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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended January 31, 2004
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 33-12755
SHARPER IMAGE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2493558
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _X_
Indicate by check mark whether registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act). Yes _X_ No ___
1
The aggregate market value of the voting common stock held by non-affiliates of
the Registrant based on the reported last sale price for the common stock on the
Nasdaq National Market on July 31, 2003, was $353,076,885.
There were 15,519,236 shares of Common Stock, par value $.01,
outstanding on April 12, 2004.
Documents incorporated by reference
Portions of Registrant's Proxy Statement for the Annual Meeting of Stockholders
presently scheduled to be held June 7, 2004 are incorporated by reference into
Part III of this report.
2
PART I
This Annual Report on Form 10-K and the documents incorporated herein
by reference of Sharper Image Corporation (referred to as the "Company," "The
Sharper Image," "it," "we," "our," "ours," and "us") contain forward-looking
statements within the meaning of federal securities laws that have been made
pursuant to the provisions of the Private Securities Litigation Reform Act of
1995. Such forward-looking statements are based on current expectations,
estimates and projections about the Company's industry, management's beliefs and
certain assumptions made by the Company's management. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates,"
or variations of such words and similar expressions, are intended to identify
such forward-looking statements. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. Therefore, actual results may differ materially from
those expressed or forecasted in any such forward-looking statements. Such risks
and uncertainties include those set forth herein under "Factors Affecting Future
Operating Results" on pages 13 through 22 as well as those noted in the
documents incorporated herein by reference. Unless required by law, the Company
undertakes no obligation to update publicly any forward-looking statements,
whether as a result of new information, future events or otherwise. However,
readers should carefully review the statements set forth in other reports or
documents the Company files from time to time with the Securities and Exchange
Commission, particularly the Quarterly Reports on Form 10-Q and any Current
Reports on Form 8-K.
Item 1. Business
Overview
The Sharper Image is a leading specialty retailer of innovative, high
quality products that are useful and entertaining and are designed to make life
easier and more enjoyable. We offer a unique assortment of products in the
electronics, recreation and fitness, personal care, houseware, travel, toy,
gifts and other categories. Our merchandising philosophy focuses principally on
new and creative proprietary Sharper Image Design products and exclusive Sharper
Image branded products and, to a lesser extent, on third party branded products.
We design and develop our Sharper Image Design products, while Sharper Image
branded products are generally designed by us with third parties.. We believe
that our unique merchandising and creative marketing strategies have made The
Sharper Image one of the most widely recognized retail brand names in the United
States of America.
The Sharper Image was founded in 1977 by Richard Thalheimer, who
currently serves as Chairman and Chief Executive Officer. We mailed our first
catalog in 1979, began the expansion into store operations in 1981 and commenced
online operations in 1994. We market and sell our merchandise primarily through
three integrated sales channels: The Sharper Image stores, The Sharper Image
catalog, which includes revenue from all direct marketing activities and
television infomercials, and the Internet. We believe that this multi-channel
approach provides us with significant marketing, advertising, sales and
operational synergies and provides our customers with enhanced shopping
flexibility and superior customer service.
Our merchandising strategy emphasizes products that are innovative and
new-to-market. In recent years, we have focused significant resources on the
development and marketing of our Sharper Image Design and Sharper Image branded
products. Sharper Image Design and Sharper Image branded products typically
generate higher gross margins than other products, minimize direct price
comparisons and, we believe, strengthen The Sharper Image brand as well as
broaden our customer reach. The percentage of our total revenues attributable to
Sharper Image Design and Sharper Image branded products was approximately 73% in
fiscal 2003 and 76% for fiscal 2002.
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Our store operations generated the highest proportion of our sales,
representing 58.6% and 57.2% of total revenues for fiscal 2003 and 2002,
respectively. As of January 31, 2004, we operated 149 The Sharper Image stores
in 37 states and the District of Columbia. The Sharper Image stores present an
interactive and entertaining selling environment that emphasizes the features
and functionality of our innovative, fun and useful products and allows the
customer to interact with and experience the product while shopping. Our average
store sales per square foot are consistently above industry averages, and during
fiscal 2003 and 2002, we generated average sales of $676 and $627, respectively,
per square foot. For our stores opened for more than one year, our average sales
per square foot was $710. During fiscal 2003, we opened 25 new stores and we
closed three stores at lease maturity. We plan to increase our number of stores
by 15%-20% during fiscal 2004.
We also offer our products through direct marketing activities. The
Sharper Image catalog, an award winning, full-color monthly catalog, uses
dramatic visuals and creative product descriptions designed and produced by our
in-house staff of writers and production artists. The Sharper Image catalog
generally features between 200 and 250 products in each monthly catalog,
increasing to over 350 products during the holiday shopping season, and also
serves as a significant advertising vehicle for our stores and our Internet
operations. During fiscal 2003 and 2002 we mailed approximately 86 million and
78 million The Sharper Image catalogs to over 18 million and 16 million
individuals, respectively. We also conduct a television advertising program
through infomercials on a select few of our most popular products. For fiscal
2003, 19.9% of our total revenues were generated by our catalog and direct
marketing operations, including revenue generated directly from catalogs, print
advertising, single product mailers and television infomercials, compared to
23.0% in fiscal 2002.
The Sharper Image products are also marketed through our Internet
operations, primarily through our own Web site which we have operated at
sharperimage.com since 1995. The Sharper Image was an early entrant into
Internet retailing, and has participated in online shopping since 1994. Our
Internet operations generated 14.7% and 13.5% of total revenues in fiscal 2003
and 2002, respectively. In addition to our Web site, we offer our products
through Internet marketing agreements with Google, eBay, MSN Shopping, Amazon,
Linkshare, Yahoo! Shopping, Catalog City, and AOL. We believe that our Sharper
Image Design and Sharper Image branded products are particularly well positioned
to be marketed and sold over the Internet and that our Internet operations have
enabled us to expand and diversify our existing customer base. We plan to
continue to allocate resources to our Internet operations by establishing
additional strategic relationships with other Internet retail partners and
continuing to enhance the technical capabilities and presentation of products on
our Web site. We also operate an auction site where consumers can bid to win
products at less than retail prices. This provides us with the opportunity to
broaden our customer base and manage our closeout, repackaged and reconditioned
inventory. We currently also offer international Web sites where Internet
shoppers are able to get local delivery of Sharper Image Design and Sharper
Image branded products, which in some cases have been specifically adapted for
use throughout Europe.
We are known for our varied product mix and a merchandising philosophy
focusing on innovative, well designed, high quality products that are either
developed by The Sharper Image, exclusive to The Sharper Image or in limited
distribution. In product lines where we compete directly with other retailers,
we generally choose to sell the best available version of the product with the
most advanced features. Manufacturers and inventors frequently approach us to
launch technologically advanced products with features that are unique and
innovative.
During fiscal 2003 and 2002, we continued the expansion of our in-house
Sharper Image Design product development function. The percentage of total
revenues attributable to Sharper Image Design and
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Sharper Image branded products was approximately 73% of total revenues in fiscal
2003, compared with approximately 76% in fiscal 2002. The popularity of third
party branded products such as digital cameras and massage chairs during fiscal
2003 contributed to the lower percentage of sales coming from Sharper Image
Design and Sharper Image branded products. Our goal is to increase the
percentage of total revenues attributable to Sharper Image Design and Sharper
Image branded products, although we cannot assure you that this will happen.
Sharper Image Design and Sharper Image branded products generally carry higher
margins than third party branded products and we plan to continue to devote
resources to our Sharper Image Design product development efforts and our
Sharper Image brand merchandising philosophy.
Our business is highly seasonal, with sales peaks in the end-of-year
holiday shopping season as well as for Mother's Day, Father's Day and graduation
gift-giving. See "Business--Seasonality."
In addition to our primary business, we leverage our name and
reputation through our Corporate Incentives and Rewards program and wholesale
sales of Sharper Image brand products, which include Sharper Image Design and
Sharper Image branded products. We also have wholesale marketing arrangements
with established retail chains, such as Linen `n Things, Bed, Bath and Beyond,
Circuit City, May Department Stores and Federated Department Stores.
The Sharper Image stores
Our store operations generate the highest proportion of our sales,
representing 58.6% of total revenues for fiscal 2003 and 57.2% in fiscal 2002.
The Sharper Image stores present an interactive and entertaining selling
environment that emphasizes the features and functionality of our products and
allows the customer to experience the product while shopping. We have three
store formats: The Sharper Image stores, The Sharper Image Design stores and
outlet stores.
Each store is generally staffed with approximately 8 to 12 associates,
including a manager, an assistant manager, a senior sales associate, sales
associates and other support staff. A number of our high volume stores are
staffed with 15 to 20 associates. Our store managers have an average tenure of
over five years. Our store personnel are compensated primarily through
commissions. In order to maintain a high customer service level, our sales
associates undergo considerable training on our many new and often technically
oriented products. The Sharper Image stores are designed by our visual design
and creative staff at our headquarters in San Francisco, California to
standardize, where possible, layout so as to simplify their operations.
The stores are operated according to standardized procedures to
maintain high level of customer service, merchandise display and pricing,
product demonstration, inventory maintenance, personnel training, administration
and security. The original The Sharper Image stores typically have 2,200 to
3,000 square feet of selling space and approximately 1,300 to 2,200 square feet
of storage and administrative space. The typical cost of leasehold improvements,
before landlord contributions, but including fixtures, equipment and pre-opening
expenses, averages $400,000 to $550,000 per store. Initial inventory for a new
The Sharper Image store has generally cost approximately $200,000. Outlet stores
are approximately half the cost of the original The Sharper Image stores. We
also operate a second retail format of The Sharper Image Design stores, which
are approximately half the size of the original stores. The Sharper Image Design
stores typically consist of between 1,200 to 2,000 square feet of selling space
and feature higher margin Sharper Image Design and private label products, in
addition to other top selling merchandise. As of January 31, 2004, we had 136
The Sharper Image stores, nine The Sharper Image Design stores and four outlet
locations for a total of 149 stores.
5
Over the past five years, we have been updating the look and appeal of
our new retail stores and remodeling select existing stores. The updated format
presents an open, fresh and inviting environment designed to appeal to both men
and women and highlight our Sharper Image Design and Sharper Image branded
products and attractive product packaging. The average cost of converting an
existing store to the new format is similar to that of building a new store,
which ranges from $400,000 to $550,000, subject to leasehold allowances. We
intend to continue to selectively remodel stores utilizing the new store format
typically at the time of the store's lease renewal.
The Sharper Image catalog and direct marketing
The Sharper Image catalog is a full-color catalog that is mailed to an
average of five to six million individuals each month, with an increase to six
to eight million individuals during the Father's Day and graduation months and
an increase to nine to 13 million individuals during the holiday season. The
Sharper Image direct marketing operations, including revenues generated directly
from catalogs, single product mailers, print ads and television infomercials,
generated 19.9% of our total revenues in fiscal 2003 and 23.0% in fiscal 2002.
Our catalog has been recognized for creative excellence by leading catalog
industry trade groups. The catalog is currently the primary advertising vehicle
for our retail stores and our Internet business. During fiscal 2003 and 2002, we
mailed approximately 85 million and 78 million The Sharper Image catalogs to
over 18 million and 16 million households, respectively. Circulation and number
of pages of The Sharper Image catalog is under continual review to balance the
costs of mailing the catalogs with the revenues generated. The mailings increase
significantly for the peak seasons of Mother's Day, Father's Day, graduation
gift-giving and the holiday shopping season to reflect the seasonal nature of
the business. In fiscal 2003 and 2002, we increased our focus on the use of
television infomercials and single product mailers highlighting select products.
The Sharper Image catalog design uses dramatic visuals and
problem-solving and benefit-oriented product descriptions. The catalog design
features the most important products prominently. The number of items featured
each month ranges between 200 and 250 products during the first three quarters
of the year, increasing to more than 350 products during the holiday shopping
season in the fourth quarter. The Sharper Image catalog is designed and produced
by our in-house staff of writers and production artists. This enables us to
maintain quality control and shorten the lead-time needed to produce the
catalog. The monthly production and distribution schedule permits frequent
changes in the product selection. During fiscal 2003, The Sharper Image catalog
contained between 52 and 96 pages for non-peak months and between 52 and 128
pages for the peak seasons of Father's Day and the holiday shopping season.
We have developed a proprietary customer database of more than 17
million names, which we use regularly. We collect customer names through our
catalog and Internet order processing, as well as electronic point-of-sale
registers in our retail stores. The names and associated sales information are
merged daily into our customer master file. This daily merge process provides a
constant source of current information to help assess the effectiveness of the
catalog as a form of retail advertising, identify new customers that can be
added to our in-house mailing list without using customer lists obtained from
other catalogers, and identify our top purchasers. To further enhance the
effectiveness of our catalog mailings to individuals in the customer database,
our in-house staff utilizes our statistical evaluation and selection techniques
to determine which customer segments are likely to contribute the greatest
revenue per mailing. We have established a data bank of top purchasers who
receive preferred services, including invitations for special sales events and
enhanced customer service. During fiscal 2003 and 2002, we expanded our
television infomercial presence by highlighting several popular Sharper Image
Design and private label products on cable and national broadcast stations. We
believe that this type of direct marketing will
6
broaden the existing customer base and will also increase customer traffic and
sales in retail store locations.
Internet operations
The Sharper Image was an early entrant into Internet retailing. We have
participated in online shopping since 1994, and have maintained our own Web site
at sharperimage.com since 1995. Revenues from our Internet operations including
auction sales increased to $95.1 million in fiscal 2003 from $69.2 million in
fiscal 2002. During fiscal 2003, revenues from our Internet operations including
auction sales increased 37.4%, transactions increased 34.4% and average revenue
per transaction increased 1.9%. Our Internet operations benefit from our brand
name, customer base, The Sharper Image catalogs and unique product offerings, as
well as our multimedia approach to advertising. We believe that The Sharper
Image catalog in particular is a significant factor in generating Internet
sales. In addition, we are able to leverage our catalog operational
infrastructure for fulfillment and customer service experience, providing us
with a significant advantage over Internet retailers who have not developed such
capabilities. Shoppers on the Web site have the convenience of exchanging or
returning products purchased through the Internet at our store locations. We
send out periodic email campaigns to our list of Internet shoppers. These emails
include sneak previews of newly released products and special offers that are
intended to drive sales in all selling channels.
Our goal is to make sharperimage.com a Web site that provides our
Internet customers with an interactive experience similar to The Sharper Image
stores. We continue to update our Web site by incorporating advanced
technologies to improve our product presentations and make our site increasingly
customer friendly, while retaining our entertainment quality. Our Web site,
www.sharperimage.com, incorporates much of the look and feel of the new store
design. It includes features such as dynamic browsing, inventory status, order
tracking, Flash technology, gift guides by category and product, and catalog
quick order. We continually evaluate, test and enhance the Web site and during
fiscal 2003 we added an online gift registry and upgraded our customer service
area. We have also enhanced our backend systems by updating our servers and
programs to ensure the speed and efficiency of the Web site.
