UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended April 30, 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: 0-15827
SHARPER IMAGE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2493558
(State of Incorporation) (I.R.S. Employer Identification No.)
650 Davis Street, San Francisco, California 94111
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 445-6000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ____
---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No ____
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
Common Stock, $0.01 par value, 15,569,720 shares as of June 7, 2004
SHARPER IMAGE CORPORATION
FORM 10-Q
For the Quarter Ended April 30, 2004
INDEX
PART I. FINANCIAL INFORMATION Page
ITEM 1. Condensed Financial Statements (unaudited)
Balance Sheets as of April 30, 2004,
January 31, 2004 and April 30, 2003 3
Statements of Operations
for the three months ended April 30, 2004 and 2003 4
Statements of Cash Flows
for the three months ended April 30, 2004 and 2003 5
Notes to Condensed Financial Statements 6- 8
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9- 24
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk 25
ITEM 4. Controls and Procedures 25
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K 26
SIGNATURE PAGE 27
CERTIFICATIONS 28- 31
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SHARPER IMAGE CORPORATION
CONDENSED BALANCE SHEETS
(Unaudited)
April 30, January 31, April 30,
2004 2004 2003
Dollars in thousands, except per share amounts (Note A)
-------- -------- --------
ASSETS
Current Assets:
Cash and equivalents $ 74,678 $ 83,471 $ 36,012
Accounts receivable, net of allowance for doubtful
accounts of $1,300, $1,266 and $905 20,728 21,196 13,469
Merchandise inventories 102,760 110,058 77,262
Prepaid expenses, deferred taxes and other 22,726 20,303 20,377
-------- -------- --------
Total Current Assets 220,892 235,028 147,120
Property and equipment, net 77,308 70,190 52,836
Deferred taxes and other assets 4,524 4,337 4,636
-------- -------- --------
Total Assets $302,724 $309,555 $204,592
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 19,257 $ 23,434 $ 20,465
Accrued expenses 17,833 16,126 16,847
Accrued compensation 5,790 11,793 4,810
Reserve for refunds 17,561 17,161 12,737
Deferred revenue 25,357 25,781 21,235
Income taxes payable 1,636 9,399 474
-------- -------- --------
Total Current Liabilities 87,434 103,694 76,568
Other liabilities 18,282 15,935 9,707
Commitments and Contingencies -- -- --
-------- -------- --------
Total Liabilities 105,716 119,629 86,275
-------- -------- --------
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,
15,563,036, 15,322,635 and 12,669,585 shares 156 153 127
Additional paid-in capital 102,184 97,211 50,204
Retained earnings 94,668 92,562 67,986
-------- -------- --------
Total Stockholders' Equity 197,008 189,926 118,317
-------- -------- --------
Total Liabilities and Stockholders' Equity $302,724 $309,555 $204,592
======== ======== ========
See notes to condensed financial statements.
3
SHARPER IMAGE CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended
Dollars in thousands, except per share amounts April 30,
----------------------------
2004 2003
------------ ------------
REVENUES:
Net Sales $ 152,711 $ 113,528
Delivery 3,694 2,781
------------ ------------
156,405 116,309
------------ ------------
COST AND EXPENSES:
Cost of products 62,437 47,617
Buying and occupancy 16,049 13,021
Advertising 37,072 25,565
General, selling and administrative 37,393 28,900
------------ ------------
152,951 115,103
------------ ------------
OTHER INCOME AND EXPENSE:
Interest income 164 99
Interest expense (38) (51)
Other expense (10) (105)
------------ ------------
116 (57)
------------ ------------
Earnings Before Income Tax Expense 3,570 1,149
Income tax expense 1,464 471
------------ ------------
Net Earnings $ 2,106 $ 678
============ ============
Net Earnings Per Share-basic $ 0.14 $ 0.05
============ ============
Net Earnings Per Share-diluted $ 0.13 $ 0.05
============ ============
Weighted Average Number of Shares - basic 15,496,000 12,653,000
Weighted Average Number of Shares - diluted 16,404,000 13,300,000
See notes to condensed financial statements.
