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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, 2003 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, 15,192,298 shares as of December 11, 2003
SHARPER IMAGE CORPORATION
FORM 10-Q
For the Quarter Ended October 31, 2003
INDEX
PART I. FINANCIAL INFORMATION Page
ITEM 1. Condensed Financial Statements (unaudited)
Balance Sheets as of October 31, 2003,
January 31, 2003 and October 31, 2002 (as restated) 3
Statements of Operations
for the three and nine months ended October 31, 2003 and 2002
(as restated) 4
Statements of Cash Flows
for the nine months ended October 31, 2003 and 2002
(as restated) 5
Notes to Condensed Financial Statements 6-10
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-26
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk 27
ITEM 4. Controls and Procedures 27
PART II. OTHER INFORMATION
IITEM 6. Exhibits and Reports on Form 8-K 28
SIGNATURE PAGE 29
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SHARPER IMAGE CORPORATION
CONDENSED BALANCE SHEETS
(Unaudited)
October 31, January 31, October 31,
2003 2003 2002
Dollars in thousands, except per share amounts (Note A) As Restated (Note G)
-------- ----------- --------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 21,947 $ 55,633 $ 1,904
Short-term investments 4,000 -- --
Accounts receivable, net of allowance for doubtful
accounts of $764, $967 and $684 20,427 12,597 12,335
Merchandise inventories 136,324 74,756 93,769
Prepaid catalog costs 5,920 1,869 6,945
Prepaid expenses, deferred taxes and other 18,716 13,658 12,489
-------- -------- --------
Total Current Assets 207,334 158,513 127,442
Property and equipment, net 63,472 52,165 50,959
Deferred taxes and other assets 5,012 3,749 4,836
-------- -------- --------
Total Assets $275,818 $214,427 $183,237
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 39,383 $ 26,597 $ 30,160
Accrued expenses 18,510 14,996 17,498
Accrued compensation 6,194 8,614 4,572
Reserve for refunds 14,386 12,498 7,669
Deferred revenue 22,958 19,113 17,737
Income taxes payable -- 6,472 --
Current portion of notes payable -- -- 185
-------- -------- --------
Total Current Liabilities 101,431 88,290 77,821
Notes payables -- -- 1,893
Other liabilities 10,765 8,753 6,813
Commitments and Contingencies -- -- --
-------- -------- --------
Total Liabilities 112,196 97,043 86,527
-------- -------- --------
Stockholders' Equity:
Preferred stock, $0.01 par value:
Authorized 3,000,0000 shares: Issued and outstanding, none -- -- --
Common stock, $0.01 par value:
Authorized 25,000,000 shares: Issued and outstanding,
15,123,881, 12,638,952 and 12,631,886 shares 151 126 126
Additional paid-in capital 93,692 49,950 46,155
Retained earnings 69,779 67,308 50,429
-------- -------- --------
Total Stockholders' Equity 163,622 117,384 96,710
-------- -------- --------
Total Liabilities and Stockholders' Equity $275,818 $214,427 $183,237
======== ======== ========
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,
----------- -----------
2003 2002 2003 2002
---- ---- ---- ----
As restated As restated
(Note G) (Note G)
REVENUES:
Net sales $ 127,827 $ 103,191 $ 369,557 $ 294,321
Delivery 3,105 2,558 8,893 7,476
List rental and licensing 143 360 303 806
------------ ------------ ------------ ------------
131,075 106,109 378,753 302,603
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Cost of products 59,371 48,218 167,184 133,185
Buying and occupancy 14,331 11,813 40,526 34,210
Advertising 24,260 20,027 75,702 61,357
General, selling, and administrative 31,726 26,832 91,561 75,528
------------ ------------ ------------ ------------
129,688 106,890 374,973 304,280
------------ ------------ ------------ ------------
OTHER:
Interest income 136 22 596 265
Interest expense (27) (80) (153) (208)
Other income 342 108 342 304
Other expense (168) (123) (377) (331)
------------ ------------ ------------ ------------
283 (73) 408 30
------------ ------------ ------------ ------------
Earnings (Loss) Before Income Tax
Expense (Benefit) 1,670 (854) 4,188 (1,647)
Income Tax Expense (Benefit) 685 (350) 1,717 (675)
------------ ------------ ------------ ------------
Net Earnings (Loss) $ 985 $ (504) $ 2,471 $ (972)
============ ============ ============ ============
Net Earnings (Loss) Per Share
Basic $ 0.07 $ (0.04) $ 0.17 $ (0.08)
============ ============ ============ ============
Diluted $ 0.06 $ (0.04) $ 0.16 $ (0.08)
============ ============ ============ ============
Weighted Average Number of
Shares Outstanding
Basic 15,089,000 12,422,000 14,185,000 12,223,000
Diluted 16,052,000 12,422,000 15,059,000 12,223,000
See notes to condensed financial statements.