In fiscal 2003 and 2002, the editors and readers of Internet Retailer
Magazine honored sharperimage.com as one of the industry's 50 best Web sites.
We also have an established Internet auction site which allows
customers to bid on and acquire a broad range of new, returned, repackaged and
refurbished Sharper Image products for less than regular retail price. Our
products are also featured on eBay's auction site, as well as on our eBay store.
Most products purchased on the auction site have the same warranty that
accompanies full price products and customers also enjoy a thirty-day return
privilege. We believe that bidders have an enhanced level of confidence in our
operations since, unlike many other Internet auction sites, we are an
established retailer with an inventory of well-known products under warranty
with established return policies. The auction site not only offers consumers the
enjoyment of bidding and winning products at less than retail price, it also
allows us the opportunity to effectively manage our closeout products, while
maintaining gross margin goals.
We are pursuing additional steps to achieve continued growth of our
Internet operations. These steps include technological improvements, dramatic
visual presentations, development of international Web sites in Europe and
establishment of strategic Internet marketing arrangements. We have established
relationships with Google, eBay, MSN Shopping, Linkshare, Amazon, Yahoo!
Shopping, Catalog City, and AOL.
7
Other operations
In addition to our store, catalog and Internet operations, we also have
a business-to-business operation, which includes wholesaling, our Sharper Image
Corporate Incentives and Rewards program and licensing. We also derive revenues
from our customer list rental program.
Our business development department is the primary group responsible
for wholesale marketing to other retailers, including fine department and
specialty stores in the United States, as well as retailers in other countries.
We have wholesale marketing arrangements with established retail chains such as
Linen `n Things, Bed, Bath and Beyond, Circuit City, May Department Stores and
Federated Department Stores. This group's sales increased by 54% and were $27.0
million in fiscal 2003, as compared to $17.5 million in fiscal 2002.
Under the Sharper Image Corporate Incentives and Rewards program, we
sell product, rewards cards, incentive and merchandise certificates to major
corporations and not-for-profit entities, who in turn distribute them under
their programs to increase their sales, or to motivate and reward their high
achiever employees and best customers. The Sharper Image stores, catalog and
Internet Web site are the primary means of offering, delivering and redeeming
the incentives and gifts. We record revenues and expenses for our Sharper Image
Rewards program through our stores, catalog and direct marketing and Internet
operations.
We continue to pursue opportunities in foreign countries, primarily
through wholesale and Internet channels as well as through limited licensing
arrangements. For fiscal 2003 and 2002, international sales accounted for less
than 1% of total revenues.
Merchandising, sourcing and development
Merchandising
Our merchandise mix emphasizes innovative products that are
new-to-market, unique Sharper Image Design and Sharper Image branded products
which are generally available exclusively through The Sharper Image, or branded
products not available in broad distribution. We choose each product separately
because our sales are driven by individual products, and our marketing efforts
focus on each item's unique attributes, features and benefits. This approach
distinguishes us from other retailers who are oriented more to category or
product classification. We adjust our merchandise mix to reflect market trends
and customer buying habits. New products are selected or developed and brought
into our merchandise mix based on criteria such as anticipated popularity, gross
margin, uniqueness, value, competitive alternatives, exclusivity, quality and
vendor performance. As a result of such shifting emphasis among individual items
and depending on the customers' demand and the level of marketing and
advertising programs, the mix of sales by category changes from time to time and
the sales volume of individual or related products can be significant to any
particular reporting period's total sales. The effect of changes from year to
year in the mix of sales by category can be to increase or decrease the
merchandise gross margin rates since margins vary according to category of
merchandise.
Our current merchandise strategy is to offer an assortment of products
with emphasis on Sharper Image Design and Sharper Image branded products. We
intend to continue to focus on offering products in the $20 to $500 price range
to appeal to a wide customer base. We also intend to continue to increase our
Sharper Image Design and Sharper Image branded product offerings.
8
Sharper Image Design products are produced for us on a contract basis,
substantially all by manufacturers in Asia, primarily China. We provide all
product specifications to the contract manufacturers. Development lead-time is
generally in the range of 12 to 18 months, although certain product
introductions may require a shorter or longer lead-time.
We generate information frequently on merchandise orders and inventory,
which is reviewed by our buyers, our senior merchandising staff and top
management. We average new offerings of approximately 50 to 100 products during
the peak selling seasons. We carefully consider which products will not be
offered in future months based upon numerous factors, including revenues
generated, gross margins, the cost of catalog and store space devoted to each
product, product availability and quality.
Product sourcing
The process of finding new products involves our buyers reviewing
voluminous product literature, traveling extensively throughout the United
States and Asia to attend trade shows and exhibitions and meeting with
manufacturers. We enjoy relationships with many major manufacturers who use The
Sharper Image regularly to introduce their newest products in the United States.
We purchase merchandise from numerous foreign and domestic
manufacturers and importers. We had a single supplier that provided
approximately 21% of our net merchandise purchases in fiscal 2003. In fiscal
2003 and 2002, substantially all of the products offered by us were manufactured
in Asia, primarily China.
Product development
Our Sharper Image Design group has over ten years of experience in
designing and developing new products, as well as finding new product ideas from
outside sources. The product development group meets regularly with the
merchandising and sales staff to review new Sharper Image Design product
opportunities, product quality and customer feedback. From these creative
sessions, product ideas are put into design, development and production.
Successful product introductions during the past three years include: Car
Console Cooler; Feel Good Fan; Turbo Groomer 5.0; Automatic Eyeglass Cleaner; CD
Shower Companion; Ultrasonic Jewelry Cleaner; Personal Entertainment Center; Big
Screen Travel Clock; CD Soother Alarm Clock with 20 Soother Sounds; DVD Power
Tower; Electric X7 Scooter; Hot and Cold Mini Fridge; Ionic Breeze GP Silent Air
Purifier with Germicidal Protection; Ionic Breeze Personal Air Purifier; Ionic
Breeze Quadra Silent Air Purifier; Ionic Conditioning Quiet Hair Dryer; "Now You
Can Find It" Wireless Electronic Locator; Personal Cooling System; Shower
Companion Plus; Sound Soother 20; and the Talking Travel Companion.
In addition, we emphasize and work with vendors to develop private
label products focusing on unique and innovative features that would distinguish
us from competitors. Successful private label introductions include, among
others, several uniquely styled stereo systems, as well as various personal care
and home-related products. We believe that the appeal of the Sharper Image
Design and Sharper Image branded products also serves as a key factor in
broadening our customer base and enhancing and strengthening our brand appeal.
Our goal is to continue to increase sales of these products through the
introduction of new, and the continued popularity of existing, Sharper Image
Design and private label products.
9
Customer service
We are committed to providing our customers with courteous,
knowledgeable and prompt service. Our customer service and catalog sales groups
at the corporate headquarters, in Little Rock, Arkansas and in Ontario,
California provide personal attention to customers who call toll free or send
emails to request a catalog subscription, place an order or inquire about a
product. Our customer service group is also responsible for resolving customer
problems promptly and to the customer's complete satisfaction. We also contract
with third party call centers for additional sales and customer service
representative coverage. These third party call centers are subject to the same
high-level expectations of customer service as our internal staff.
We seek to hire and retain qualified sales and customer service
representatives in our store, catalog and Internet operations and to train them
thoroughly. Each new store manager undergoes an intense program during which the
manager is trained in all aspects of our business. Sales personnel are trained
during the first two weeks of employment, or during the weeks before a new store
opens, and updated periodically with on-going sales training sessions. Training
for sales personnel focuses primarily on acquiring a working knowledge of our
products and on developing selling skills and an understanding of our high
customer service standards. Each sales associate is trained to adhere to our
philosophy of "taking ownership" of every customer service issue that may arise.
We have also developed ongoing programs conducted at each store and by district
that are designed to keep each salesperson up to date on each new product
offered.
Order fulfillment and distribution
We own a fulfillment and distribution facility in Little Rock, Arkansas
of approximately 110,000 square feet. During fiscal 2003, we entered into a
lease for a distribution center in Richmond, Virginia, and re-located our
distribution center in Ontario, California to a larger space. We currently have
leased facilities in Little Rock, Arkansas, Ontario, California and Richmond,
Virginia, totaling approximately 350,000 square feet for mail order and store
fulfillment needs, returns processing and storage. Our merchandise generally is
delivered to the catalog and Internet customers and to The Sharper Image stores
directly from our distribution facilities. Some products are shipped directly
from the vendor to the customer or to the stores. The shipment of products
directly from vendors to the stores and customers reduces the level of inventory
required to be carried at the distribution center, freight costs and the
lead-time required to receive the products. Each catalog order is received via
remote terminal at the distribution facility after the order has been approved
for shipment. Our goal is to ship the majority of catalog and Internet orders
within 24 - 48 hours after the order is received. We believe that the additional
distribution center and added capacity will allow us to reach our goal. Store
customers generally take their purchases with them.
Maintaining sufficient inventory levels is critical to our business and
sales and inventory information about store, catalog and Internet operations is
provided on an ongoing basis to our merchandising staff and to top management
for review. Our stores are equipped with electronic point-of-sale registers that
communicate daily with the main computer system at our corporate headquarters,
transmitting sales, inventory and customer data, as well as receiving data from
our headquarters. The sales, inventory and customer data enable sales and
corporate personnel to monitor sales by item on a daily basis, provide the
information utilized by the automatic replenishment system, or ARS, and
merchandising personnel for inventory allocations, provide management with
current inventory and merchandise information, and enable our in-house mailing
list to be updated regularly with customer names and activity.
We have developed a proprietary ARS to improve sales with minimal
inventory investment. The ARS generates information on merchandise inventory and
sales by each store location, which management reviews daily. Sales information
by product and location is systematically compared daily to each
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product's "model stock" to determine store shipment quantities and frequency.
The ARS computes any adjustments to the model stock level based on factors such
as sales history by location in relation to our total sales of each product.
Under this system, the model stock is continually revised based on this
analysis. Recommended adjustments to model stock levels and recommended shipment
amounts are reviewed daily by a group of our store distributors and
merchandising managers who are responsible for allocating inventory to stores.
Advertising
While the catalog remained our primary advertising vehicle during
fiscal 2003 and 2002, we also broadened our customer base through increased
multimedia advertising, including television infomercials, single product
mailers, newspapers, magazines, radio, email marketing programs, Internet
advertising and marketing programs, and business-to-business trade publications.
We increased our spending on television media infomercials, which highlighted
selected Sharper Image Design and Sharper Image branded products. We believe we
will be able to achieve our goal of near break-even results on this type of
advertising due to the broad appeal of the products in conjunction with the
higher gross margin that Sharper Image Design and private label products
generally carry, although there is no assurance that this goal will be met.
These increased advertising initiatives were utilized to realize our
goal of acquiring new customers, which we believe will produce additional sales
in the stores, catalog and Internet channels, and business-to-business sales in
the current and future periods. We continually re-evaluate our advertising
strategies to improve the effectiveness of our advertising programs.
Information technology
We maintain an integrated management information system for
merchandising, point-of sale, order fulfillment, distribution and financial
reporting. We believe our system increases productivity by providing extensive
merchandise information and inventory control. We continually evaluate and
enhance our computer systems and information technology in connection with
providing additional and improved management and financial information. We have
backup systems for our mainframe and servers located at our distribution center
in Little Rock, Arkansas.
Our Web site, www.sharperimage.com, incorporates much of the look and
feel of the new store design. It includes features such as dynamic browsing,
inventory status, order tracking, Flash technology, gift guides by category and
product, and catalog quick order. We continually evaluate, test and enhance the
Web site and during fiscal 2003 we added an online gift registry and upgraded
our customer service area. We have also enhanced our backend systems by updating
our servers and programs to ensure the speed and efficiency of the Web site.
Competition
We operate in a highly competitive environment. We compete principally
with a diverse mix of department stores, sporting goods stores, discount stores,
specialty retailers and other catalog and Internet retailers that offer products
similar to or the same as some of those we offer. Many of our competitors are
larger companies with greater financial resources, a wider selection of
merchandise and greater inventory availability. Larger retailers, such as
department stores, offer a wider range of products and offer the convenience of
one-stop shopping. Specialty retailers, such as electronic 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.
11
Since we offer a more limited range of products compared to our
competitors, our ability to anticipate the preferences of our customers and
effectively market and distinguish The Sharper Image brand is critical. Although
we attempt to market products not generally available elsewhere and have
emphasized exclusive products in our merchandising strategy, some of our
products or similar products can also be found in other retail stores or through
other catalogs or through the Internet. We offer competitive pricing where other
retailers market certain products similar to our products at lower prices. In
addition, a number of other companies have attempted to imitate the presentation
and method of operation of our catalog and stores and our Sharper Image Design
products. Our ability to distinguish our products from similar products offered
by our competitors is particularly important in order to maintain pricing and
because of the ease with which customers can comparison shop on-line. A
significant portion of our sales and net income are generated by our air
purification line of products. We believe the success of this product line has
and will continue to encourage other companies to imitate these products.
We compete principally on the basis of product exclusivity, selection,
brand recognition, quality and price of our products, merchandise presentation
in the catalog, stores and on the Internet, our customer list and the quality of
our customer service. We have committed additional resources to our internal
product development group to create and produce Sharper Image Design products,
and to our merchandising team to support a program to increase the Sharper Image
brand products exclusively available from us. We believe that these Sharper
Image Design and Sharper Image brand products provide a competitive advantage
for us in our merchandising offering.
Intellectual Property
We believe our registered service mark and trademark "The Sharper
Image" and the brand name recognition that we have developed are of significant
value. We actively protect our brand name and other intellectual property rights
to ensure that the quality of our brand and the value of our proprietary rights
are maintained. We seek patents to establish and protect our proprietary rights
relating to the technologies and products we are currently developing, that we
may develop, or that our competitors may develop. We have taken and will
continue, in the future, to take all steps necessary to broaden and enhance our
patent protection by obtaining both utility and design patent protection
directed to our proprietary products. For instance, we currently own 46 U.S.
utility patents and more than 90 U.S. design patents.
We have at least six U.S. utility patents and several U.S. design
patents that protect our air purification line of products. The earliest
expiration date of any of these utility patents is 2018. In addition, we own
license rights under a utility patent relating to our air purification line of
products. This patent is due to expire in December 2005. We also have multiple
foreign and domestic pending patent applications directed to our air
purification line of products. Although we believe our existing patents, as well
as our ongoing patent prosecution efforts, will continue to provide protection
for our air purification products, upon the expiration of our licensed patent,
this product line could face additional competition.
