfillment
and warehouse facilities for additional seasonal requirements. Any disruption in
the operations at any distribution center, particularly during the Holiday
shopping season, could have a negative effect on our business.
In addition, we rely upon third party carriers for our product
shipments, including shipments to and from all of our stores. As a result, we
are subject to certain risks, including employee strikes and inclement weather,
associated with such carriers' ability to provide delivery services to meet our
shipping needs. We are also dependent on temporary employees to adequately staff
our distribution facility, particularly during busy periods such as the Holiday
shopping season. We cannot assure you that we will continue to receive adequate
assistance from our temporary employees, or that we will continue to have access
to sufficient sources of temporary employees.
Results for our comparable store sales may fluctuate
Our comparable store sales are affected by a variety of factors,
including, among others:
o customer demand in different geographic regions;
o our ability to efficiently source and distribute products;
o changes in our product mix;
o effects of competition; and
o general economic conditions.
Our comparable store sales have fluctuated significantly in the past
and we believe that such fluctuations may continue. Our historic comparable
store net sales changes were as follows:
Percentage
Fiscal Year Increase (Decrease)
----------- -------------------
1999 12.3
2000 29.0
2001 (16.0)
2002 (First nine months) 13.6
27
These historical results are not necessarily indicative of future
results, and we cannot assure you that our comparable store sales results will
continue to increase in the future. Any reduction in or failure to increase our
comparable store sales results could impact our future operating performance and
cause the price of the common stock to fluctuate.
We experience intense competition in the rapidly changing retail markets
We operate in a highly competitive environment. We principally compete
with a variety of department stores, sporting goods stores, discount stores,
specialty retailers and other catalogs that offer products similar to or the
same as our products. We may increasingly compete with major Internet retailers.
Many of our competitors are larger companies with greater financial resources, a
wider selection of merchandise and greater inventory availability. If we
experience increased competition, our business and operating results could be
adversely affected.
The United States retail industry (the specialty retail industry in
particular) and e-commerce sector are dynamic in nature and have undergone
significant changes over the past several years. Our ability to anticipate and
successfully respond to continuing challenges is critical to our long-term
growth and we cannot assure you we will anticipate and successfully respond to
changes in the retail industry.
We depend on a high volume of mall traffic to generate sales
Substantially all of our stores are located in shopping malls. Our
sales are derived, in part, from the high volume of traffic in those malls. We
benefit from the ability of the malls' anchor tenants, generally large
department stores, and other area attractions to generate consumer traffic in
our stores' vicinity and on the continuing popularity of malls as shopping
destinations. Sales volume and mall traffic may be adversely affected by
economic downturns in a particular area, competition from non-mail retailers and
other malls where we do not have stores, and the closing of anchor tenants. In
addition, a decline in the desirability of the shopping environment in a
particular mall or a decline in the popularity of mall shopping among our target
consumers could have a material adverse effect on our business.
A decrease in the growth of web usage or inadequate Internet infrastructure
would adversely affect our business
The Internet industry is rapidly evolving. A decrease in the growth of
Web usage would have a material and adverse effect on our business. Some of the
factors that may inhibit growth in Web usage are:
o inadequate Internet infrastructure;
o security and privacy concerns;
o inconsistent quality of service; and
o unavailability of cost-effective, high-speed service.
The success of our sharperimage.com website depends upon the ability of
the Internet infrastructure to support increased use. The performance and
reliability of the Web may decline as the number of users increases or the
bandwidth requirements of users increase. Even if the necessary infrastructure
or technologies are developed, we may have to spend considerable amounts to
adapt our solutions accordingly.
28
We may be subject to regulations regarding state sales and use tax on catalog
and Internet sales and other Internet regulation
Our business may be affected by the adoption of regulations or rules
governing the sale of our products, with regard to state sales and use taxes and
the regulation of the Internet. Because we have broad store presence, we are
currently required to collect taxes for the majority of our catalog and Internet
transactions. However, any unfavorable change in the state sales and use tax,
which affects our catalog and Internet sales, could adversely affect our
business and results of operations. In addition, the Internet at present is
largely unregulated and we are unable to predict whether significant regulations
or taxes will be imposed on Internet commerce in the near future. We are unable
to predict how such regulations could affect the further development of our
Internet business.
Excessive merchandise returns could harm our business
As part of our customer service commitment, we maintain a liberal
merchandise return policy, which allows customers to return most merchandise. We
make allowances for returns of store, catalog and Internet sales in our
financial statements based on historical return rates. We cannot assure you that
actual merchandise returns will not exceed our allowances. In addition, because
our allowances are based on historical return rates, we cannot assure you that
the introduction of new merchandise in our stores or catalogs, the opening of
new stores, the introduction of new catalogs, increased sales over the Internet,
changes in the merchandise mix or other factors will not cause actual returns to
exceed return allowances. Any significant increase in merchandise returns that
exceed our allowances could adversely affect our future results.
We face certain litigation risks
We are party to lawsuits in the normal course of our business.
Litigation can be expensive, lengthy and disruptive to normal business
operations. Moreover, the results of legal proceedings are difficult to predict.
An unfavorable resolution of a particular lawsuit could have a material adverse
effect on our business, results of operations, or financial condition.