4
SHARPER IMAGE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
October 31,
-----------
Dollars in thousands 2003 2002
---- ----
As restated
(Note G)
Cash was Provided by (Used for) Operating Activities:
Net earnings (loss) $ 2,471 $ (972)
Adjustments to reconcile net earnings (loss) to cash
used for operating activities:
Depreciation and amortization 12,291 10,810
Deferred rent expenses and landlord allowances 210 159
Loss on sale or disposal of equipment 370 49
Change in operating assets and liabilities:
Accounts receivable (7,830) (4,237)
Merchandise inventories (61,568) (43,088)
Prepaid catalog costs, prepaid expenses and other (7,451) (5,841)
Accounts payable, accrued expenses and reserve for refunds 15,768 18,126
Deferred revenue, income taxes and other liabilities (836) 333
-------- --------
Cash Used for Operating Activities (46,575) (24,661)
-------- --------
Cash was Used for Investing Activities:
Property and equipment expenditures (23,957) (17,302)
Purchases of short-term investments (4,000) --
-------- --------
Cash Used for Investing Activities (27,957) (17,302)
-------- --------
Cash was Provided by (Used for) Financing Activities:
Proceeds from issuance of common stock due to
public offering, net of fees 38,471 --
Proceeds from issuance of common stock resulting from
stock options exercised 2,785 3,579
Payments made for credit facility fees (410) --
Principal payments on notes payable and revolving credit facility -- (129)
-------- --------
Cash Provided by (Used for) Financing Activities 40,846 3,450
-------- --------
Net Decrease in Cash and Equivalents (33,686) (38,513)
-------- --------
Cash and Equivalents at Beginning of Period 55,633 40,417
-------- --------
Cash and Equivalents at End of Period $ 21,947 $ 1,904
======== ========
Supplemental Disclosure of Cash Paid for:
Interest $ 97 $ 195
Income Taxes $ 9,518 $ 707
See notes to condensed financial statements.
5
SHARPER IMAGE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
Three-month and nine-month periods ended October 31, 2003 and 2002
(Unaudited)
NOTE A- Financial Statements
The condensed balance sheets at October 31, 2003 and 2002, and the related
condensed statements of operations for the three and nine month periods ended
October 31, 2003 and 2002 and related condensed statements of cash flows for the
nine month periods ended October 31, 2003 and 2002 have been prepared by Sharper
Image Corporation (the "Company"), without audit. In the opinion of management,
the condensed financial statements include all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position, results of operations and cash flows as of October 31, 2003 and 2002,
and for the three and nine month periods then ended. The balance sheet at
January 31, 2003, presented herein, has been derived from the audited balance
sheet of the Company.
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 2002 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 occur 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 its first
three fiscal quarters and has in the past 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.
NOTE B - Employee Stock Compensation
The Company accounts for stock-based employee compensation using the intrinsic
value method in accordance with the provisions of Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." No
compensation expense has been recognized for employee stock options in the
accompanying financial statements in accordance with the provisions of APB 25.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation", establishes a fair value method of accounting for
stock options and other equity instruments. SFAS No. 123 requires the disclosure
of pro forma income and earnings per share as if the Company had adopted the
fair value method. For determining pro forma earnings per share, the fair value
of the stock options and employees' purchase rights were estimated using the
Black-Scholes option pricing model. The Company's calculations are based on a
multiple option approach and forfeitures are recognized as they occur. Had
compensation cost for these stock option and stock purchase plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the methods of SFAS No. 123, the Company's net earnings
(loss) and net earnings (loss) per share would have been as the pro forma
amounts indicate below:
6
Three Months Ended Nine Months Ended
October 31 October 31
---------- ----------
2003 2002 2003 2002
---- ---- ---- ----
Net earnings (loss), as reported $ 985,000 $ (504,000) $ 2,471,000 $ (972,000)
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards, net
of related tax effect 453,000 421,000 1,222,000 1,264,000
----------- ----------- ------------- -------------
Pro forma net earnings (loss) $ 532,000 $ (925,000) $ 1,249,000 $ (2,236,000)
=========== =========== ============= =============
Basic net earnings (loss) per weighted average share:
As reported $ 0.07 $ (0.04) $ 0.17 $ (0.08)
Pro forma $ 0.04 $ (0.07) $ 0.09 $ (0.18)
Diluted net earnings (loss) per weighted average share:
As reported $ 0.06 $ (0.04) $ 0.16 $ (0.08)
Pro forma $ 0.03 $ (0.07) $ 0.08 $ (0.18)
NOTE C - Earnings 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,
----------- -----------
2003 2002 2003 2002
----------- ------------ ----------- ------------
Net earnings (loss) $ 985,000 $ (504,000) $ 2,471,000 $ (972,000)
Average shares of common stock
outstanding during the period 15,089,000 12,422,000 14,185,000 12,223,000
=========== ============ =========== ============
Basic earnings (loss) per share $ 0.07 $ (0.04) $ 0.17 $ (0.08)
=========== ============ =========== ============
Average shares of common stock
outstanding during the period 15,089,000 12,422,000 14,185,000 12,223,000
Add:
Assumed options exercised due to exercise
price being less than average market
price net of assumed stock repurchases 963,000 -- 874,000 --
----------- ------------ ----------- ------------
Diluted weighted average number
of shares outstanding 16,052,000 12,422,000 15,059,000 12,223,000
=========== ============ =========== ============
Diluted earnings (loss) per share $ 0.06 $ (0.04) $ 0.16 $ (0.08)
=========== ============ =========== ============
7
NOTE D- Revolving Loan and Notes Payable
On October 31, 2003, the Company terminated its old secured credit facility and
entered into a new revolving secured credit facility with Wells Fargo Bank,
National Association. The new credit facility has a maturity date of October 31,
2006, and will allow borrowings and letters of credit up to a maximum of $50
million at all times during the year, with a "borrowing base" determined by
inventory levels and specified accounts receivable. The new credit facility is
secured by the Company's inventory, accounts receivable, accounts and specified
other assets. Borrowings under the new credit facility bear interest at either
the adjusted LIBOR rate plus 1.50% or at Wells Fargo's prime rate less 0.25%.