4
SHARPER IMAGE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
Dollars in thousands April 30,
--------------------
2004 2003
-------- --------
Cash Provided by (Used for) Operating Activities:
Net earnings $ 2,106 $ 678
Adjustments to reconcile net earnings to net cash
provided by (used for) operating activities:
Depreciation and amortization 4,427 4,216
Tax benefit from stock option exercises 2,390 117
Deferred rent expenses and landlord allowances 413 121
Loss on disposal of equipment 11 97
Change in operating assets and liabilities:
Accounts receivable 468 (872)
Merchandise inventories 7,298 (2,506)
Prepaid expenses and other (2,610) (5,742)
Accounts payable, reserve for refunds and accrued expenses (8,073) (7,846)
Deferred revenue, taxes payable and other liabilities (6,253) (3,038)
-------- --------
Cash Provided by (Used for) Operating Activities 177 (14,775)
-------- --------
Cash Provided by (Used for) Investing Activities:
Property and equipment expenditures (11,563) (4,984)
Proceeds from sale of equipment 7 --
-------- --------
Cash Used for Investing Activities (11,556) (4,984)
-------- --------
Cash Provided by Financing Activities:
Proceeds from issuance of common stock, upon
exercise of stock options 2,586 138
-------- --------
Cash Provided by Financing Activities 2,586 138
-------- --------
Net Decrease in Cash and Equivalents (8,793) (19,621)
-------- --------
Cash and Equivalents at Beginning of Period 83,471 55,633
-------- --------
Cash and Equivalents at End of Period $ 74,678 $ 36,012
======== ========
Supplemental Disclosure of Cash Paid for:
Interest $ 39 $ 52
Income Taxes $ 6,855 $ 9,245
See notes to condensed financial statements.
5
SHARPER IMAGE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
Three-month periods ended April 30, 2004 and 2003
(Unaudited)
NOTE A- Financial Statements
The condensed balance sheets at April 30, 2004 and 2003, and the related
condensed statements of operations and cash flows for the three-month periods
then ended have been prepared by Sharper Image Corporation (the "Company"),
without audit. In the opinion of management, the condensed financial statements
include all adjustments (which include only normal recurring adjustments)
necessary to present fairly the financial position, results of operations and
cash flows as of April 30, 2004 and 2003, and for the three-month periods then
ended. The balance sheet at January 31, 2004, presented herein, has been derived
from the audited balance sheet of the Company.
Certain information and disclosures normally included in the notes to the annual
financial statements prepared in accordance with accounting principles generally
accepted in the United States of America have been omitted from these interim
financial statements. Accordingly, these interim financial statements should be
read in conjunction with the financial statements and notes thereto included in
the Company's 2003 Annual Report.
The Company's business is highly seasonal, reflecting the general pattern
associated with the retail industry of peak sales and earnings during the
Holiday shopping season. A substantial portion of the Company's total revenues
and all or most of the Company's net earnings usually occur in the fourth
quarter ending January 31. The Company, as is typical in the retail industry,
generally experiences lower revenues and net operating results during the other
quarters and has incurred and may continue to incur losses in these quarters.
The results of operations for these interim periods are not necessarily
indicative of the results for the full fiscal year.