We own or have rights to various copyrights, trademarks and trade names
used in our business. These include The Sharper Image(R), Sharper Image
Design(R), Sound Soother(R), Ionic Breeze(R), The Breeze(R), Quadra(R), and
Ionic Hair Wand II(R), Personal Cooling System(TM), Quiet Power(TM) Motorized
Tie Rack, Shower Companion(TM), and Turbo Groomer(TM).
Seasonality
Our business is highly seasonal, with sales peaks in the end-of-year
holiday shopping seasons as well as for Mother's Day, Father's Day and
graduation gift-gift giving. A substantial portion of our total
12
revenues, and all or most of our net earnings, occur in our fourth fiscal
quarter ending January 31. We generally experience lower revenues during the
other quarters and, as is typical in the retail industry, have incurred and may
continue to incur losses in these quarters. In addition, similar to many
retailers, we make merchandising and inventory decisions for the holiday season
well in advance of the holiday selling season. Accordingly, unfavorable economic
conditions or deviations from projected demand for products during the fourth
quarter could have a material adverse effect on our financial position or
results of operations for the entire fiscal year. The fourth quarter accounted
for more than 40% of total revenues in both fiscal 2003 and 2002. In addition,
the fourth quarter accounted for all of our net earnings in fiscal 2002 and
substantially all of our net earnings in 2003.
Employees
As of January 31, 2004, we employed approximately 2,400 associates,
approximately 60% of whom were full time. We also hire a significant number of
seasonal employees during our peak holiday selling season. We consider our
associate relations to be good.
Available information
Our Internet address is www.sharperimage.com. We make available on our
Web site our annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and all amendments to those reports as soon as
reasonably practicable after such material is electronically filed with or
furnished to the SEC. Information on our Web site is not incorporated into this
annual report.
Factors Affecting Future Operating Results
The following factors, in addition to the other information contained
in this report, should be considered carefully in evaluating us 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 us 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, store expansions, possible changes in
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
13
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, 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 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 significant 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 2003 and 2002, the sales of our air purification line of
products constituted a significant portion of our total revenues and net income.
Although not as significant, the sales from our home and portable stereo system
and massage product lines constituted a substantial portion of our total
revenues and net income.
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. We may not be able to accurately
anticipate the magnitude of these effects on future quarterly results.
14
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. Our goal is to increase the percentage of total
revenues attributable to Sharper Image Design and Sharper Image branded
products, although we expect this percentage may decline from time to time, as
it did from 2002 to 2003, and cannot assure you we will otherwise achieve our
goal. 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 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, availability of
raw materials 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. There is increasing political pressure on
China to permit the exchange rate of its currency, the Yuan, to float against
the dollar. Although substantially all of our supply contracts in China are
denominated in dollars, our suppliers could attempt to renegotiate these
contracts if the Yuan/dollar exchange rate were to change.
We had a single supplier for a number of our products, located in Asia
that provided approximately 21% of the net merchandise purchases in fiscal 2003
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, 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.
15
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.
We believe our registered service mark and trademark "The Sharper
Image" and the brand name recognition that we have developed are of significant
value. We actively protect our brand name and other intellectual property rights
to ensure that the quality of our brand and the value of our proprietary rights
are maintained. We seek patents to establish and protect our proprietary rights
relating to the technologies and products we are currently developing, that we
may develop, or that our competitors may develop. We have taken and will
continue, in the future, to take all steps necessary to broaden and enhance our
patent protection by obtaining both utility and design patent protection
directed to our proprietary products. For instance, we currently own 46 U.S.
utility patents and more than 90 U.S. design patents.
We have at least six U.S. utility patents and several U.S. design
patents that protect our air purification line of products. The earliest
expiration date of any of these utility patents is 2018. In addition, we own
license rights under a utility patent relating to our air purification line of
products. This patent is due to expire in December 2005. We also have multiple
foreign and domestic pending patent applications directed to our air
purification line of products. Although we believe our existing patents, as well
as our ongoing patent prosecution efforts, will continue to provide protection
for our air purification products, upon the expiration of our licensed patent,
this product line could face additional competition.
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.
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
16
accounted for more than 40% of total revenues in both fiscal 2003 and 2002. In
addition, the fourth quarter accounted for all of our net earnings in fiscal
2002 and substantially all of our net earnings in fiscal 2003. 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 experienced
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)
----------- ------------------------------
1999 12.3
2000 29.0
2001 (16.0)
2002 13.6
2003 15.3
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 generally become comparable
once they have a full year of comparable sales. 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.
17
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 $26.0
million or 26.7% in fiscal 2003 from the prior fiscal year. While we believe
that increased expenditures on these and other media have resulted in increased
revenues during fiscal 2003, we cannot assure you that this trend will continue
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 depend on the continued availability of
television infomercial time at reasonable prices. Although we do not currently
expect any difficulties in obtaining television infomercial time generally, 2004
is a presidential election year and a substantial increase in political
advertising may limit the availability, or increase the price, of infomercial
time available to us. 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;
o our ability to identify customer demand in different
geographic areas;
18
o the availability and cost of store fixtures;
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
19
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 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.
We have distribution and fulfillment operations located in Little Rock,
Arkansas, Ontario, California and Richmond, Virginia. Any disruption of the
operations in these centers 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. During fiscal 2003, we
entered into a lease for a distribution center in Richmond, Virginia, which we
are planning to have fully operational during fiscal 2004. 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.
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
20
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 recall 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's 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.
A single shareholder exerts considerable influence over our business
affairs and may make business decisions which may not be in your best interest.
As of January 31, 2004, Richard Thalheimer, our Founder, Chairman and
Chief Executive Officer, beneficially owned approximately 21% 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.
21
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 January
31, 2004, the price per share of our common stock has ranged from a high of $
36.16 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.
Item 2. Properties
The Company occupies approximately 58,000 square feet of office space
for its corporate headquarters in San Francisco, CA. The Company signed a lease
extension in February 2000, extending the expiration date to January 2006. The
Company also leases approximately 5,600 square feet for its product development
offices in Northern California.
As of January 31, 2004 the Company operated 149 The Sharper Image
stores under leases covering a total of approximately 595,135 square feet.
The Company owns and operates a 110,000 square foot distribution
facility located in Little Rock, Arkansas. Distribution and warehouse functions
are conducted through this facility, a 137,000 square foot leased facility in
Ontario, California, a 104,000 square foot leased facility in Little Rock,
Arkansas, and a 113,000 square foot leased facility in Richmond, Virginia and
other seasonally occupied space rented by the Company in close proximity
thereto.
22
Item 3. Legal Proceedings
We aggressively pursue claims against companies with products that
infringe our intellectual property.
In addition, from time-to-time, we are involved in various disputes and
legal proceedings that arise in the ordinary course of business. These include
disputes and lawsuits related to intellectual property, product liability and
employee relations matters. We do not believe that the resolution of these
matters will have a material adverse effect on our financial position or results
of operations.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 4A. Executive Officers of the Registrant
Set forth below is a list of the executive officers of the Company,
together with brief biographical descriptions.
Name Position Age
- ---- -------- ---
Richard Thalheimer Founder, Chief Executive Officer 56
and Chairman of the Board
Tracy Wan President and Chief Operating Officer 44
Jeffrey Forgan Executive Vice President, Chief 46
Financial Officer and Corporate Secretary
Anthony Farrell Senior Vice President, Creative Services 54
Craig Trabeaux Senior Vice President, Retail Operations 47
Richard Thalheimer is our founder and has served as our Chief Executive
Officer and a Director since 1978 and as Chairman of the Board of Directors
since 1985. Mr. Thalheimer also served as our President from 1977 through July
1993.
Tracy Wan has been our President and Chief Operating Officer since
April 1999. Ms. Wan served as Executive Vice President and Chief Financial
Officer from August 1998 through April 1999; Senior Vice President and Chief
Financial Officer from February 1995 through August 1998; as Vice President and
Chief Financial Officer from September 1994 through February 1995; as Vice
President and Controller from November 1991 through September 1994; and as
Controller from July 1989 through November 1991.
Jeffrey Forgan has been our Executive Vice President and Chief
Financial Officer since May 2002. Mr. Forgan served as our Senior Vice President
and Chief Financial Officer from April 1999 through May 2002. Prior to that, Mr.
Forgan served as Vice President, Corporate Finance with Foundation Health
Systems from 1995 to 1998, and was with Deloitte & Touche LLP from 1980 to 1995,
serving as an audit partner during 1995. Mr. Forgan is a certified public
accountant.
Anthony Farrell has been our Senior Vice President, Creative Services,
since July 1998. Mr. Farrell was a consultant to The Sharper Image from April
1998 through July 1998. Mr. Farrell was senior vice president, merchandising
with SelfCare Catalog from March 1991 through December 1997.
23
Craig Trabeaux has been our Senior Vice President, Retail Operations
since September 2000. Mr. Trabeaux served as Vice President, Stores from
September 1999 through September 2000; as Regional Manager from February 1998
through September 1999; as Senior District Manager from October 1995 through
January 1998; as District Manager from February 1989 through September 1995; and
as Store Manager July 1987 through January 1989.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The common stock of Sharper Image Corporation is traded in the NASDAQ
National Market under the symbol SHRP. The following table sets forth, for the
period indicated, the range of high and low last sale prices reported for our
common stock.
Fiscal Year 2003 Fiscal Year 2002
High Low High Low
First Quarter $21.10 $14.51 $22.68 $10.70
Second Quarter 30.74 19.50 22.85 14.26
Third Quarter 29.09 23.15 22.09 13.90
Fourth Quarter 36.16 27.78 24.95 14.46
We have not paid cash dividends to holders of its common stock and do
not intend to pay cash dividends for the foreseeable future.
As of April 12, 2004, there were 368 holders of record and the closing
price of our common stock was $33.02 per share as reported by the NASDAQ Stock
Market
24
Item 6. Selected Financial Data
Fiscal Year Ended January 31,
Dollars are in thousands --------------------------------------------------------------------------------------
except for earnings 2004 2003 2002 2001 2000
per share and statistics (Fiscal 2003) (Fiscal 2002) (Fiscal 2001) (Fiscal 2000) (Fiscal 1999)
------------ ------------ ------------ ------------ ------------
Operating Results
Revenue $ 647,511 $ 513,769 $ 389,105 $ 414,550 $ 300,432
Earnings before income taxes 42,803 26,956 1,878 28,739 15,541
Net earnings $ 25,254 $ 15,907 $ 1,127 $ 16,978 $ 9,325
Earnings per common equivalent share--
Basic $ 1.75(1)(2)$ 1.29(2) $ 0.09(2) $ 1.41(2) $ 0.89(2)
Diluted $ 1.65(1)(2)$ 1.21(2) $ 0.09(2) $ 1.34(2) $ 0.85(2)
Balance Sheet Data
Working capital $ 131,334 $ 70,223 $ 53,128 $ 58,978 $ 54,644
Total assets 309,555 214,427 162,522 179,323 142,119
Long-term notes payable -- -- 2,033 2,206 2,366
Stockholders' equity $ 189,926 $ 117,384 $ 94,103 $ 93,091 $ 77,123
Current ratio 2.27 1.80 1.88 1.74 1.93
Statistics
Number of stores at year end 149 127 109 97 89
Comparable store sales 15.3% 13.6% (16.0%) 29.0% 12.3%
increase (decrease)
Annualized net sales per 676 627 578 763 546
square foot
Number of catalogs mailed(3) 85,247,000 77,772,000 70,135,000 62,252,000 47,581,000
Average revenue per
transaction
Stores $ 142 $ 128 $ 118 $ 117 $ 106
Catalog $ 198 $ 199 $ 174 $ 164 $ 145
Internet(4) $ 148 $ 145 $ 127 $ 108 $ 97
Return on average 16.4% 15.0% 1.2% 19.9% 16.4%
stockholders' equity
Book value per share $ 13.15 $ 9.52 $ 7.90 $ 7.73 $ 7.33
Weighted average number of
shares outstanding
Basic 14,446,128 12,327,157 11,904,562 12,036,569 10,516,358
Diluted 15,333,235 13,182,050 12,302,852 12,659,265 11,021,520
(1) The earnings per common equivalent share reflect the effect of the
additional 2.1 million shares issued from the May 2003 stock offering.
(2) The earnings per common equivalent share reflect the additional 3.0 million
shares issued from the July 1999 secondary offering.
(3) Based upon Sharper Image catalog - excludes other specialty and test
mailing catalogs.
(4) Includes results from auction site opened in the quarter ended April 30,
1999.
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Overview
The Sharper Image is a multi-channel specialty retailer of innovative, high
quality products that are useful and entertaining and are designed to make life
easier and more enjoyable. Our unique assortment of products offers design,
creativity and technological innovation, in addition to fun and entertainment.
We market and sell our merchandise primarily through three integrated sales
channels: The Sharper Image stores, The Sharper Image catalog, which includes
revenue from all direct marketing activities and television infomercials, and
the Internet. We also market to other businesses through our corporate sales,
where revenues are recorded in each of our three sales channels and wholesale
operations.
Our total revenues increased 26.0% to $647.5 million in the year ended January
31, 2004 (fiscal 2003) from $513.8 million in the year ended January 31, 2003
(fiscal 2002). This increase was due primarily to the popularity of our Sharper
Image Design and Sharper Image branded products, including our air
25
purification line of products, the opening of 22 net new stores, a comparable
store sales increase of 15.3%, and an increase in our multimedia advertising
which we believe increased sales in all selling channels.
Our store operations generated the highest proportion of our sales, representing
58.6% and 57.2% of total revenues for fiscal 2003 and 2002, respectively. As of
January 31, 2004, we operated 149 The Sharper Image stores in 37 states and the
District of Columbia. As part of our growth strategy, we have opened 25, 20 and
14 The Sharper Image stores, and closed three, two and two stores at lease
maturity, in fiscal 2003, 2002 and 2001, respectively. Our catalog and direct
marketing operations, including revenue generated directly from catalogs, print
advertising, single product mailers and television infomercials, generated 19.9%
and 23.0% of our total revenues for fiscal 2003 and 2002, respectively. Our
Internet operations generated 14.7% and 13.5% of total revenues in fiscal 2003
and 2002, respectively.
One of our goals is to increase the percentage of total revenues attributable to
Sharper Image Design and Sharper Image branded products, which typically
generate higher margins than our third party branded products. The percentage of
our total revenues attributable to Sharper Image Design and Sharper Image
branded products was approximately 73% in fiscal 2003 from approximately 76% in
fiscal 2002. The popularity of third party branded products such as digital
cameras and massage chairs during fiscal 2003 contributed to the lower
percentage of sales coming from Sharper Image Design and Sharper Image branded
products.