The new credit facility contains financial covenants that only apply during an
event of default or when the borrowing base falls below a specified level. These
financial covenants require the Company to maintain a minimum EBITDA (as
defined) of $35 million and to maintain capital expenditures below a specified
level based on the Company's projections. The new credit facility contains
limitations on incurring additional indebtedness, making additional investments
and permitting a change of control. There was no activity under this agreement
on October 31, 2003, other than the issuance on the closing date of a $9.8
million backstop letter of credit to cover letter of credit commitments
outstanding under our old secured credit facility.
NOTE E - Stock Offering
On May 7, 2003, the Company completed a public offering of its common stock in
which it sold 1.9 million shares at a price to the public of $19.50. On May 13,
2003, the Company closed the sale of an additional 237,424 shares of common
stock subject of the underwriters' over-allotment option. The Company received
proceeds from the public offering of $38.5 million, net of underwriters'
discount and offering expenses.
NOTE F - 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 2002 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.
8
Financial information for the Company's business segments is as follows:
Three Months Ended Nine Months Ended
October 31, October 31,
----------- -----------
2003 2002 2003 2002
---- ---- ---- ----
Dollars in thousands
Revenues:
Stores $ 70,728 $ 57,154 $ 210,751 $ 165,583
Catalog and Direct Marketing 25,295 23,304 85,564 76,588
Internet 17,351 12,758 52,528 36,889
Other 17,701 12,893 29,910 23,543
--------- --------- --------- ---------
Total Revenues $ 131,075 $ 106,109 $ 378,753 $ 302,603
--------- --------- --------- ---------
Operating Contributions:
Stores $ 3,300 $ 2,774 $ 13,873 $ 10,082
Catalog and Direct Marketing 3,397 2,988 13,778 9,727
Internet 2,058 1,236 6,121 4,582
Unallocated (7,085) (7,852) (29,584) (26,038)
Earnings (Loss) Before Income
--------- --------- --------- ---------
Tax Expense (Benefit) $ 1,670 $ (854) $ 4,188 $ (1,647)
--------- --------- --------- ---------
October 31, January 31, October 31,
2003 2003 2002
---- ---- ----
Assets:
Stores $ 44,257 $ 35,281 $ 33,832
Catalog and Direct Marketing -- -- --
Internet 1,906 3,330 3,644
Unallocated 229,655 175,816 145,761
--------- --------- ---------
Total Assets $ 275,818 $214,427 $ 183,237
--------- --------- ---------
9
NOTE G - Restatement
Subsequent to the issuance of the Company's financial statements as of
and for the quarter ended October 31, 2002, the Company's management determined
that three errors existed in previously issued financial statements. First, for
its sales on direct marketing shipments, revenues were adjusted to reflect the
adoption of SAB 101, "Revenue Recognition in Financial Statements," in the first
quarter of fiscal 2000. As such, revenues were adjusted to reflect recognition
at the time of customer receipt versus time of shipment. Second, costs paid for
package design costs, which had been capitalized and recognized over a two-year
period, were corrected to be expensed as incurred. Finally, the method for
calculating diluted weighted average shares oustanding in the earnings per share
calculation was corrected to include the reduction in shares outstanding
resulting from the anticipated repurchases of stock using proceeds of future
income tax benefits associated with unexercised stock options. As a result, the
accompanying financial statements have been restated from the amounts previously
reported. A summary of the effects of the restatement is as follows:
Dollars in thousands As of October 31, 2002
----------------------
As Previously
Reported As Restated
-------- -----------
Property and equipment, net $ 51,333 $ 50,959
Prepaid expenses and other 12,347 12,489
Retained earnings 50,660 50,429
Total stockholders' equity 96,942 96,710
Dollars in thousands, except per Three Months Ended Nine Months Ended
share amounts October 31, 2002 October 31, 2002
---------------- ----------------
As Previously As Previously
Reported As Restated Reported As Restated
-------- ----------- -------- -----------
Revenues $ 106,109 $ 106,109 $ 301,353 $ 302,603
Cost of products 48,218 48,218 132,655 133,185
General, selling and administrative 27,361 26,832 77,034 75,528
Loss before income tax benefit (835) (854) (2,339) (1,647)
Income tax benefit (342) (350) (958) (675)
Net loss (493) (504) (1,381) (972)
Basic loss per common equivalent
equivalent share $ (0.04) $ (0.04) $ (0.11) $ (0.08)
============== ============== ============== ==============
Diluted loss per common
equivalen share $ (0.04) $ (0.04) $ (0.11) $ (0.08)
============== ============== ============== ==============
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
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 report on Form 10-K for the
year ended January 31, 2003, as filed with the Securities and Exchange
Commission. The statements contained in this Form 10-Q that are not purely
historical are forward-looking statements within the meaning of the federal
securities laws. Such forward-looking statements may include but are not limited
to statements regarding our future products and enhancements, 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 Form 10-Q. Additionally, statements
concerning future matters such as the development of new products or
enhancements, possible changes in legislation and other statements regarding
matters that are not historical are forward-looking statements. All
forward-looking statements in this Form 10-Q are based upon information
available to us as of the date hereof, and we assume no obligation to revise or
update any such forward-looking statements in order to reflect any event or
circumstance that may arise after the date of this Form 10-Q. Actual results
could differ materially from our current expectations. Factors that could cause
or contribute to such differences include, but are not limited to those set
forth under "Factors Affecting Future Operating Results" below in this Quarterly
Report, and elsewhere in this Quarterly Report.