We may be subject to risks associated with our products, including product
liability or patent and trademark infringement claims
Our current and future products may contain defects, which could
subject us to product liability claims and product recalls. Although we maintain
limited product liability insurance, if any successful product liability claim
or product recall is not covered by or exceeds our insurance coverage, our
business, results of operation and financial condition would be harmed.
Additionally, third parties may assert claims against us alleging infringement,
misappropriation or other violations of patent, trademark or other proprietary
rights, whether or not such claims have merit. Such claims can be time consuming
and expensive to defend and could require us to cease using and selling the
allegedly infringing products, which may have a significant impact on total
Company sales volume, and to incur significant litigation costs and expenses.
29
We depend on our key personnel
Our success depends to a significant extent upon the abilities of our
senior management, particularly Richard Thalheimer, our founder, Chairman and
Chief Executive Officer. The loss of the services of any of the members of our
senior management or of certain other key employees could have a significant
adverse effect on our business, financial condition and results of operation. We
maintain key man life insurance on Mr. Thalheimer in the amount of $15 million.
The terms of Mr. Thalheimer's employment with the Company are governed by an
employment agreement. Our future performance will depend upon our ability to
attract and retain qualified management, merchandising and sales personnel.
There can be no assurance that members of our existing management team will be
able to manage our Company or our growth or that we will be able to attract and
hire additional qualified personnel as needed in the future.
We are controlled by a single shareholder
As of December 11, 2002, Richard Thalheimer beneficially owned
approximately 31% of all of the outstanding shares of the common stock of the
Company. As a result, Mr. Thalheimer will continue to exert substantial
influence over the election of directors and over our corporate actions.
Our common stock price is volatile
Our common stock is quoted on the Nasdaq National Market, which has
experienced and is likely to experience in the future significant price and
volume fluctuations, which could reduce the market price of our common stock
without regard to our operating performance. We believe that among other
factors, any of the following factors could cause the price of the common stock
to fluctuate substantially:
o monthly fluctuations in our comparable store sales;
o announcements by other accessory and gift item retailers;
o the trading volume of our common stock in the public market;
o general economic conditions;
o financial market conditions;
o acts of terrorism; and
o threats of war.
Our charter documents, Delaware law, our stockholders rights and other
agreements may make a takeover more difficult
We are a Delaware corporation. The Delaware General Corporation Law
contains certain provisions that may make a change in control of our Company
more difficult or prevent the removal of incumbent directors. In addition, our
Certificate of Incorporation and Bylaws and our stockholders rights and other
agreements contain provisions that may have the same effect. These provisions
may have a negative impact on the price of our common stock, may discourage
third-party bidders from making a bid for our Company or may reduce any premiums
paid to stockholders for their common stock.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risks, which include changes in interest rates
and, to a lesser extent, foreign exchange rates. The Company does not engage in
financial transactions for trading or speculative purposes.
The interest payable on the Company's credit facility is based on variable
interest rates and therefore affected by changes in market interest rates. If
interest rates on existing variable debt rose 0.48% (10% from the bank's
reference rate) during the three-month or nine-month periods ending October 31,
2002, the Company's results from operations and cash flows would not have been
materially affected. In addition, the Company has fixed and variable income
investments consisting of cash equivalents and short-term investments, which are
also affected by changes in market interest rates. The Company does not use
derivative financial instruments in its investment portfolio.
The Company enters into a significant amount of purchase obligations outside of
the U.S. that are settled in U. S. dollars, and therefore, has only minimal
exposure to foreign currency exchange risks. The Company does not hedge against
foreign currency risks and believes that foreign currency exchange risk is
immaterial.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our chief executive
officer and our chief financial officer, after evaluating the effectiveness of
the Company's "disclosure controls and procedures" (as defined in the Securities
Exchange Act of 1934 Rules 13a-14c) and 15-d-14(c)) as of a date (the
"Evaluation Date") within 90 days before the filing date of this quarterly
report, have concluded that as of the Evaluation Date, our disclosure controls
and procedures were adequate and designed to ensure that material information
relating to us would be made known to them by others within those entities.
(b) Changes in internal controls. There were no significant changes in our
internal controls or to our knowledge, in other factors that could significantly
affect our disclosure controls and procedures subsequent to the Evaluation Date.
32
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.26 Officer Non-Qualified Deferred Compensation Plan.
10.27 Employment Agreement.
15.0 Letter Re: Unaudited Interim Financial Information.
99.1 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of
2002, Chief Executive Officer.
99.2 Certification Pursuant To Section 906 Of The Sarbanes-Oxley Act of
2002, Chief Financial Officer.
(b) Reports on Form 8-K
The Company has not filed any reports on Form 8-K for the three months
ended October 31, 2002.
33
SIGNATURES
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.
SHARPER IMAGE CORPORATION
Date: December 16, 2002 by:/s/ Tracy Y. Wan
------------------------
Tracy Y. Wan
President
Chief Operating Officer
by:/s/ Jeffrey P. Forgan
------------------------
Jeffrey P. Forgan
Executive Vice President
Chief Financial Officer
34
CERTIFICATIONS
I, Richard Thalheimer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sharper Image
Corporation ("registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 16, 2002
By:/s/ Richard Thalheimer
------------------------
Chairman and Chief Executive Officer
35
CERTIFICATIONS
I, Jeffrey P. Forgan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Sharper Image
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: December 16, 2002
By:/s/ Jeffrey P. Forgan
-----------------------
Executive Vice President and Chief Financial Officer
36