Our business is highly seasonal, with sales peaks in the end-of-year holiday
shopping seaons as well as for Mother's Day, Father's Day and graduation
gift-gift giving. A substantial portion of our total revenues, and all or most
of our net earnings, occur in our fourth fiscal quarter ending January 31. We
generally experience lower revenues during the other quarters and, as is typical
in the retail industry, have incurred and may continue to incur losses in these
quarters. In addition, similar to many retailers, we make merchandising and
inventory decisions for the holiday season well in advance of the holiday
selling season. Accordingly, unfavorable economic conditions or deviations from
projected demand for products during the fourth quarter could have a material
adverse effect on our financial position or results of operations for the entire
fiscal year. The fourth quarter accounted for more than 40% of total revenues in
both fiscal 2003 and 2002. In addition, the fourth quarter accounted for all of
our net earnings in fiscal 2002 and substantially all of our net earnings in
2003.
Our financial statements for fiscal 2003 reflect certain reclassifications made
to prior year financial statements in order to conform to the January 31, 2004
financial statements.
Critical accounting policies and estimates
Our discussion and analysis of our financial condition and results of operations
are based upon our financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses and the related disclosures. Estimates and assumptions include, but are
not limited to, the carrying value of inventory, fixed asset lives, deferred
cost recovery period, income taxes and contingencies and litigation. We base our
estimates on analyses of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.
We believe that the following represents our more critical estimates and
assumptions used in the preparation of our financial statements.
26
Revenue recognition. We recognize revenue at the point of sale at our retail
stores and at the time of customer receipt for our catalog and direct marketing
sales, including the Internet. We recognize revenue for sales to resellers of
sales made on a wholesale basis when the products are shipped, which is the time
title passes to the purchaser. We record estimated reductions to revenue for
customer returns based on our historical return rates. Revenues are recorded net
of sale discounts and other rebates and incentives offered to customers.
Deferred revenue represents merchandise certificates, gift cards and rewards
cards outstanding and unfilled cash orders at the end of the fiscal period.
Delivery revenue is recognized at the time of customer receipt.
Merchandise inventories. We write down inventory for estimated obsolescence on
unmarketable inventory equal to the difference between the cost of inventory and
the estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those projected
by management, additional inventory writedowns may be required.
Accounts receivable. Counterparties to our accounts receivable include credit
card issuers, corporate marketing incentive customers, wholesale customers,
installment plan customers for purchases of a limited number of products,
merchandise vendors, and landlords from whom we expect to receive amounts due.
We record an allowance for credit losses based on estimates of customers'
ability to pay. If the financial condition of our customers were to deteriorate,
additional allowances may be required.
Store closure reserves. We record reserves for closed stores based on future
lease commitments, anticipated future subleases of properties and current
risk-free interest rates. If interest rates or the real estate leasing markets
change, additional reserves may be required.
Other accounting estimates inherent in the preparation of our financial
statements include estimates associated with our evaluation of the
recoverability of deferred tax assets as well as those used in the determination
of liabilities related to litigation, product liability, and taxation. Various
assumptions and other factors underlie the determination of these significant
estimates. The process of determining significant estimates is fact specific and
takes into account factors such as historical experience, current and expected
economic conditions and product mix. We constantly re-evaluate these significant
factors and make adjustments where facts and circumstances dictate.
Historically, actual results have not significantly deviated from those
determined using the estimates described above.
As discussed in the Notes to the Financial Statements, we are involved in
litigation incidental to our business, the disposition of which is expected to
have no material effect on our financial position or results of operations. It
is possible, however, that future results of operations for any particular
quarterly or annual period could be materially affected by changes in our
assumptions related to these proceedings. We accrue our best estimates of the
probable cost for the resolution of legal claims. Such estimates are developed
in consultation with outside counsel handling these matters and are based upon a
combination of litigation and settlement strategies. To the extent additional
information arises or our strategies change, it is possible that our best
estimates of our probable liability in these matters may change.
27
Results of Operations
Percentage of Total Revenues
Fiscal Year Ended January 31,
2004 2003 2002
(Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
------------- -------------- -------------
Revenues:
Net store sales 58.6% 57.2% 59.3%
Net catalog sales 19.9 23.0 21.9
Net Internet sales 14.7 13.5 12.7
Net wholesale sales 4.2 3.4 2.8
Delivery 2.6 2.7 3.1
List rental and licensing 0.0 0.2 0.2
----------------------------------------------------
Total Revenues 100.0 100.0 100.0
Costs and Expenses:
Cost of products 42.8 42.9 46.9
Buying and occupancy 9.0 9.4 10.2
Advertising 19.0 19.0 17.6
General, selling and administrative 22.6 23.5 24.8
----------------------------------------------------
Operating income 6.6 5.2 0.5
Other income 0.0 0.0 0.0
----------------------------------------------------
Earnings before income tax expense 6.6 5.2 0.5
Income tax expense 2.7 2.1 0.2
----------------------------------------------------
Net Earnings 3.9% 3.1% 0.3%
====================================================
Fiscal Year Ended January 31,
----------------------------------------------------------------
2004 2003 2002
(Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
------------------ ------------------- ---------------------
Revenues:
Dollars in thousands
Net store sales $379,349 $293,795 $230,799
Net catalog and direct marketing
sales 128,652 118,192 85,087
Net Internet sales 95,086 69,208 49,349
Net wholesale sales 26,997 17,507 10,893
----------------------------------------------------------------
Total net sales 630,084 498,702 376,128
List rental and licensing 377 977 985
Delivery 17,050 14,090 11,992
----------------------------------------------------------------
Total revenues $647,511 $513,769 $389,105
================================================================
28
Year ended January 31, 2004 (fiscal 2003), compared to year ended January 31,
2003 (fiscal 2002)
Revenues. Net sales for fiscal 2003 increased $131.4 million or 26.3%, from the
prior fiscal year. Returns and allowances for fiscal 2003 were 10.7% of sales,
as compared to 12.0% for fiscal 2002. The increase in net sales was attributable
primarily to increases in net sales from stores of $85.6 million; from catalog
and direct marketing of $10.5 million; from Internet operations of $25.9
million; and from wholesale of $9.5 million.
The increase in total revenue for fiscal 2003, as compared to fiscal 2002 was
due primarily to the popularity of our Sharper Image Design and Sharper Image
branded products, which continues to be a key factor in the increases in net
sales in all selling channels. Sales of Sharper Image Design and Sharper Image
branded products decreased to approximately 73% of total revenues in fiscal 2003
from approximately 76% for fiscal 2002. The popularity of third party branded
products such as digital cameras and massage chairs during fiscal 2003
contributed to the lower percentage of sales coming from Sharper Image Design
and Sharper Image branded products. We believe that the continued development
and introduction of new and popular products is a key strategic objective and
important to our future success. Contributing to the increase in net sales was a
comparable store sales increase of 15.3% over fiscal 2002 and the opening of 22
net new stores during fiscal 2003. We also believe that the increased investment
in our advertising initiatives in fiscal 2003 and 2002, which include the
significant increase in television infomercial advertising and single product
mailers, highlighting primarily selected Sharper Image Design and Sharper Image
branded products and the 9.6% increase in catalogs circulated contributed to
the higher revenues in all selling channels.
Net store sales for fiscal 2003 increased $85.6 million, or 29.1%, while
comparable store sales increased by 15.3% from fiscal 2002. The increase in net
store sales was attributable primarily to the opening of 25 new stores during
fiscal 2003, the increased sales of Sharper Image Design and Sharper Image
branded products, the 15.3% increase in comparable store sales, and the
increased television infomercial and single product mailer advertising,
partially offset by the closing of three stores at their lease maturity. The
opening of 25 new stores, offset by the three store closures in fiscal 2003,
resulted in an incremental increase to net store sales of $26.3 million from the
prior fiscal year.
The increase in comparable store sales primarily resulted from a 17.9% increase
in total store transactions for fiscal 2003 and an 11.1% increase in the average
revenue per transaction, compared with fiscal 2002. The increase in average
revenue per transaction was attributable primarily to the overall product mix
offered, and multimedia advertising strategies, including infomercial
advertising. Also contributing to the increase in average revenue per
transaction are the increased sales of Sharper Image Design and Sharper Image
branded products, particularly our air purification products. Average net sales
per square foot for fiscal 2003 for all stores increased to $676 from $627 in
fiscal 2002. Average net sales per square foot for our comparable store base for
fiscal 2003 was $710. Average net sales per square foot is calculated by
averaging over all stores the amount of each store's net sales divided by that
store's total square footage under lease. Average revenue per transaction is
calculated by dividing the amount of gross sales, exclusive of delivery revenue
and sales taxes, per channel by the gross number of transactions in that
channel.
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. A store opened on or
prior to the 15th of a month is treated as open for the entire month. Stores
generally become comparable once they have 24 months of comparable sales for our
annual calculation. We believe that
29
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.
Net catalog and direct marketing sales, which includes direct sales generated
from catalog mailings, single product mailers, print advertising and television
infomercials, for fiscal 2003 increased $10.5 million or 8.8%, from fiscal 2002.
This increase was due primarily to a 24.7% increase in television infomercial
advertising expense, a 26.1% increase in single product mailers circulated, and
a 23.1% increase in The Sharper Image catalog pages circulated, which includes a
9.6% increase in The Sharper Image catalogs circulated. The increase in net
catalog and direct marketing sales for fiscal 2003 reflects a 10.4% increase in
transactions and a decrease of 0.2% in average revenue per transaction, compared
to fiscal 2002.
For fiscal 2003 and 2002, 29.4% and 29.9% of the net catalog and direct
marketing sales were generated from television infomercial direct sales. We
intend to continue our aggressive multimedia advertising programs during fiscal
2004 to attract new customers, while achieving a favorable return on advertising
investment. Our goal is to achieve direct response sales resulting in near
breakeven results on all direct marketing advertising initiatives. We
continually review our advertising initiatives, including the pages and number
of catalogs and single product mailers circulated, and the amount of and return
on investment from television infomercial advertising, in our efforts to improve
revenues from catalog and direct marketing advertising.
Net Internet sales from our sharperimage.com Web site, which includes The
Sharper Image and eBay auction sites, in fiscal 2003 increased $25.9 million, or
37.4%, from fiscal 2002. This increase was attributable primarily to a 120.3%
increase in Internet advertising which includes paid for search engine key word
placement and revenue share costs incurred for affiliate programs, a 34.4%
increase in Internet transactions and a 1.9% increase in average revenue per
transaction.
During fiscal 2003, our Web site enhancements included the launch of our online
gift registry, customer service site contents and navigation bar enhancements to
highlight our online outlet store. We have also continued to improve the speed
and efficiency of the processing and hardware capabilities.
Net wholesale sales for fiscal year 2003 increased $9.5 million, or 54.2%,
compared to fiscal 2002. The increase is attributable primarily due to
increasing Sharper Image Design product sales to our existing wholesale customer
base and to test programs with new wholesale customers. We believe that the
wholesale business, pursued with select partners, will continue to strengthen
our brand name and broaden our customer base.
Cost of Products. Cost of products for fiscal 2003 increased $56.5 million, or
25.6%, from fiscal 2002. This increase is due primarily to the higher sales
volume, partially offset by the lower relative cost of products for our Sharper
Image Design and Sharper Image branded products. The gross margin rate for
fiscal 2003 was 57.2%, or 0.1 percentage points higher, than the fiscal 2002
rate of 57.1%. The gross margin rate was adversely affected by delivery expense
of $20.6 million in excess of delivery income collected of $17.1 million due
primarily to the increase in single product mailers which offered free shipping
when an order is placed and free shipping given on infomercial orders when a
customer elects a single payment plan.
Our gross margin rate fluctuates with changes in our merchandise mix, primarily
Sharper Image Design and Sharper Image branded 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 product lines. Additionally, the auction sites
and other selected promotional activities, such as free
30
shipping offers, 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 cannot accurately predict future gross margin rates, although our
goal is to continue to increase sales of Sharper Image Design and Sharper Image
branded products to capitalize on the higher margins realized on these products.
Buying and Occupancy. Buying and occupancy costs for fiscal 2003 increased $9.7
million, or 20.2%, from fiscal 2002. This increase reflects a full year of
occupancy costs for the 20 new stores opened in fiscal 2002, the occupancy costs
associated with the 25 new stores opened in fiscal 2003 and rent increases for
some existing store locations, partially offset by five stores closed at lease
maturity during fiscal 2003 and 2002. Buying and occupancy costs as a percentage
of total revenues decreased to 9.0% in fiscal 2003 from 9.4% for fiscal 2002. In
fiscal 2003, we opened a total of 25 new stores, exceeding our goal of a 15%-20%
increase in the number of stores opened on an annual basis. Our goal is to
continue to increase new store openings by 15%-20% in fiscal 2004 but we cannot
assure you we will achieve this goal.
Advertising. Advertising expenses for fiscal 2003 increased $26.0 million, or
26.7%, from fiscal 2002. The increase in advertising expense was attributable
primarily to a 24.7% increase in television infomercial advertising expense and
a 120.3% increase in Internet advertising, which includes search engine key word
placement and revenue share costs incurred for affiliate programs. Also
contributing to the increase in advertising is a 26.1% increase in the number of
single product mailers circulated and a 23.1% increase in the number of Sharper
Image catalog pages circulated, which includes a 9.6% increase in the number of
Sharper Image catalogs circulated. During fiscal 2003, we continued our other
multimedia advertising initiatives, which included radio, television and print
advertising, among others. Although we believe these initiatives 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 fiscal 2003, we increased the circulation of our single product mailer,
which highlights our most popular Sharper Image Design products. We believe that
the single product mailer will continue to extend our brand name by prospecting
to future Sharper Image customers, at a reduced cost in comparison to mailing a
Sharper Image catalog. We also increased our television media spending on
infomercials highlighting selected Sharper Image Design and Sharper Image
branded products and expanded our multimedia advertising initiatives of various
print ads and radio.
Advertising expenses as a percentage of total revenues remained constant at
19.0% for fiscal 2003 and fiscal 2002. Although there is a declining marginal
benefit obtained by increasing advertising expenditures, we monitor the
effectiveness of our advertising in order to achieve a reasonable overall return
on our investment in advertising.
We believe that expansion of all our advertising initiatives contributed to the
sales increases for fiscal 2003 and increased brand awareness. Our advertising
strategy will continue to be an important factor in our future revenue growth
and as a result, we expect advertising costs to be higher in fiscal 2004 than in
fiscal 2003.
General, Selling and Administrative. General, selling and administrative, or
GS&A, expenses for fiscal 2003 increased $25.9 million, or 21.5%, from fiscal
2002. Contributing to this increase was an increase of $12.5 million due
primarily to variable expenses from increased net sales, which includes $9.5
million due to variable expenses from increased sales from all sales channels
and $3.0 million due to variable expenses from increased sales and selling
expenses related to the 25 new stores opened in fiscal 2003. Also contributing
to the increase were increases of $1.6 million for health care and insurance,
$3.0 million for
31
distribution center shipping costs incurred for product delivery to our stores,
and $1.1 million related to professional fees.
GS&A expenses for fiscal 2003 decreased as a percentage of total revenues to
22.6% from 23.5% in fiscal 2002 due to better leverage of fixed costs on an
expanding sales base. GS&A costs were controlled as a result of our continual
review of GS&A expenses and infrastructure.