11
The discussion and analysis gives effect to the restatement of previously issued
financial statements. See Note G to the condensed financial statements for
further discussion.
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 2003 2002 2003 2002
---- ---- ---- ----
Revenues:
Net store sales 54.0% 53.9% 55.6% 54.7%
Net catalog and direct marketing sales 19.3 22.0 22.6 25.3
Net Internet sales 13.2 12.0 13.9 12.2
Net wholesale sales 11.0 9.4 5.5 5.0
Delivery 2.4 2.4 2.3 2.5
List rental and licensing 0.1 0.3 0.1 0.3
----- ----- ----- -----
Total Revenues 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Cost of products 45.3 45.4 44.1 44.0
Buying and occupancy 10.9 11.1 10.7 11.3
Advertising 18.5 18.9 20.0 20.3
General selling and administrative 24.2 25.3 24.2 24.9
Other Income 0.2 (0.1) 0.1 (0.0)
----- ----- ----- -----
Earnings (Loss) Before Income Taxes 1.3 (0.8) 1.1 (0.5)
Income Tax Expense (Benefit) 0.5 (0.3) 0.5 (0.2)
----- ----- ----- -----
Net Earnings (Loss) 0.8% (0.5)% 0.6% (0.3)%
===== ===== ===== =====
The following table sets forth the components of total revenues for the periods
indicated.
Three Months Ended Nine Months Ended
October 31, October 31,
----------- -----------
2003 2002 2003 2002
---- ---- ---- ----
Revenues (dollars in thousands)
Net store sales $ 70,728 $ 57,154 $210,751 $165,583
Net catalog and direct marketing sales 25,295 23,304 85,564 76,588
Net Internet sales 17,351 12,758 52,528 36,889
Net wholesale sales 14,453 9,975 20,714 15,261
-------- -------- -------- --------
Total Net Sales 127,827 103,191 369,557 294,321
Delivery 3,105 2,558 8,893 7,476
List rental and licensing 143 360 303 806
-------- -------- -------- --------
Total Revenues $131,075 $106,109 $378,753 $302,603
======== ======== ======== ========
12
Revenues
Net sales for the third quarter increased $24.6 million, or 23.9%, from the
comparable three-month period of the prior year. Net sales for the nine-month
period ended October 31, 2003 increased $75.2 million, or 25.6%, from the
comparable period last year. Returns and allowances for the three-month and
nine-month periods ended October 31, 2003, were 10.2% and 10.8% of sales, as
compared with 11.7% and 11.4% of sales for the comparable prior year periods.
The increase in net sales for the three and nine-month periods ended October 31,
2003 compared to the same periods last year was primarily attributable to
increases in net sales from stores of $13.6 and $45.2 million; net catalog and
direct marketing of $2.0 and $9.0 million; Internet operations of $4.6 and $15.6
million; and wholesale sales of $4.5 and $5.5 million, respectively.
The increase in total revenues for the third quarter of fiscal 2003, as compared
to the third quarter of fiscal 2002 was due primarily to the popularity of our
Sharper Image Design proprietary products, Sharper Image brand products and
certain top selling new other brand products, all of which continue to be key
factors in the increases in net sales in all selling channels. Sharper Image
Design proprietary products and Sharper Image brand products was approximately
75% of net sales in the first nine months of fiscal 2003, which was even as
compared to the same period of 2002. The continued development and introduction
of new and popular products is a key strategic objective and important to our
future success. Also contributing to the increase in total revenues was a
comparable store sales increase of 10.0% and the opening of 22 new stores since
the third quarter of fiscal 2002. We believe the increased investment in our
advertising initiatives in fiscal 2002 which continued through the third quarter
of fiscal 2003, including the significant increase in television infomercial
advertising and single product mailers highlighting primarily selected Sharper
Image Design products, contributed to the higher revenues in all selling
channels.
For the three-month and nine-month periods ended October 31, 2003, as compared
with the same periods last year, net store sales increased $13.6 million, or
23.7%, and $45.2 million, or 27.3%, while comparable store sales increased by
10.0% and 14.3%, respectively. The increase in net store sales for the three and
nine-month periods ended October 31, 2003 were primarily attributable to the
popularity of Sharper Image Design proprietary and Sharper Image brand products,
the increased television infomercial advertising which we believe drives traffic
into the stores and the opening of 22 new stores, partially offset by the
closing of three stores at lease maturity since October 31, 2002. The increase
in net store sales for the three-month period ended October 31, 2003 as compared
with the same prior year period reflects a 12.7% increase in average revenue per
transaction and a 14.7% increase in total store transactions. Total store
transactions increased 16.5% for the nine-month ended October 31, 2003 and
average revenue per transaction increased by 12.5%, compared with the same prior
year period.
Comparable store sales is not a measure that has been defined under generally
accepted accounting principles. We define comparable store sales as sales from
stores where selling square feet did not change by more than 15% in the previous
12 months and which have been open for at least 12 months. Stores generally
become comparable once they have 24 months of comparable sales for our annual
calculation. We believe that comparable store sales, which excludes the effect
of a change in the number of stores open, provides a more useful measure of the
performance of our store sales channel than does the absolute change in
aggregate net store sales.
Average revenue per transaction is calculated by dividing the amount of gross
sales, exclusive of delivery revenue and sales taxes, by the gross number of
transactions in that channel.
13
For the three and nine-month periods ended October 31, 2003, as compared with
the same periods 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 $2.0 million, or 8.5%,
and $9.0 million, or 11.7%, respectively. The net sales increase from these
direct marketing activities for the three-month period ended October 31, 2003,
was due primarily to a 6.7% increase in catalogs circulated, 10.6% increase in
catalog pages circulated and a 33.3% increase in television infomercial
advertising highlighting selected Sharper Image Design products, as compared
with the same prior year period. The increase in net catalog and direct
marketing sales for the third quarter of fiscal 2003 reflects a 5.8% increase in
transactions and an increase of 1.3% in average revenue per transaction as
compared with the same prior year period. The net sales increase from these
direct marketing activities for the nine-month period ended October 31, 2003, as
compared to the same period last year, was due primarily to a 20.6% increase in
television infomercial advertising, 38.9% increase in single product mailers
circulated, a 11.2% increase in Sharper Image catalogs circulated and a 16.1%
increase in catalog pages circulated. For the nine-month period ended October
31, 2003, the increase in net catalog and direct marketing sales reflects a
13.8% increase in transactions, partially offset by a decrease of 2.2% in
average revenue per transaction.
For the three and nine-month periods ended October 31, 2003, Internet sales from
our sharperimage.com web site, which includes the Sharper Image and eBay auction
sites, increased $4.6 million, or 36.0% and $15.6 million, or 42.4%,
respectively, from the same periods last year. The Internet sales increase for
the three months ended October 31, 2003 was attributable to an increase of 29.4%
in transactions and an increase of 4.2% in average revenue per transaction as
compared to the same period last year. The Internet sales increase for the nine
months ended October 31, 2003 was attributable to a 39.8% increase in Internet
transactions and a 1.7% increase in average revenue per transaction, as compared
to the same period of the prior year. The increases in internet sales during the
three and nine months ended October 31, 2003 are attributable to increases in
the utilization of search engines key words, as well as other advertising and
marketing placement expenses. We continue to utilize the auction site to
increase our Internet business, broaden our customer base and to manage
inventories, including closeouts, repackaged and refurbished items.
For the three and nine-month periods ended October 31, 2003, wholesale sales
increased $4.5 million, or 44.9%, and $5.5 million, or 35.7%, respectively, from
the same periods of the prior year. The increase is primarily attributable to
the testing of programs with new wholesale customers. We believe that the
wholesale business will continue to strengthen our brand name and broaden our
customer base.
Cost of Products
Cost of products for the three-month and nine-month periods ended October 31,
2003 increased $11.1 million, or 23.1%, and $34.0 million, or 25.5%, from the
comparable prior year periods. The increases in cost of products are due to the
higher sales volume compared to the same periods last year which was partially
offset by the lower relative cost of products for our Sharper Image Design
proprietary and Sharper Image brand products. The gross margin rate for the
three and nine-month periods ended October 31, 2003, was 54.7% and 55.8%,
respectively, which was 0.3 percentage points higher and 0.1 percentage points
lower than the comparable periods of the prior year. For the three- and
nine-month periods, the gross margin rate was negatively affected by delivery
expense in excess of delivery income collected due to the increase in single
product mailers which offered free shipping when an order was placed, and the
free shipping on the delivery of our selection of massage chairs.
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Our gross margin rate fluctuates with the changes in our merchandise mix,
primarily Sharper Image Design proprietary and Sharper Image brand products,
which changes as we make new items available in various categories or introduce
new proprietary products. The variation in merchandise mix from category to
category from year to year is characteristic of our sales results being driven
by individual products rather than by general lines of merchandise.
Additionally, the auction sites and other selected promotional activities, such
as free shipping offers, will, in part, tend to offset the rate of increase in
our gross margin rate. Our gross margins may not be comparable to those of other
retailers, since some retailers include the costs related to their distribution
network in cost of products while we, and other retailers, exclude them from
gross margin and include them instead in general, selling and administrative
expenses. We also include the net costs of delivery expense to customers in our
gross margin rate. We cannot accurately predict future gross margin rates,
although our goal is to continue to increase sales of Sharper Image Design
proprietary and Sharper Image brand products to capitalize on the higher margins
realized on these products.
Buying and Occupancy
Buying and occupancy costs for the three-month and nine-month periods ended
October 31, 2003 increased $2.5 million, or 21.3%, and increased $6.3 million,
or 18.5%, from the comparable prior year periods. The increases reflect the
occupancy costs associated with the 22 new stores opened since October 31, 2002
and rent increases associated with lease renewals, partially offset by the
occupancy costs of the three Sharper Image stores closed at lease maturity since
October 31, 2002. Buying and occupancy costs as a percentage of total revenues
decreased to 10.9% from 11.1% for the three-month period ended October 31, 2003,
and decreased to 10.7% from 11.3% for the nine-month period ended October 31,
2003. Our goal is to continue to grow the number of new stores by 15%-20% on an
annual basis, but we cannot assure you we will achieve this goal.
Advertising
Advertising for the three-month and nine-month periods ended October 31, 2003
increased $4.2 million, or 21.1%, and $14.3 million, or 23.4%, from the
comparable prior year periods. The increase in advertising expense for the
three-month period ended October 31, 2003, was primarily attributable to a 33.3%
increase in television infomercial advertising, a 6.7% increase in the number of
Sharper Image catalogs mailed, a 10.6% increase in catalog pages circulated, and
a 193.2% increase in internet advertising, which include paid for search engine
key word placement and revenue share costs incurred for affiliate programs.