Other income (expense)- The increase in other income is primarily due to the
interest income earned on higher investment balances generated from the proceeds
from our public stock offering and improved operating results, offset by the
write-off of fixed assets for store locations remodeled prior to the expiration
of their existing lease.
Income taxes. The effective tax rate was 41% for fiscal 2003 and 2002. Income
taxes are accounted for using an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in our financial statements or
tax returns. In estimating future tax consequences, all expected future events
then known to us are considered, other than changes in the tax law or rates.
Year ended January 31, 2003 (fiscal 2002), compared to year ended January 31,
2002 (fiscal 2001)
Revenues. Net sales for fiscal 2002 increased $122.6 million or 32.6%, from the
prior fiscal year. Returns and allowances for fiscal 2002 were 12.0% of sales,
as compared to 12.1% for fiscal 2001. The increase in net sales was attributable
primarily to increases in net sales from stores of $63.0 million; from catalog
and direct marketing of $33.1 million; from Internet operations of $19.9
million; and from wholesale of $6.6 million.
The increase in total revenue for fiscal 2002, as compared to fiscal 2001 was
due primarily to the popularity of our Sharper Image Design and Sharper Image
branded products, which continues to be a key factor in the increases in net
sales in all selling channels. Sharper Image Design and Sharper Image branded
products increased to approximately 76% of total revenues in fiscal 2002 from
approximately 70% for fiscal 2001. We believe that the continued development and
introduction of new and popular products is a key strategic objective and
important to our future success. Contributing to the increase in net sales was a
comparable store sales increase of 13.6% over fiscal 2001 and the opening of 18
net new stores during fiscal 2002. We also believe that the increased investment
in our advertising initiatives in fiscal 2002 and 2001, including the
significant increase in television infomercial advertising and single product
mailers, highlighting primarily selected Sharper Image Design and Sharper Image
branded products, contributed to the higher revenues in all selling channels. We
believe that fiscal 2001 revenues were adversely affected by the onset of the
economic recession, the events of September 11, 2001 and subsequent anthrax
scare, and a faster-than-expected end to the Razor Scooter fad which drove
exceptional sales volumes in fiscal 2000.
Net store sales for fiscal 2002 increased $63.0 million, or 27.3%, while
comparable store sales increased by 13.6% from fiscal 2001. The increase in net
store sales was attributable primarily to the opening of 20 new new stores
during fiscal 2002, the increased sales of Sharper Image Design and Sharper
Image branded products, the 13.6% increase in comparable store sales, and the
increased television infomercial and single product mailer advertising,
partially offset by the closing of two stores at lease maturity. The opening of
18 net new stores resulted in an incremental increase to net store sales of
$22.9 million from the prior fiscal year.
Total store transactions for fiscal 2002 increased 16.0% and average revenue per
transaction increased 8.5%, compared with fiscal 2001. The increase in average
revenue per transaction was attributable
32
primarily to the overall product mix offered, multimedia advertising strategies,
including infomercial advertising which highlighted products with retail prices
which are higher than our average in the prior year, and the increased sales of
Sharper Image Design and Sharper Image branded products, particularly our air
purification products. Average net sales per square foot for fiscal 2002
increased to $627 from $578 in fiscal 2001. Average net sales per square foot is
calculated by averaging over all stores the amount of each store's net sales
divided by that store's square footage under lease. Average revenue per
transaction is calculated by dividing the amount of gross sales, exclusive of
delivery revenue and sales taxes, per channel by the gross number of
transactions in that channel.
Net catalog and direct marketing sales, which includes sales generated from
catalog mailings, single product mailers, print advertising and television
infomercials, for fiscal 2002 increased $33.1 million or 38.9%, from fiscal
2001. This increase was due primarily to a 44.4% increase in television
infomercial advertising expense, a 264.6% increase in single product mailers
circulated, and a 20.8% increase in The Sharper Image catalog pages circulated,
which includes a 10.9% increase in The Sharper Image catalogs circulated. The
increase in net catalog and direct marketing sales for fiscal 2002 reflects a
21.8% increase in transactions and an increase of 14.5% in average revenue per
transaction, compared to fiscal 2001.
Net Internet sales from our sharperimage.com Web site, which includes The
Sharper Image auction site, in fiscal 2002 increased $19.9 million, or 40.2%,
from fiscal 2001. This increase was attributable primarily to a 47.0% increase
in Internet advertising, a 24.4% increase in Internet transactions and a 14.2%
increase in average revenue per transaction. Excluding auction sales for these
periods, net Internet sales increased 53.4%, transactions increased 34.4% and
average revenue per transaction increased 15.8%. We believe the decrease in
auction sales for fiscal 2002 compared to fiscal 2001 was attributable primarily
to our decision to raise bid prices during late fiscal 2001 and to reduce the
number of products offered on our auction site, which resulted in an improved
gross margin rate and gross margin dollars from auctions. We continue to utilize
the auction site to increase our Internet business, broaden our customer base
and manage inventories, including closeouts, repackaged and reconditioned items.
Net wholesale sales for fiscal year 2002 increased $6.6 million, or 60.7%,
compared to fiscal 2001. The increase is attributable primarily to a strategic
wholesale marketing arrangement we tested with Circuit City Stores. The
arrangement with Circuit City Stores initially allowed for the showcase and
testing of a select assortment of Sharper Image Design and Sharper Image branded
products on large dedicated fixtures in over 600 Circuit City Superstores. We
will continue to evaluate this wholesale marketing arrangement in fiscal 2003.
Cost of Products. Cost of products for fiscal 2002 increased $38.1 million, or
20.9%, from fiscal 2001. This increase is due primarily to the higher sales
volume, partially offset by the lower relative cost of products for our Sharper
Image Design and Sharper Image branded products. The gross margin rate for
fiscal 2002 was 57.1%, or 4.0 percentage points higher, than the fiscal 2001
rate of 53.1%. This increase was due primarily to increased sales of Sharper
Image Design and Sharper Image branded products, which generally carry higher
margins than third party branded products. Sharper Image Design and Sharper
Image branded products as a percentage of total revenues, exclusive of net
wholesale sales, increased to approximately 76% for fiscal 2002, as compared to
approximately 70% for fiscal 2001.
We believe that our gross margin for fiscal 2002 was negatively affected by the
labor dispute between the Pacific Maritime Association, or PMA, and the
International Longshore and Warehouse Union, or ILWU, whose members are
primarily responsible for the removal of cargo from container loaded shipping
vessels in West Coast U.S. ports. In response to the 10-day lockout by the PMA
in October 2002 and drop in productivity during the subsequent months, we
increased usage of airfreight transportation, which
33
adversely affected our gross margins for the third and to a greater extent the
fourth quarters of fiscal 2002.
Buying and Occupancy. Buying and occupancy costs for fiscal 2002 increased $8.3
million, or 20.8%, from fiscal 2001. This increase reflects a full year of
occupancy costs for the 14 new stores opened in fiscal 2001, the occupancy costs
associated with the 20 new stores and one temporary store opened in fiscal 2002
and rent increases for some existing store locations, partially offset by two
stores closed at lease maturity during fiscal 2002. Buying and occupancy costs
as a percentage of total revenues decreased to 9.4% in fiscal 2002 from 10.2%
for fiscal 2001. In fiscal 2002, we opened a total of 20 new stores, exceeding
our goal of a 10%-15% increase in the number of stores opened on an annual
basis.
Advertising. Advertising expenses for fiscal 2002 increased $28.9 million, or
42.2%, from fiscal 2001. The increase in advertising expense was attributable
primarily to a 44.4% increase in television infomercial advertising expense, a
264.6% increase in the number of single product mailers circulated, and a 20.8%
increase in the number of Sharper Image catalog pages circulated, which included
a 10.9% increase in the number of The Sharper Image catalogs circulated. During
fiscal 2002, we continued our other multimedia advertising initiatives, which
included radio, television and print advertising, among others. The higher cost
of postage on various direct marketing mailers, including the catalog and single
product mailers, contributed to advertising cost increases although these
increases were partially offset by the savings from lower paper costs during
fiscal 2002. Advertising expenses as a percentage of total revenues increased to
19.0% in fiscal 2002 from 17.6% in fiscal 2001.
General, Selling and Administrative. General, selling and administrative, or
GS&A, expenses for fiscal 2002 increased $24.1 million, or 25.0%, from fiscal
2001. Contributing to this increase was an increase of $5.4 million due
primarily to variable expenses from increased net sales and selling expenses
related to the 20 new stores opened during fiscal 2002, and the annualized
selling expenses related to the 14 stores opened in fiscal 2001, partially
offset by the reduced selling expenses of two stores closed at lease maturity
during fiscal 2002. Also contributing to the increase were increases of $3.3
million for distribution shipping costs incurred for product delivery to our
stores (which primarily reflects additional airfreight costs incurred in
connection with the West Coast Port Strike), $2.5 million related to
technological system enhancements made in our operational areas and $1.1 million
due to increases in health benefits and company-wide insurance premiums.
GS&A expenses for fiscal 2002 decreased as a percentage of total revenues to
23.5% from 24.8% in fiscal 2001. 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)- The decrease in other income is due to a reduction in
the interest rate earned on invested balances, an increase in interest expense
incurred on the early payoff of our mortgage loan, partially offset by a
reduction in losses on the disposal of assets.
Liquidity and capital resources
We met our short-term liquidity needs and our capital requirements during fiscal
2003 with cash generated from operations, trade credits, existing cash balances
and proceeds from a public offering of our common stock.
Net cash provided by operating activities totaled $21.1 million for fiscal 2003,
as compared to $37.0 million for fiscal 2002. The fiscal 2003 net cash provided
by operating activities decreased $15.9 million compared to fiscal 2002, is due
primarily to the increased merchandise inventory levels required as a result of
the 25 new stores opened during fiscal 2003, the timing of the receipt of
imported products due to Chinese New
34
Years when many factories overseas close for up to three weeks, and the
inventory we believe necessary to sustain our current sales growth trends. The
comparable decrease was also due to the increase in accounts receivable balances
and decreases in accounts payable. Partially offsetting the comparable decrease
in net cash provided by operating activities was the increase in net earnings
from fiscal 2003 over 2002.
Net cash used in investing activities, primarily capital expenditures for new
and remodeled stores, technological enhancements, tooling costs for Sharper
Image Design products and the expansion of our distribution facilities totaled
$35.2 million in fiscal 2003 compared to $23.2 million in fiscal 2002. In fiscal
2003, we opened 25 new stores and remodeled six stores. In fiscal 2002, we
opened 20 new stores and remodeled six stores.
Net cash provided by financing activities totaled $41.9 million during fiscal
2003, which was the result of $38.5 million in net proceeds from the public
offering of our common stock in May 2003, and, $4.2 million in proceeds from the
issuance of common stock in connection with our stock option plan, offset
partially by $0.8 million in financing fees.
On October 31, 2003, we terminated our 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
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. As of January 31, 2004, letter of credit commitments outstanding
under the new credit facility were $4.2 million, which includes a $2.9 million
backstop letter of credit to cover credit commitments outstanding under our old
secured credit facility.
The table below presents our significant commercial credit facilities and their
associated expiration dates.
($ in millions)
Maximum Amount of Commitment expiration Per Period
- ------------------------------------------------------------------------------
Maximum Commercial Commitments Less than 1 Year 1-3 Years Total Amount
Committed
- -------------------------------------------------- ---------- ------------
Revolving Credit Facility $0.0 $50.0 $50.0
------------------ ---------- ------------
Total Commercial Commitment $0.0 $50.0 $50.0
================== ========== ============
*This represents the maximum commitment under the revolving credit facility. It
includes limits of $35 million for letters of credit.
35
As of January 31, 2003, we paid off the mortgage loan collateralized by our
Little Rock, Arkansas distribution center. This note reflected a fixed interest
rate of 8.40%, provided for monthly payments of principal and interest in the
amount of $29,367 and was scheduled to mature in January 2011.
The table below presents our significant contractual obligations at January 31,
2004.
$ in millions Less 1-3 4-5 After 5 Total
Contractual Obligations than 1 Years Years Years
Year
- ------------------------------------ ---------- ----------- ----------- ----------- ------------
Revolving Credit Facility $4.2 - - - $4.2
Letters of Credit
Operating Leases (1) 30.4 $52.9 $44.2 $75.4 202.9
Purchase Obligations (2) 59.0 - - - 59.0
---------- ----------- ----------- ----------- ------------
Total Contractual Cash Obligations $93.6 $52.9 $44.2 $75.4 $266.1
========== =========== =========== =========== ============
(1) The Company's operating leases are described in Note F of the Notes to
the Financial Statements.
(2) As of January 31, 2004, the Company had $59 million of outstanding
purchase orders, which were primarily related to orders for general
merchandise inventories. Such purchase orders are generally cancelable
at the discretion of the Company until the order has been shipped. The
table above excludes certain immaterial executory contract for goods
and serves that tend to be recurring in nature and similar in amount
year after year.
For fiscal 2004, we plan to continue our accelerated new store unit growth goal
with a 15% to 20% increase target in the number of stores on an annual basis and
to remodel five to 10 of our existing store locations. We plan to continue our
capital investment in tooling costs for proprietary products and to further
expand our infrastructure through exercising our lease options to increase our
distribution center capabilities and continue our enhancement of our
technological systems. We believe that our total capital expenditures for fiscal
2004 will be approximately $35 million to $40 million.
Absent unfavorable economic conditions or deviations from projected demand for
our products, particularly during the fourth quarter, we expect to achieve
positive cash flow from operations on an annual basis, although we likely will
need to finance holiday and new-store increases in inventories through trade
credits and our credit facility. We believe we will be able to fund our capital
expenditures for new and remodeled stores, technological enhancements and
tooling costs for Sharper Image Design products through existing cash balances,
cash generated from operations, trade credits, and, as necessary, our credit
facility.
New accounting pronouncements
In December 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 46(R) "Consolidation of Variable Interest Entities."
FIN 46(R) replaces FIN 46 and addresses consolidation by business enterprises of
variable interest entities. The provisions of FIN 46(R) are effective for the
first reporting period that ends after December 15, 2003 for variable interests
in those entities commonly referred to as special-purpose entities. Application
of the provisions of FIN 46(R) for all other entities is effective for the first
reporting period ending after March 15, 2004. The Company has no interest in any
entity considered a special purpose entity. The Company believes the adoption of
the provisions of FIN 46(R) in the first quarter of 2004 will have no impact on
net earnings, cash flows or financial position.