Additionally, we continued our other multimedia advertising initiatives, which
included radio and newspaper advertising, among others. The increase in
advertising expense for the nine-month period ended October 31, 2003 was
primarily attributable to a 20.6% increase in television infomercial
advertising, a 38.9% increase in the number of single-product mailers
circulated, a 16.1% increase in the number of Sharper Image catalogs pages and a
11.2% increase in the number of Sharper Image catalogs circulated. 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. Advertising expenses as a
percentage of total revenues decreased to 18.5% from 18.9% for the three-month
period ended October 31, 2003, and decreased to 20.0% from 20.3% for the
nine-month period ended October 31, 2003. Although there is usually a declining
marginal benefit obtained by increasing advertising expenditures, we monitor the
effectiveness of our advertising in order to achieve a reasonable return on our
investment in advertising.
We believe that the expansion of our multimedia advertising initiatives
contributed to the sales increases for the first nine months of 2003 and will
continue be an important factor in our future revenue growth. As a result,
advertising expenses are anticipated to be higher in the remainder of fiscal
2003 than in fiscal 2002.
15
General, Selling and Administrative Expenses
General, selling and administrative (GS&A) expenses for the three and nine-month
periods ended October 31, 2003 increased $4.9 million, or 18.2%, and $16.0
million, or 21.2%, from the comparable prior year periods. Contributing to the
increase in GS&A expenses for the three-month period ended October 31, 2003 was
$3.3 million due to variable expenses from increased sales which includes $2.7
million due to variable expenses from increased sales from all sales channels
and $0.6 million due to variable expenses from increased sales and selling
expenses related to the 22 new stores opened since October 31, 2002, as well as
increases in health benefits and distribution shipping costs incurred for
product delivery to our stores. Contributing to the nine-month increase was $3.2
million due primarily to variable expenses from increased sales and selling
expenses related to the 22 new stores opened since October 31, 2002, partially
offset by the reduced selling expenses of three stores closed at lease maturity
since October 31, 2002. Also contributing to the increase was $5.9 million due
to variable expenses from increased sales from all sales channels, as well as
increases related to technological system enhancements made in our operational
areas, increases in health benefits and company-wide insurance premiums and for
distribution shipping costs incurred for product delivery to our stores. GS&A
expenses for the three-month period ended October 31, 2003 decreased as a
percentage of total revenues to 24.2% from 25.3%. For the nine-month period
ended October 31, 2003 GS&A expenses decreased as a percentage of total revenues
to 24.2% from 24.9%.
Other Income and Expense
Other income, net, for the three and nine-month periods ended October 31, 2003,
increased $356,000 and $378,000 from the comparable prior year periods,
primarily due to the interest income earned on higher investment balances
generated from the proceeds from our public stock offering and improved
operating results.
Liquidity and Capital Resources
We met our short-term liquidity needs and our capital requirements in the
nine-month period ended October 31, 2003 with cash generated from the proceeds
of our public stock offering, by operations, and existing cash balances.
Net cash used for operating activities totaled $46.6 million for the first nine
months of fiscal 2003, an increase of $21.9 million from the same period of
fiscal 2002. The increase in net cash used for operating activities is primarily
due to an increase in our payments to vendors for merchandise inventories.
Net cash used in investing activities totaled $28.0 million in the first nine
months of fiscal 2003 compared to $17.3 million in the same period of fiscal
2002. Cash was used primarily in capital expenditures for new stores, tooling
costs for proprietary products and technological upgrades to our operational
infrastructure. During the first nine months of fiscal 2003, we opened 15 new
stores and closed three stores at their lease maturity. In addition, we invested
$4.0 million in short-term investments subsequent to our public offering to
achieve higher investment returns.
Net cash provided by financing activities totaled $40.8 million during the nine
months ended October 31, 2003, which was the result of $38.5 million in net
proceeds from the public offering of our common stock, $2.8 million in proceeds
from the issuance of common stock in connection with our stock option plan,
offset partially by $0.4 million in financing fees.
16
On October 31, 2003, we terminated our old secured credit facility and entered
into a new revolving secured credit facility with Wells Fargo Bank, National
Association. The new credit facility has a maturity date of October 31, 2006,
and will allow us borrowings and letters of credit up to a maximum of $50
million at all times during the year, with a "borrowing base" determined by
inventory levels and specified accounts receivable. The new credit facility is
secured by our inventory, accounts receivable, accounts and specified other
assets. Borrowings under the new credit facility bear interest at either the
adjusted LIBOR rate plus 1.50% or at Wells Fargo's prime rate less 0.25%. The
new credit facility contains financial covenants that only apply during an event
of default or when the borrowing base falls below a specified level. These
financial covenants require us to maintain a minimum EBITDA (as defined) of $35
million and to maintain capital expenditures below a specified level based on
our projections. The new credit facility contains limitations on incurring
additional indebtedness, making additional investments and permitting a change
of control. There was no activity under this agreement on October 31, 2003,
other than the issuance on the closing date of a $9.8 million backstop letter of
credit to cover letter of credit commitments outstanding under our old secured
credit facility.
During the nine-month period ended October 31, 2003, we opened 15 new stores and
closed three stores at lease maturity. For the remainder of fiscal 2003, we are
on plan to achieve our goal of a 15%-20% growth in the number of new stores
opened and to remodel three stores at lease maturity. Total capital expenditures
are estimated to be approximately $28 to $30 million for fiscal 2003.
On May 7, 2003, we completed a public offering of our common stock in which we
sold 1.9 million shares at a price to the public of $19.50. On May 13, 2003, we
closed the sale of an additional 237,424 shares of common stock subject to the
underwriters' over-allotment option. We received proceeds from the public
offering of $38.5 million, net of underwriters' discounts and offering expenses.
We intend to use the proceeds for working capital and general corporate
purposes, including expanding the number of our stores, remodeling existing
stores, increasing our distribution capabilities and strengthening our
information technology infrastructure.
We believe we will be able to fund our cash needs for the remainder of fiscal
2003 and fiscal 2004 through existing cash balances, revolving credit facility
and cash generated from operations.
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 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 first three fiscal quarters and typically 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.
17
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. This report (including without limitation the following Factors
Affecting Future Operating Results) 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.
Although forward-looking statements in this report reflect the good faith
judgment of our management, such statements can only be based on facts and
factors we currently know about. 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
discussed below and in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" 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.
If we fail to continuously offer new merchandise that our customers find
attractive, the demand for our products may be limited.
In order to meet our strategic goals, we must successfully offer our
customers new, innovative and high quality products on a continuous basis. 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. Some products or a group of related products can
produce sales volumes that are significant to our total sales volume in a
particular period.
If other retailers, especially department stores or discount retailers,
offer the same products or products similar to those we sell, if our products
receive unfavorable reviews, 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.
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 we do not maintain sufficient inventory levels, or if we are unable to
deliver our products to our customers in sufficient quantities, our operating
results will be adversely affected.
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
18
sufficient inventory levels, particularly during the peak holiday selling
seasons. If we fail to achieve these goals, we may be unable to meet customer
demand, and our future results will 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.
A substantial portion of our sales during any given period of time may be
generated by a particular product or line of products and if sales of those
products or line of products decrease, our stock price may be adversely
affected.
During fiscal 2002 and first nine months of fiscal 2003, the sales of
our air purification line of products constituted a substantial portion of our
total revenues. Although not as substantial, the sales from our home and
portable stereo system and massage product lines constituted a significant
portion of our total revenues. We believe that sales from these product lines
will continue to constitute a substantial portion of our sales for the
foreseeable future, although we cannot assure you that sales of these product
lines will continue to increase or will continue at this level. If sales of
these products or any one of these products decrease, our stock price could be
adversely affected.
Our future growth will be substantially dependent on the continued
increase in sales 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.
Poor economic conditions may reduce consumer spending on discretionary retail
products such as the ones we offer.
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.
Our success depends in part on our ability to internally design and develop our
Sharper Image Design products.
We have invested significant resources in and are increasingly
dependent on the success of the Sharper Image Design products that we design and
develop. These products have typically generated higher gross margins than other
products and our merchandising strategy emphasizes these products. 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 volumes that are significant to our total sales volume in a particular
period. In order to be successful, we must continue to design and develop
products that meet the demands of our customers, as well as create customer
demand for these 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 and our business would be adversely
affected if our suppliers are not able to meet our demand and alternative
sources are not available.
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
19
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, epidemics such as SARS, 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 China that provided approximately
24% of the net merchandise purchases in fiscal 2002 and is expected to provide a
comparable percentage in the future. If we were unable to obtain products from
this supplier on a timely basis or on commercially reasonable terms, or if the
Yuan were to appreciate materially against the US dollar, our operating results
may be adversely affected.
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 selling to us at
any time. We compete with many other companies for production facilities and
import quota capacity. 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 and our business can be harmed by work stoppages or other interruptions
to delivery 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.
Our ability to protect our proprietary technology, which is vital to our
business, particularly our air purification products, is uncertain and our
inability to protect these rights could impair our competitive advantage and
cause us to incur substantial expense to enforce our rights.
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.
Of our 26 utility patents, we currently have three utility patents, as well as
the license rights to use a fourth utility patent, and multiple design patents
that are related to our air purification line of products. The licensed utility
patent is due to expire in December 2005, and the earliest expiration date of
the other utility patents related to our air purification line of products is
2018.
We cannot assure you that a third party will not infringe upon or
design around any patent issued or licensed to us, including the patents and
license agreement related to our air purification line of products, 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, we may be required to pay damages, stop production and sales
of infringing products or be subject to increased competition from similar
products. 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.
20
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 will have adequate remedies for any breach or that competitors
will not know of or independently discover our trade secrets.
Our quarterly operating results and comparable store sales 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. The fourth
quarter accounted for more than 40% of total revenues in both fiscal 2002 and
2001. In addition, the fourth quarter accounted for all of our net earnings in
fiscal 2001 and substantially all of our net earnings in fiscal 2002. 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
our first three quarters of the fiscal year 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, like 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 comparable store sales also fluctuate significantly and can
contribute to fluctuations in our quarterly operating results. Our comparable
store sales are affected by a variety of factors, including customer demand in
different geographic regions, our ability to efficiently source and distribute
products, changes in our product mix, competition and advertising.
Our comparable store sales have fluctuated significantly in the past
and we believe that such fluctuations may continue. Our historic comparable net
store sales changes from the prior fiscal year were as follows:
Fiscal year Percentage increase (decrease)
----------- ------------------------------
2000 29.0
2001 (16.0)
2002 13.6
2003 (First nine months) 14.3
Comparable store sales are defined as sales from stores where selling
square feet did not change by more than 15% in the previous 12 months and which
have been open for at least 12 full months. Stores
21
generally become comparable once they have 24 months of comparable sales for our
annual calculation. We cannot assure you that our comparable store sales results
will 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 our common stock to decrease.