36
Uncertainties and risks
This discussion and analysis should be read in conjunction with our financial
statements and notes thereto. This discussion contains forward-looking
statements that are subject to risks and uncertainties that could cause actual
results to differ materially from those set forth in these forward-looking
statements. These risks and uncertainties include, without limitation, risks of
changing market conditions in the overall economy and the retail industry,
consumer demand, the opening of new stores, actual advertising expenditures by
us, the success of our advertising and merchandising strategy, availability of
products, and other factors detailed from time to time in our annual and other
reports filed with the Securities and Exchange Commission. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date of this report. We undertake no obligations to publicly
release any revisions to these forward-looking statements or reflect events or
circumstances after the date of this report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Quantitative and qualitative disclosure about market risk
We are exposed to market risks, which include changes in interest rates and, to
a lesser extent, foreign exchange rates. We do not engage in financial
transactions for trading or speculative purposes.
The interest payable on our credit facility is based on variable interest rates
and therefore affected by changes in market interest rates. If interest rates on
existing variable rate debt increased .4% (10% from the bank's reference rate)
as of January 31, 2004 our results from operations and cash flows would not have
been materially affected. In addition, we have fixed and variable income
investments consisting of cash equivalents and short-term investments, which are
also affected by changes in market interest rates. We do not use derivative
financial instruments in our investment portfolio.
We enter into a significant amount of purchase obligations outside of the United
States, which are settled in U.S. dollars and, therefore, have only minimal
exposure to foreign currency exchange risks. We do not hedge against foreign
currency risks and believe that foreign currency exchange risk is immaterial.
37
Item 8. Financial Statements and Supplementary Data
Board of Directors and Stockholders
Sharper Image Corporation
San Francisco, California
We have audited the accompanying balance sheets of Sharper Image Corporation as
of January 31, 2004 and 2003, and the related statements of operations,
stockholders' equity and cash flows for each of the three fiscal years in the
period ended January 31, 2004. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Sharper Image Corporation as of January 31,
2004 and 2003, and the results of its operations and its cash flows for each of
the three fiscal years in the period ended January 31, 2004 in conformity with
accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
San Francisco, California
April 12, 2004
38
Sharper Image Corporation
Balance Sheets
January 31, January 31,
(Dollars in thousands, except per share amounts) 2004 2003
-------- --------
Assets
Current assets:
Cash and equivalents $ 83,471 $ 55,633
Accounts receivable, net of allowance for doubtful accounts
of $1,266 and $967 21,196 12,597
Merchandise inventories 110,058 74,756
Prepaid expenses, deferred taxes and other 20,303 15,527
-------- --------
Total current assets 235,028 158,513
Property and equipment, net 70,190 52,165
Deferred catalog costs and other assets 4,337 3,749
-------- --------
Total assets $309,555 $214,427
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 23,434 $ 26,597
Accrued expenses 16,126 14,996
Accrued compensation 11,793 8,614
Reserve for refunds 17,161 12,498
Deferred revenue 25,781 19,113
Income taxes payable 9,399 6,472
-------- --------
Total current liabilities 103,694 88,290
Deferred taxes and other liabilities 15,935 8,753
Commitments and contingencies -- --
-------- --------
Total liabilities 119,629 97,043
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, 15,322,635, and
12,638,952 shares 153 126
Additional paid-in capital 97,211 49,950
Retained earnings 92,562 67,308
-------- --------
Total stockholders' equity 189,926 117,384
-------- --------
Total liabilities and stockholders' equity $309,555 $214,427
======== ========
See notes to financial statements.
39
Sharper Image Corporation
Statements of Operations
Fiscal Year Ended January 31,
-----------------------------
2004 2003 2002
(Dollars in thousands, except per share amounts) (Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
------------ ------------ ------------
Revenues:
Net sales $ 630,084 $ 498,702 $ 376,128
Delivery 17,050 14,090 11,992
List rental and licensing 377 977 985
------------ ------------ ------------
647,511 513,769 389,105
------------ ------------ ------------
Costs and expenses:
Cost of products 277,043 220,519 182,436
Buying and occupancy 57,918 48,185 39,901
Advertising 123,339 97,360 68,479
General, selling, and administrative 146,465 120,556 96,464
------------ ------------ ------------
604,765 486,620 387,280
------------ ------------ ------------
Other income (expense):
Interest income 785 367 702
Interest expense (291) (465) (355)
Other income -- 1 99
Other expense (437) (96) (393)
------------ ------------ ------------
57 (193) 53
------------ ------------ ------------
Earnings before income tax expense 42,803 26,956 1,878
Income tax expense 17,549 11,049 751
------------ ------------ ------------
Net earnings $ 25,254 $ 15,907 $ 1,127
============ ============ ============
Earnings per common equivalent share:
Basic $ 1.75 $ 1.29 $ 0.09
============ ============ ============
Diluted $ 1.65 $ 1.21 $ 0.09
============ ============ ============
Weighted average shares used in the computation
of earnings per common equivalent share:
Basic 14,446,128 12,327,157 11,904,562
Diluted 15,333,235 13,182,050 12,302,852
See notes to financial statements.
40
Sharper Image Corporation
Statements of Stockholders' Equity
Additional
Common Stock Paid-in Retained
(Dollars in thousands) Shares Amount Capital Earnings Total
----------- ----------- ----------- ----------- -----------
Balance at February 1, 2001 11,961,911 $ 120 $ 42,697 $ 50,274 $ 93,091
Issuance of common stock for stock options
exercised (including income tax benefit) 108,773 1 872 873
Repurchase of common stock (100,000) (1) (987) (988)
Net earnings 1,127 1,127
----------- ----------- ----------- ----------- -----------
Balance at January 31, 2002 11,970,684 120 42,582 51,401 94,103
Issuance of common stock for stock options
exercised (including income tax benefit) 668,268 6 7,368 7,374
Net earnings 15,907 15,907
----------- ----------- ----------- ----------- -----------
Balance at January 31, 2003 12,638,952 126 49,950 67,308 117,384
Issuance of common stock for stock options
exercised (including income tax benefit) 546,259 6 8,767 8,773
Issuance of common stock due to stock follow-on
offering (net of expenses) 2,137,424 21 38,494 38,515
Net earnings 25,254 25,254
----------- ----------- ----------- ----------- -----------
Balance at January 31, 2004 15,322,635 $ 153 $ 97,211 $ 92,562 $ 189,926
=========== =========== =========== =========== ===========
See notes to financial statements.
41
Sharper Image Corporation
Statements of Cash Flows
Fiscal Year Ended January 31,
-----------------------------
2004 2003 2002
(Dollars in thousands) (Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
-------- -------- --------
Cash provided by (used for) operating activities:
Net earnings $ 25,254 $ 15,907 $ 1,127
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization 16,426 15,456 11,560
Tax benefit from stock option exercises 4,622 3,733 209
Deferred rent expenses and landlord allowances 361 279 332
Deferred income taxes 399 (2,331) (123)
Loss on disposal of equipment 744 94 395
Change in operating assets and liabilities:
Accounts receivable (8,599) (4,499) 1,624
Merchandise inventories (35,302) (24,075) 11,905
Prepaid catalog costs, prepaid expenses and other (2,575) 2,577 (24)
Accounts payable, reserve for refunds and
accrued expenses 5,809 20,932 (13,242)
Deferred revenue, taxes payable and other liabilities 13,998 8,908 (4,609)
-------- -------- --------
Cash provided by operating activities 21,137 36,981 9,154
-------- -------- --------
Cash provided by (used for) investing activities:
Property and equipment expenditures (35,195) (23,199) (20,284)
Proceeds from sale of equipment -- -- 11
-------- -------- --------
Cash used for investing activities (35,195) (23,199) (20,273)
-------- -------- --------
Cash provided by (used for) financing activities:
Proceeds from issuance of common stock upon exercise of
stock options 4,151 3,641 664
Repurchase of common stock -- -- (988)
Payments made for financing fees (770) -- --
Proceeds from notes payable and revolving credit facility -- 19,000 15,625
Principal payments on notes payable and revolving credit
facility -- (21,207) (15,784)
Proceeds from issuance of common stock due to follow-on
stock offering, net of expenses 38,515 -- --
-------- -------- --------
Cash provided by (used for) financing activities 41,896 1,434 (483)
-------- -------- --------
Net increase (decrease) in cash and equivalents 27,838 15,216 (11,602)
Cash and equivalents at beginning of period 55,633 40,417 52,019
-------- -------- --------
Cash and equivalents at end of period $ 83,471 $ 55,633 $ 40,417
======== ======== ========
Supplemental disclosure of cash paid for:
Interest expense $ 131 $ 456 $ 349
Income taxes $ 9,615 $ 743 $ 8,991
See notes to financial statements.
42
Sharper Image Corporation Notes to financial statements
Note A--Summary of significant accounting policies
Sharper Image Corporation (the "Company") is a leading specialty
retailer that introduces and sells quality, innovative and entertaining
products. These products are sold through its retail stores, catalogs (which
includes other sources of direct marketing such as single product mailers,
television infomercials, radio and newspapers), and over the Internet. The
Company also markets to other businesses through its corporate sales and
wholesale operations.
Accounting Estimates: The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. The Company's significant accounting judgments and
estimates include depreciable lives of long-lived assets, long-lived asset
impairment, reserves on inventory and sales return reserve.
Revenue Recognition: The Company recognizes revenue at the point of
sale at its retail stores and at the time of customer receipt for its catalog
and direct marketing sales, including the Internet. The Company recognizes
revenue for sales to resellers of sales made on a wholesale basis when the
products are shipped, which is the time title passes to the purchaser. The
Company records estimated reductions to revenue for customer returns based upon
historical return rates. Revenues are recorded net of sale discounts and other
rebates and incentives offered to customers. Deferred revenue represents
merchandise certificates gift cards and rewards cards outstanding and
merchandise that is still in the delivery process at the end of the fiscal
period. Delivery revenue is recognized at the commencement of delivery to
customers.
Cost of Products: Cost of products includes total cost of products
sold, inventory shrink, letter of credit fees, inventory write-downs, inbound
freight costs, costs to refurbish products for resale, inspection costs, cost of
customer accommodations and promotions and costs to deliver product to
customers.
Buying and Occupancy: Buying and occupancy includes salaries for
merchandise buyers, occupancy costs for all store locations and distribution
facilities including rent, utilities, real estate taxes, common area
maintenance, repairs and maintenance, depreciation on leasehold improvements and
fixtures, janitorial services and waste removal.
General, Selling and Administrative: General, selling and
administrative includes all costs related to sales associates, including payroll
and benefits, all corporate personnel cost, including payroll and benefits,
supplies, store signs, credit card fees, third party fees including
telemarketing expenses, Internet hosting charges, telephone-related to the
corporate offices, toll free phone numbers for catalog and other direct
marketing orders, freight charges related to delivery of product from
distribution centers to stores and between distribution centers, purchasing and
receiving costs, warehouse costs, corporate insurance, depreciation on corporate
assets such as computers and distribution center facilities, bad debt expense,
check guarantee fees and professional fees.
Start-up Activities: All start-up and pre-opening costs are expensed as
incurred.
Deferred Catalog and Advertising Costs: Direct costs incurred for the
production and distribution of catalogs are capitalized and amortized, once the
catalog is mailed, over the expected sales period, which does not exceed three
months. Other advertising costs are expensed as incurred and amounted to $80.7
43
million, $60.0 million and $35.3 million for the fiscal years ended January 31,
2004, 2003, and 2002, respectively.
Fair Value of Financial Instruments: The carrying value of cash,
accounts receivable, accounts payable and notes payable approximates their
estimated fair value.
Cash and Equivalents: Cash and equivalents represent cash and
short-term, highly liquid investments with original maturities of three months
or less. Receivables from banks related to debit and credit cards are shown in
accounts receivable and totaled $5.8 million and $2.8 million at January 31,
2004 and 2003, respectively.
Merchandise Inventories: Merchandise inventories are stated at lower of
cost (first-in, first-out method) or market. The Company reduces the carrying
value of its inventory for estimated obsolescence or unmarketable inventory
equal to the difference between the cost of inventory and the estimated market
value based upon assumptions about future demand and market conditions.
Property and Equipment: Property and equipment are stated at cost net
of accumulated depreciation. Depreciation is computed using the straight-line
method over the estimated useful lives of the various assets which range from
three to 10 years for office furniture and equipment and transportation
equipment, and 40 years for buildings. Leasehold improvements are amortized
using the straight-line method over the lesser of their estimated useful lives
or the term of the applicable leases, which range from seven to 18 years.
The Company designs and produces its own proprietary products for sale.
External costs incurred for tooling, dies, patents and trademarks are
capitalized and amortized over the estimated life of these products, which is
generally two years. At January 31, 2004, and 2003, capitalized costs included
in property and equipment, net of related amortization, were $3.4 million and
$2.8 million, respectively.
Costs incurred in the development of the Internet Web site and
enhancements to the Company's information infrastructure are capitalized once
the preliminary project stage is completed and management authorizes and commits
to funding a computer software project and it is probable that the project will
be completed and the software will be used to perform the function intended.
Costs incurred for training and ongoing maintenance are expensed as incurred.
The Company reviews its long-lived assets, including identifiable
intangible assets, whenever events or changes indicate the carrying amount of
such assets may not be recoverable. The Company's policy is to review the
recoverability of all assets, at a minimum, on an annual basis. Based on the
Company's review at January 31, 2004 and 2003, no material adjustments were made
to long-lived assets.
Income Taxes: Income taxes are accounted for using an asset and
liability approach that requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of events then known to
management that have been recognized in the Company's financial statements or
tax returns. In estimating future tax consequences, all expected future events
then known to management are considered other than changes in the tax law or
rates.
Store Closure Reserves - Prior to January 1, 2003, the Company recorded
the estimated costs associated with closing a store during the period in which
the store was identified and approved by management under a plan of termination,
which included the method of disposition and the expected date of completion.
These costs include direct costs to terminate a lease, lease rental payments net
of expected sublease income, and the difference between the carrying values and
estimated recoverable values of long-lived tangible and intangible assets.
Severance and other employee-related costs were recorded in the
44
period in which the closure and related severance packages were communicated to
the affected employees. No such reserves were provided for the reporting periods
presented.
Effective with the adoption of SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, on January 1, 2003, the Company
recognizes a liability for costs associated with closing a store when the
liability is incurred. The present value of expected future lease costs and
other closure costs is recorded when the store is closed. Severance and other
employee-related costs are recorded in the period in which the closure and
related severance packages are communicated to the affected employees. Accretion
of the discounted present value of expected future costs is recorded in
operations. Store closure reserves are reviewed and adjusted periodically based
on changes in estimates. No such reserves are recorded at January 31, 2004 and
2003.
Accounts Payable: Accounts payable represents amounts owed to third
parties at the end of the period.
Deferred Rent. When a lease requires fixed escalations of the minimum
lease payments, rental expense is recorded on a straight-line basis and the
difference between the average rental amount charged to expense and the amount
payable under the lease is recorded as deferred rent. At January 31, 2004 and
2003, the balance of deferred rent was $4.4 million and $3.6 million,
respectively, and is included in long-term liabilities on the accompanying
balance sheet.
Derivative Instruments and Hedging Activities. SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended,
requires the Company to record all derivatives as either assets or liabilities
on the balance sheet and to measure those instruments at fair value. The Company
did not hold or trade any derivative instruments in 2003, 2002 or 2001.
Stock-Based Compensation - The Company has one stock-based employee
compensation plan, as described in Note G. The Company accounts for stock-based
employee compensation using the intrinsic value method in accordance with the
provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees. No
compensation expense is recognized for employee stock options, because it is the
Company's practice to grant stock options with an exercise price equal to the
market price of the underlying common stock on the date of grant. The following
table illustrates the effect on net income and earnings per share if the Company
had applied the fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation, to all stock-based employee compensation:
Fiscal year ended January 31,
--------------------------------------------------------------------
Dollars in thousands, except per share amounts 2004 2003 2002
(Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
--------------------- -------------------- -----------------------
Net income, as reported $25,254 $15,907 $1,127
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effects (2,006) (1,539) (1,098)
------- ------- ------
Pro forma net income $23,248 $14,368 $29
======= ======= ======
Basic earnings per share:
As reported $1.75 $1.29 $0.09
Pro forma $1.61 $1.17 $0.00
Diluted earnings per share:
As reported $1.65 $1.21 $0.09
Pro forma $1.52 $1.09 $0.00
45
The Company estimates the fair value of stock option grants using the
Black-Scholes option pricing model, with the following weighted average
assumptions:
Fiscal year ended January 31,
------------------------------------------------------
2004 2003 2002
(Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
------------- ------------- -------------
Dividend yield -- -- --
Expected volatility 52% 59% 37%
Risk-free interest rate 3.12% 1.81% 4.09%
Expected life (years) 5 5 5
Earnings Per Share - Basic earnings per share are computed by dividing
net income by the weighted average number of common shares outstanding during
the period. Diluted earnings per share are computed by dividing net income by
the weighted average number of common shares and dilutive common equivalent
shares (stock options) outstanding during the period. The following is a
reconciliation of the number of shares used in the Company's basic and diluted
earnings per share computations:
Fiscal year ended January 31,
-----------------------------------------------------
2004 2003 2002
(Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
---------- ---------- ----------
Basic weighted average number of shares
outstanding 14,446,128 12,327,157 11,904,562
Application of treasury stock method on stock
options outstanding:
Assumed options exercised due to exercise
price being less than average market price, net
of assumed stock repurchases 887,107 854,893 398,290
---------- ---------- ----------
Diluted weighted average number of shares
outstanding 15,333,235 13,182,050 12,302,852
========== ========== ==========
The computations of diluted earnings per share in fiscal 2003, 2002 and 2001
exclude 31,100, 51,850 and 303,500 stock options, respectively, because their
exercise price exceeded the average market price for the period and thus, their
effect would have been anti-dilutive.
Comprehensive Income: Comprehensive income consists of net earnings or
loss for the current period and other comprehensive income (income, expenses,
gains and losses that currently bypass the income statement and are reported
directly as a separate component of equity). Comprehensive income does not
differ from net earnings for the Company for the years ended January 31, 2004,
2003 and 2002.
New Accounting Pronouncements: In December 2003, the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation ("FIN") No. 46(R)
"Consolidation of Variable Interest Entities." FIN 46(R) replaces FIN 46 and
addresses
46
consolidation by business enterprises of variable interest entities. The
provisions of FIN 46(R) are effective for the first reporting period that ends
after December 15, 2003 for variable interests in those entities commonly
referred to as special-purpose entities. Application of the provisions of FIN
46(R) for all other entities is effective for the first reporting period ending
after March 15, 2004. The Company has no interest in any entity considered a
special purpose entity. The Company believes the adoption of the provisions of
FIN 46(R) in the first quarter of 2004 will have no impact on net earnings, cash
flows or financial position.
Reclassification: Certain reclassifications were made to prior years'
financial statements in order to conform to the classifications of the January
31, 2004 financials statements.
Note B--Property and equipment
Property and equipment is summarized as follows:
January 31,
---------------------
(Dollars in thousands) 2004 2003
-------- --------
Leasehold improvements $ 37,885 $ 33,032
Furniture, fixtures and equipment and
other capitalized costs 110,126 86,240
Land 53 53
Building 2,874 2,874
-------- --------
150,938 122,199
Less accumulated depreciation and amortization 80,748 70,034
-------- --------
$ 70,190 $ 52,165
======== ========
Note C--Other assets
The Company had an agreement to advance the premiums on a split-dollar
life insurance policy for its Founder, Chairman and Chief Executive Officer,
which was terminated during fiscal 2003. The Company had an interest in the
insurance benefits equal to the amount of the premiums advanced. The amount
receivable for premiums advanced as of January 31, 2003 was $2.1 million. Upon
termination of the agreement in fiscal 2003, the Company was reimbursed for all
premiums paid. As of January 31, 2004, the balance in other assets is comprised
of investments and deferred financing costs.
Note D--Revolving loan and notes payable
On October 31, 2003, the Company terminated its 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. As of January 31, 2004, letter of credit
47
commitments outstanding under the new credit facility were $4.2 million, which
includes a $2.9 million backstop letter of credit to cover credit commitments
outstanding under the Company's old secured credit facility. As of January 31,
2003, letter of credit commitments outstanding under the previous secured credit
facility were $2.1 million. There were no direct borrowings under the credit
facilities during fiscal 2003 and 2002. The weighted average interest rate
incurred on the revolving credit facility was 4.10% and 4.75% for fiscal 2003
and 2002, respectively.
Note E--Income taxes
Fiscal year ended January 31,
-----------------------------
2004 2003 2002
(Dollars in thousands) (Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
-------- -------- --------
Current:
Federal $ 14,640 $ 11,422 $ 746
State 2,510 1,958 128
-------- -------- --------
17,150 13,380 874
-------- -------- --------
Deferred:
Federal 340 (1,990) (105)
State 59 (341) (18)
-------- -------- --------
399 (2,331) (123)
-------- -------- --------
$ 17,549 $ 11,049 $ 751
======== ======== ========
The difference between the effective income tax rate and the United
States federal income tax rate is summarized as follows:
Fiscal year ended January 31,
-----------------------------
2004 2003 2002
(Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
------------- ------------- -------------
Federal tax rate 35.0% 35.0% 35.0%
State income tax, less federal benefit 6.0 6.0 6.0
Other -- -- (1.0)
---- ---- ----
Effective tax rate 41.0% 41.0% 40.0%
==== ==== ====
48
Deferred taxes result from differences in the recognition of expense
for income tax and financial reporting purposes. The principal components of
deferred tax assets (liabilities) are as follows:
January 31,
-----------
2004 2003
------------------------- --------------------------
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Assets Liabilities Assets Liabilities
------- ------- ------- -------
Current:
Nondeductible reserves $14,654 $11,973
Deferred catalog costs $ 1,384 $ 1,131
State taxes 2,674 2,265
------- ------- ------- -------
Current 14,654 4,058 11,973 3,396
------- ------- ------- -------
Noncurrent:
Deferred rent 1,761 1,432
Depreciation 762 3,135
Deductible software costs 5,596 4,314
Other 59 967
------- ------- ------- -------
Noncurrent 2,523 5,655 4,567 5,281
------- ------- ------- -------
Total $17,177 $ 9,713 $16,540 $ 8,677
======= ======= ======= =======
Note F--Leases
The Company leases retail facilities, offices, and equipment under
operating leases for terms expiring at various dates through 2017. Under the
terms of certain of the leases, rents are adjusted annually for changes in the
consumer price index and increases in property taxes. The aggregate minimum
annual lease payments under leases in effect at January 31, 2004, are as
follows:
(Dollars in thousands)
Fiscal year ending January 31,
2005 $30,363
2006 28,627
2007 24,317
2008 22,703
2009 21,471
Later years 75,385
---------
Total minimum lease commitments $202,866
=========
Many of the Company's leases contain predetermined fixed escalations of
the minimum rentals during the initial term. For these leases, the Company has
recognized the related rental expense on a straight-line basis and has recorded
the difference between the expense charged to income and amounts
49
payable under the leases as deferred rent, which is included in Deferred Taxes
and Other Liabilities on the accompanying balance sheet. Total minimum rent to
be received by the Company from non-cancelable sublease agreements through 2005
is approximately $269,000 as of January 31, 2004, which has not been netted
against the above amounts.
Some store leases contain renewal options for periods ranging up to
five years. Most leases also provide for payment of operating expenses, real
estate taxes and for additional rent based on a percentage of sales.
Rental expense for all operating leases was as follows:
Fiscal year ended January 31,
-----------------------------
2004 2003 2002
(Dollars in thousands) (Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
------------------ ------------------ -------------------
Minimum rentals $30,108 $25,999 $22,941
Percentage rentals and other charges 12,286 10,448 8,436
------- ------- -------
$42,394 $36,447 $31,377
======= ======= =======
Note G--Stockholders' equity
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 to the underwriters' over-allotment option. The Company
received proceeds from the public offering of $38.5 million, net of
underwriters' discount and offering expenses.
During fiscal 2000, the Company adopted the 2000 Stock Incentive Plan.
The Stock Incentive Plan combines the 1985 Stock Option Plan, as amended, and
the 1994 Non-Employee Director Stock Option Plan, as amended, into a single
comprehensive equity incentive plan. The 2000 Stock Incentive Plan is divided
into four separate equity incentive programs and will allow the issuance of
non-qualified options to key employees, non-employee Board members and
consultants up to an initial aggregate of 3,147,107 shares. An automatic
increase of shares available for issuance will occur on the first trading day of
each fiscal year, beginning with fiscal 2001, by an amount equal to 3% of the
total number of shares of common stock outstanding on the last trading day of
the immediately preceding fiscal year. In no event will the annual increase
exceed 500,000 shares.
Options issued to key employees and consultants will generally vest
over a four- to six-year period from the date of the grant and are priced at
100% of the fair market value at the date of the grant. Options issued to
non-employee Board members will be immediately exercisable, vest over one year
of board service from the date of the grant and are priced at 100% of the fair
market value at the date of the grant. Any shares purchased under the option
plan will be subject to repurchase by the Company at the exercise price paid per
share, upon the optionee's cessation of Board service prior to vesting.
50
The following table reflects the activity under this plan:
Weighted
Number of average
options exercise price
--------- --------------
Balance at January 31, 2001 2,142,887 $ 7.46
Granted (weighted average fair value of $3.14) 800,350 7.96
Exercised (86,655) 5.00
Cancelled (82,619) 8.36
---------
Balance at January 31, 2002 2,773,963 $ 7.65
Granted (weighted average fair value of $7.60) 687,650 14.41
Exercised (665,801) 5.42
Cancelled (100,441) 10.33
---------
Balance at January 31, 2003 2,695,371 $ 9.83
Granted (weighted average fair value of $10.97) 580,500 23.18
Exercised (544,559) 7.20
Cancelled (43,660) 9.99
---------
Balance at January 31, 2004 2,687,652 $ 13.24
=========
Exercisable at January 31, 2002 1,397,869 $ 6.79
=========
Exercisable at January 31, 2003 1,272,707 $ 9.10
=========
Exercisable at January 31, 2004 1,272,652 $ 10.88
=========
Options outstanding Options exercisable
-------------------------------------------------------------------- -------------------------------
Weighted
average
Number remaining Weighted Number Weighted
Range of of options contractual average of options average
Exercise prices Outstanding life (years) exercise price exercisable exercise price
--------------- ----------- ------------ -------------- ----------- --------------
$1.16 - $1.99 100 0.1 $ 1.88 100 $ 1.88
2.00 - 3.99 14,618 4.5 3.66 14,618 3.66
4.00 - 7.99 308,860 7.9 6.88 115,940 6.84
8.00 - 11.99 1,293,904 7.0 9.51 856,424 9.42
11.99 - 29.70 1,070,170 9.4 19.72 285,570 17.28
--------- ---------
$1.16 - $29.70 2,687,652 8.0 $ 13.24 1,272,652 $ 10.88
========= =========
Note H--401(k) savings plan
The Company maintains a defined contribution, 401(k) Savings Plan,
covering all employees who have completed one year of service with at least
1,000 hours and who are at least 21 years of age. The Company makes employer
matching contributions at its discretion. Company contributions amounted to
$190,000, $176,000, and $172,000 for the fiscal years ended January 31, 2004,
2003 and 2002, respectively.
51
Note I--Commitments and contingencies
The Company is party to various legal proceedings arising from normal
business activities. Management believes that the resolution of these matters
will not have a material adverse effect on the Company's financial position or
results of operations.
Note J--Segment information
The Company classifies its business interests into three reportable
segments: retail stores, catalog and direct marketing, and the Internet. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies (Note A). The Company evaluates
performance and allocates resources based on operating contribution, which
excludes unallocated corporate general and administrative costs and income
taxes. The Company's reportable segments are strategic business units that offer
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 products.