We are dependent on the success of our advertising and direct marketing efforts
and our profitability will be adversely affected by increased costs associated
with these efforts.
Our revenues depend in part on our ability to effectively market and
advertise our products through The Sharper Image catalog and direct marketing
operations. 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. Our advertising expenditures increased by approximately $13.8
million or 25.3% in fiscal 2001 from the prior fiscal year, $28.9 million, or
42.2%, in fiscal 2002 from the prior fiscal year and $14.3 million or 23.4% for
the nine-month period ended October 31, 2003 from the comparable prior year
period. While we believe that increased expenditures on these and other media
have resulted in increased revenues during fiscal 2002, we cannot assure you
that increased advertising will result in increased revenues in the future. If
our advertising is ineffective and our increased advertising expenditures do not
result in increased sales volumes, our sales and profits will be adversely
affected. 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.
Our business will be harmed if we are unable to successfully implement our
growth strategy.
Our growth strategy primarily includes the following components:
o increase Sharper Image Design and private label product
offerings;
o broaden our customer base;
o open new stores; and
o broaden our sales and marketing channels
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 to our success in meeting the merchandise,
timing and service demands of an expanding customer base with changing
demographic characteristics, but there is no assurance that we will be able to
continue to have such success.
The expansion of our store operations could result in increased expenses with no
guarantee of increased profitability.
We plan to increase our number of stores by 15%-20% 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:
o the availability of attractive store locations;
o our ability to negotiate favorable lease terms;
22
o our ability to identify customer demand in different
geographic areas;
o general economic conditions; and
o availability of sufficient funds for expansion
Even though we continue to expand our store base, we have remained
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 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 financing in excess
of that available under our current credit 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 which could have significant cost increases
and could have unpredictable results.
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, produce and deliver
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. Increases in costs of mailing,
paper or printing would increase costs and 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. 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
23
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 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 negative impact on sales during that period. Additionally, 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 rate 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.
The majority of our distribution and fulfillment operations are located in our
own facility in Little Rock, Arkansas and any disruption of this center's
operations could hurt our ability to make timely delivery of our products.
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 and leased facilities in Little Rock,
Arkansas, Ontario, California, and Richmond, Virginia. 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 result in late delivery of products and make it
difficult to meet customer demand for our products.
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 facilities, 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.
We experience intense competition in the rapidly changing retail markets and if
we are unable to compete effectively, we may not be able to maintain
profitability.
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 and offer the
convenience of one-stop shopping. Specialty retailers, such as electronics
stores, may offer only a certain category of products but often offer a wider
range of selection within a particular category of product. Discount stores may
offer analogous products at lower price points. We offer a more limited range of
products compared to our competitors, and if we are unable to anticipate the
preferences of our customers and effectively market and distinguish The Sharper
Image brand or if we experience increased competition, our business and
operating results could be adversely affected.
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The U.S. 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 that we will anticipate and successfully respond to changes in
the retail industry and e-commerce sectors.
We maintain a liberal merchandise return policy, which allows customers to
return most merchandise, and as a result, excessive merchandise returns could
harm our business.
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 our 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 have a material adverse
effect on our future results.
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 recalls is not covered by or exceeds our insurance coverage, our
business, results of operations 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.
If we lose our key personnel, we may not be able to successfully develop and
merchandise our products.
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 operating results. We
maintain key man life insurance on Mr. Thalheimer in the amount of $15 million.
The terms of Mr. Thalheimer employment 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 the 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 effectively controlled by a single shareholder who exerts considerable
influence over our business affairs and may make business decisions which may
not be in your best interest.
As of December 11, 2003, Richard Thalheimer beneficially owned
approximately 22% of our common stock. As a result, Mr. Thalheimer will continue
to exert substantial influence over the election of directors and over our
corporate actions.
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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. From February 1, 2003 to October
31, 2003, the price per share of our common stock has ranged from a high of
$30.74 to a low of $14.51. We believe that among other factors, any of the
following factors could cause the price of our common stock to fluctuate
substantially:
o monthly fluctuations in our comparable store sales;
o announcements by other 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 plan and other
agreements may make a takeover of us 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 plan 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.
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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 is therefore affected by changes in market interest rates. If
interest rates on existing variable debt rose 0.4% (10% from the bank's
reference rate) during the period ending October 31, 2003, 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.
ITEM 4. CONTROLS AND PROCEDURES
(a) 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 ("Exchange Act")
Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this
quarterly report, have concluded that our disclosure controls and procedures are
effective based on their evaluation of these controls and procedures required by
paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
(b) Changes in internal control over financial reporting. There were no changes
in our internal control over financial reporting identified in connection with
the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15
that occurred during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Loan and Security Agreement dated October 31, 2003 between the Company
and Wells Fargo Retail Finance, LLC.
31.1 Certification Pursuant to Section 302 of The Sarbanes Oxley Act of
2002, Chief Executive Officer.
31.2 Certification Pursuant to Section 302 of The Sarbanes Oxley Act of
2002, Chief Financial Officer.
32.1 Certification Pursuant to Section 906 of The Sarbanes-Oxley Act of
2002, Chief Executive Officer.
32.2 Certification Pursuant to Section 906 of The Sarbanes-Oxley Act of
2002, Chief Financial Officer.
(b) Reports on Form 8-K
We did not file any report on Form 8-K during the three months ended
October 31, 2003.
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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 15, 2003 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