Financial information for the Company's business segments is as
follows:
Year ended January 31,
----------------------
2004 2003 2002
(Dollars in thousands) (Fiscal 2003) (Fiscal 2002) (Fiscal 2001)
--------- --------- ---------
Revenues
Stores $ 379,349 $ 293,795 $ 230,799
Catalog and direct marketing 128,652 118,192 85,087
Internet 95,086 69,208 49,349
Other 44,424 32,574 23,870
--------- --------- ---------
Total revenues $ 647,511 $ 513,769 $ 389,105
========= ========= =========
Operating contributions
Stores $ 53,457 $ 38,923 $ 24,056
Catalog and direct marketing 24,164 19,628 7,610
Internet 16,265 12,031 8,833
Unallocated (51,083) (43,626) (38,621)
--------- --------- ---------
Earnings before income tax expense $ 42,803 $ 29,956 $ 1,878
========= ========= =========
Depreciation and amortization
Stores $ 7,734 $ 6,224 $ 4,782
Catalog and direct marketing -- -- --
Internet 3,071 3,884 1,845
Unallocated 5,621 5,348 4,933
--------- --------- ---------
Total depreciation and amortization $ 16,426 $ 15,456 $ 11,560
========= ========= =========
Capital asset expenditures
Stores $ 21,774 $ 13,983 $ 12,296
Catalog and direct marketing -- -- --
Internet 1,727 2,400 2,134
Unallocated 11,694 6,816 5,854
--------- --------- ---------
Total capital asset expenditures $ 35,195 $ 23,199 $ 20,284
========= ========= =========
Assets
Stores $ 48,725 $ 35,281 $ 27,613
Catalog and direct marketing -- -- --
Internet 1,974 3,330 4,825
Unallocated 258,856 175,816 130,084
--------- --------- ---------
Total assets $ 309,555 $ 214,427 $ 162,522
========= ========= =========
52
Note K--Quarterly financial information (unaudited)
Fiscal Year Ended January 31, 2004
Three months ended
(Dollars in thousands, except per share April 30, July 31, October 31, January 31,
amounts) 2003 2003 2003 2004
--------- --------- --------- ---------
Revenues $ 116,309 $ 124,699 $ 128,121 $ 278,382
Expenses
Cost of products 47,617 53,526 56,417 119,483
Buying and occupancy 13,021 13,174 14,331 17,392
Advertising 25,565 25,877 24,260 47,637
General, selling and administrative 28,900 30,935 31,726 54,904
Other income (expense) (57) 182 283 (351)
Earnings before income tax expense 1,149 1,369 1,670 38,615
Income tax expense 471 561 685 15,832
--------- --------- --------- ---------
Net earnings $ 678 $ 808 $ 985 $ 22,783
========= ========= ========= =========
Earnings per common equivalent share
Basic (1) $ 0.05 $ 0.05 $ 0.07 $ 1.50
Diluted(2) $ 0.05 $ 0.05 $ 0.06 $ 1.40
53
Fiscal Year Ended January 31, 2003
Three months ended
(Dollars in thousands, except per share April 30, July 31, October 31, January 31,
amounts) 2002 2002 2002 2003
--------- --------- --------- ---------
Revenues $ 92,221 $ 100,464 $ 104,605 $ 216,479
Expenses
Cost of products 37,830 43,328 46,714 92,647
Buying and occupancy 10,989 11,408 11,813 13,975
Advertising 20,193 21,137 20,027 36,003
General, selling and administrative 23,040 25,656 26,832 45,028
Other income (expense) 84 19 (73) (223)
Earnings (loss) before income tax expense
(benefit) 253 (1,046) (854) 28,603
Income tax expense (benefit) 104 (429) (350) 11,724
--------- --------- --------- ---------
Net earnings (loss) $ 149 $ (617) $ (504) $ 16,879
========= ========= ========= =========
Earnings (loss) per common equivalent share
Basic (1) $ .01 $ (0.05) $ (0.04) $ 1.34
Diluted(2) $ .01 $ (0.05) $ (0.04) $ 1.26
(1) Basic earnings per share is calculated for interim periods including
the effect of stock options exercised in prior interim periods. Basic
earnings per share for the fiscal year is calculated using weighted
shares outstanding based on the date stock options were exercised.
Therefore, basic earnings per share for the cumulative four quarters
may not equal fiscal year basic earnings per share.
(2) Diluted net earnings per share for the fiscal year and for quarters
with net earnings are computed based on weighted average common shares
outstanding which include common stock equivalents (stock options). Net
loss per share for quarters with net losses is computed based solely on
weighted average common shares outstanding. Therefore, the net earnings
(loss) per share for each quarter do not sum up to the earnings per
share for the full fiscal year.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
Item 9A Controls And Procedures.
Evaluation of Disclosure Controls and Procedures. Our chief executive
officer and our chief financial officer, after evaluating the effectiveness of
our disclosure controls and procedures (as defined in the Securities Exchange
Act of 1934 Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by
this report, have concluded, based on the evaluation of these controls and
procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15,
that 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.
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 have
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
54
PART III
Item 10. Directors and Executive Officers of the Registrant
Information with respect to our directors is incorporated herein by
reference to our 2004 Proxy Statement to Stockholders. Information with respect
to our executive officers is contained in Part I of this Annual Report on Form
10-K.
Item 11. Executive Compensation
Information with respect to executive compensation is incorporated
herein by reference to our 2004 Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Except as set forth below, information with respect to security
ownership of beneficial owners and management is incorporated herein by
reference to our 2004 Proxy Statement.
EQUITY COMPENSATION PLAN INFORMATION
We have one equity based compensation plan, the 2000 Stock Incentive
Plan which was approved by our security holders. The following table sets forth
information as of January 31, 2004 of our equity compensation plan.
Number of Securities Remaining
Available for Future Issuance
Number of Securities to be Weighted-Average Per Share Under Equity Compensation Plan
issued Upon Exercise of Exercise Price of (Excluding Securities Reflected
Plan Category Outstanding Options Outstanding Options in the First Column)
----------------------------- --------------------------- ------------------------------ ---------------------------------
Equity compensation plan
approved
by security holders.......... 2,687,652 $13.24 31,192
Item 13. Certain Relationships and Related Transactions
Not applicable.
Item 14. Principal Accountant Fees and Services
Information with respect to principal accountant fees and services is
incorporated herein by reference to our 2004 Proxy Statement.
55
PART IV
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K
(a)1. List of Financial Statements.
The following Financial Statements and Notes thereto are included herein in PART
V, Item 8:
Independent Auditors' Report
Statements of Operations for the years ended January 31, 2004, 2003 and 2002
Balance sheets at January 31, 2004 and 2003
Statements of Stockholders' Equity for the years ended January 31, 2004, 2003
and 2002
Statements of Cash Flows for the years ended January 31, 2004, 2003 and 2002
Notes to Financial Statements.
(a)2. List of Financial Statement Schedule.
The following are filed as part of this Report:
Independent Auditors' Report on Schedule.
Schedule II - Valuation and Qualifying Accounts
(a)3. List of Exhibits.
Incorporated herein by reference is a list of the Exhibits contained in
the Exhibit Index, which begins on page 41 of this report.
(b) Reports on Form 8-K.
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 SHARPER IMAGE CORPORATION
By:/s/ Richard J. Thalheimer By:/s/ Jeffrey P. Forgan
------------------------- ---------------------
Richard J. Thalheimer Jeffrey P. Forgan
Chief Executive Executive Vice President, Chief Financial
Officer, Chairman Officer, Corporate Secretary
(Principal Executive Officer) (Principal Financial & Accounting Officer)
56
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Richard Thalheimer and Jeffrey P. Forgan, and
each of them, as such person's true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for such person and in such
person's name, place, and stead, in any and all capacities, to sign any and all
amendments to this report, and to file the same, with all exhibits thereto, and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in connection therewith, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of them, or their
or his substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Richard J. Thalheimer Chief Executive April 15, 2004
- ------------------------- Officer, Chairman
Richard J. Thalheimer (Principal Executive Officer)
/s/ Jeffrey P. Forgan Executive Vice President, April 15, 2004
- --------------------- Chief Financial Officer,
Jeffrey P. Forgan Corporate Secretary
(Principal Financial and
Accounting Officer)
/s/ Alan Thalheimer Director April 15, 2004
- -------------------
Alan Thalheimer
/s/ Gerald Napier Director April 15, 2004
- -----------------
Gerald Napier
/s/ Morton David Director April 15, 2004
- ----------------
Morton David
/s/ George James Director April 15, 2004
- ----------------
George James
57
SHARPER IMAGE CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
-----------------------------------------------
($000)
COLUMN COLUMN COLUMN COLUMN COLUMN
A B C D E
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at Additions Balance
Beginning Charged to at End of
DESCRIPTION of Period Costs & Exp. Deductions Period
- ------------------------------------------------------------------------------------------------------------------------------------
ACCOUNTS RECEIVABLE
YEAR ENDED JANUARY 31, 2004:
Allowance for doubtful accounts $967 $1,426 $1,127 $1,266
YEAR ENDED JANUARY 31, 2003:
Allowance for doubtful accounts $1,082 $1,072 $1,187 $967
YEAR ENDED JANUARY 31, 2002:
Allowance for doubtful accounts $730 $682 $330 $1,082
58
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
Board of Directors and Stockholders of
Sharper Image Corporation
We have audited the financial statements of Sharper Image Corporation as of
January 31, 2004 and 2003 and for each of the three fiscal years in the period
ended January 31, 2004, and have issued our report thereon dated April 12, 2004;
such financial statements and report are included in your 2003 Annual Report on
Form 10-K. Our audits also included the financial statement schedule of Sharper
Image Corporation, listed in Item 15. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, such financial statement schedule,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
/s/ Deloitte & Touche LLP
San Francisco, California
April 12, 2004
59
EXHIBIT INDEX
3.1 Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1
to Registration Statement on Form S-1 (Registration No. 33-12755).)
3.2 Amended and Restated Bylaws.
3.3 Form of Certificate of Designation of Series A Junior participating
Preferred Stock. (Incorporated by reference to Exhibit 3.01 to
Amendment No. 2 to the Registration Statement on Form S-2.)
4.1 Form of Rights Certificate. (Incorporated by reference to Exhibit 4.01
to Amendment No. 2 to the Registration Statement on Form S-2.)
4.2 Form of Rights Agreement dated June 7, 1999. (Incorporated by reference
to Exhibit 4.02 to Amendment No. 2 to the Registration Statement on
Form S-2.)
10.1 Amended and Restated Stock Option Plan (as amended through September
25, 1998). (Incorporated by reference to Registration Statement on Form
S-8 filed on January 19, 1996 (Registration No. 33-3327) and Exhibit to
Definitive Proxy Statement on Schedule 14A filed April 29, 1999.)
10.2 1994 Non-Employee Director Stock Option Plan dated October 7, 1994 (as
amended through September 25, 1998). (Incorporated by reference to
Registration Statement on Form S-8 filed on January 19, 1996
(Registration No. 33-3327) and Exhibit to Definitive Proxy Statement on
Schedule 14A filed April 29, 1999.)
10.3 Cash or Deferred Profit Sharing Plan, as amended. (Incorporated by
reference to Exhibit 10.2 to Registration Statement on Form S-1
(Registration No. 33-12755).)
10.4 Cash or Deferred Profit Sharing Plan Amendment No. 3. (Incorporated by
reference to Exhibit 10.15 to Form 10-K for fiscal year ended January
31, 1988.)
10.5 Cash or Deferred Profit Sharing Plan Amendment No. 4. (Incorporated by
reference to Exhibit 10.16 to Form 10-K for fiscal year ended January
31, 1988.)
10.6 Form of Stock Purchase Agreement dated July 26, 1985 relating to shares
of Common Stock purchased pursuant to exercise of employee stock
options. (Incorporated by reference to Exhibit 10.3 to Registration
Statement on Form S-1 (Registration No. 33-12755).)
10.7 Form of Stock Purchase Agreement dated December 13, 1985 relating to
shares of Common Stock purchase pursuant to exercise of employee stock
options. (Incorporated by reference to Exhibit 10.4 to Registration
Statement on Form S-1 (Registration No. 33-12755).)
10.8 Form of Stock Purchase Agreement dated November 10, 1986 relating to
shares of Common Stock purchased pursuant to exercise of employee stock
options. (Incorporated by reference to Exhibit 10.5 to Registration
Statement on Form S-1 (Registration No. 33-12755).)
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10.9 Form of Director Indemnification Agreement. (Incorporated by reference
to Exhibit 10.42 to Registration Statement on Form S-1 (Registration
No. 33-12755).)
10.10 Financing Agreement dated September 21, 1994 between the Company and
CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit
10.12 to Form 10-Q for the quarter ended October 31, 1994.)
10.11 The Sharper Image 401(K) Savings Plan. (Incorporated by reference to
Exhibit 10.21 to Registration Statement of Form S-8 (Registration No.
33-80504) dated June 21, 1994.)
10.12 Split-Dollar Agreement between the Company and Mr. R. Thalheimer, its
Chief Executive Officer dated October 13, 1995, effective as of May 17,
1995. (Incorporated by reference to Exhibit 10.17 to Form 10-K for the
fiscal year ended January 31, 1996.)
10.13 Assignments of Life Insurance Policy as Collateral, both dated October
13, 1995, effective May 17, 1995. (Incorporated by reference to Exhibit
10.18 to Form 10-K for the fiscal year ended January 31, 1996.)
10.14 Amendment to the Financing Agreement dated May 15, 1996 between the
Company and The CIT Group/Business Credit Inc. (Incorporated by
reference to Exhibit 10.19 to the Form 10-Q for the quarter ended April
30, 1996.)
10.15 Amendment to the Financing Agreement dated February 13, 1997 between
the Company and The CIT Group/Business Credit Inc. (Incorporated by
reference to Exhibit 10.21 to Form 10-K for the fiscal year ended
January 31, 1997.)
10.16 Amendment to the Financing Agreement dated March 24, 1997 between the
Company and The CIT Group/Business Credit Inc. (Incorporated by
reference to Exhibit 10.23 to Form 10-K for the fiscal year ended
January 31, 1997.)
10.17 Amendment to the Financing Agreement dated April 6, 1998 between the
Company and The CIT Group/Business Credit Inc. (Incorporated by
reference to Exhibit 10.25 to Form 10-K for the fiscal year ended
January 31, 1998.)
10.18 Amendment to the Financing Agreement dated March 23, 2000 between the
Company and The CIT Group/Business Credit Inc. (Incorporated by
reference to Exhibit 10.22 to Form 10-K for the fiscal year ended
January 31, 2000.)
10.19 Amendment to the Corporate Headquarters Office Lease Agreement dated
February 9, 2000 between the Company and its landlord, CarrAmerica
Realty Corporation. (Incorporated by reference to Exhibit 10.23 to Form
10-K for the fiscal year ended January 31, 2000.)
10.20 Amendment to the Financing Agreement dated July 18, 2000 between the
Company and The CIT Group/Business Credit, Inc. (Incorporated by
reference to Exhibit 10.23 to Form 10-Q for the quarter ended October
31, 2000.)
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10.21 Amendment to the Financing Agreement dated September 29, 2000 between
the Company and The CIT Group/Business Credit, Inc. (Incorporated by
reference to Exhibit 10.24 to Form 10-Q for the quarter ended October
31, 2000.)
10.22 Executive Bonus Plan. (Incorporated by reference to the Definitive
Proxy Statement on Schedule 14A filed May 4, 2001.)
10.23 Amendment to the Split-Dollar Agreement between the Company and Richard
Thalheimer, its Chief Executive Officer dated July 12, 2001, effective
as of March 28, 2001. (Incorporated by reference to Exhibit 10.24 to
Form 10-Q for the quarter ended October 31, 2001.)
10.24 Officer Non-Qualified Deferred Compensation Plan. (Incorporated by
reference to Exhibit 10.27 to Form 10-Q for the quarter ended October
31, 2003.)
10.25 Employment Agreement dated October 21, 2002 between the Company and
Richard Thalheimer. (Incorporated by reference to Exhibit 10.26 to Form
10-Q for the quarter ended October 31, 2003.)
10.26 Amendment to the Financing Agreement dated March 3, 2003 between the
Company and the CIT Group/Business Credit Inc. (Incorporated by
reference to Exhibit 10.28 to Form 10-Q for the quarter ended April 30,
2003).
10.27 Loan and Security Agreement dated October 31, 2003 between the Company
and Wells Fargo Retail Finance, LLC. (Incorporated by reference to
Exhibit 10.1 to Form 10-Q for the quarter ended October 31, 2003).
23.1 Independent Auditors' Consent
31.1 Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or
15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification by Chief Executive Officer pursuant to Section 906 of The
Sarbanes-Oxley Act of 2002.
32.2 Certification by Chief Financial Officer pursuant to Section 906 of The
Sarbanes-Oxley Act of 2002.
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