NOTE B - Employee Stock Compensation
The Company accounts for stock-based employee compensation using the intrinsic
value method in accordance with the provisions of Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." No
compensation expense has been recognized for employee stock options in the
accompanying financial statements in accordance with the provisions of APB 25.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation", establishes a fair value method of accounting for
stock options and other equity instruments. SFAS No. 123 requires the disclosure
of pro forma income and earnings per share as if the Company had adopted the
fair value method. For determining pro forma earnings per share, the fair value
of the stock options and employees' purchase rights were estimated using the
Black-Scholes option pricing model. The Company's calculations are based on a
multiple option approach and forfeitures are recognized as they occur. Had
compensation cost for these stock option and stock purchase plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the methods of SFAS No. 123, the Company's net earnings
and net earnings per share would have been as the pro forma amounts indicate
below:
6
Three Months Ended
April 30,
---------------------
2004 2003
---------- --------
Net earnings, as reported $2,106,000 $678,000
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards, net of related tax effect
574,000 367,000
---------- --------
Pro forma net earnings $1,532,000 $311,000
========== ========
Basic net earnings per weighted average share:
As reported $0.14 $0.05
Pro forma $0.10 $0.02
Diluted net earnings per weighted average share:
As reported $0.13 $0.05
Pro forma $0.09 $0.02
NOTE C - Earnings Per Share
Basic earnings per share is computed as net income divided by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share is computed by dividing net income by the weighted average number of
common shares and dilutive common equivalent shares (stock options) outstanding
during period.
Three Months Ended
April 30,
-------------------------
2004 2003
----------- -----------
Net earnings $ 2,106,000 $ 678,000
Average shares of common stock
outstanding during the period 15,496,000 12,653,000
=========== ===========
Basic Earnings per Share $ 0.14 $ 0.05
=========== ===========
Average shares of common stock
outstanding during the period 15,496,000 12,653,000
Add:
Assumed options exercised due to
exercise price being less than average
market price net of assumed stock repurchases 908,000 647,000
----------- -----------
Diluted weighted average number
of shares outstanding 16,404,000 13,300,000
=========== ===========
Diluted Earnings per Share $ 0.13 $ 0.05
=========== ===========
7
NOTE D- Revolving Loan and Notes Payable
On October 31, 2003, the Company entered into a revolving secured credit
facility with Wells Fargo Bank, National Association. The 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 credit facility is secured by the Company's inventory, accounts
receivable, and specified other assets. Borrowings under the credit facility
bear interest at either the adjusted LIBOR rate plus 1.50% or at Wells Fargo's
prime rate less 0.25%. The credit facility contains financial covenants that
only apply during an event of default or when the borrowing base is drawn 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 credit facility
contains limitations on incurring additional indebtedness, making additional
investments and permitting a change of control. As of April 30, 2004, letter of
credit commitments outstanding under the credit facility were $3.6 million which
includes a $1.9 million backstop letter of credit to cover credit commitments
outstanding under the Company's former secured credit facility.
NOTE E - Segment Information
The Company classifies its business interests into three reportable segments:
retail stores, catalog and direct marketing, and Internet. The accounting
policies of the segments are the same as those described in the summary of
significant accounting policies in Note A of the 2003 Annual Report. The Company
evaluates performance and allocates resources based on operating contribution,
which excludes unallocated corporate general and administrative costs and income
tax expense or benefit. The Company's reportable segments are strategic business
units that offer essentially the same products and utilize common merchandising,
distribution, and marketing functions, as well as common information systems and
corporate administration. The Company does not have intersegment sales, but the
segments are managed separately because each segment has different channels for
selling the product.
Financial information for the Company's business segments is as follows:
Three Months Ended
April 30,
-------------------------
Dollars in thousands 2004 2003
--------- ---------
Revenues:
Stores $ 81,362 $ 64,786
Catalog and Direct Marketing 38,246 30,703
Internet 26,245 16,571
Other 10,552 4,249
--------- ---------
Total Revenues $ 156,405 $ 116,309
--------- ---------
Operating Contributions:
Stores $ 11,441 $ 4,282
Catalog and Direct Marketing 2,743 5,889
Internet 4,576 2,389
Unallocated (15,190) (11,411)
--------- ---------
Earnings Before Income Tax Expense $ 3,570 $ 1,149
--------- ---------
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following information should be read in conjunction with the historical
financial information and the notes thereto included in Item 1 of this Quarterly
Report on Form 10-Q and Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in our report on Form 10-K as
filed with the Securities and Exchange Commission. The statements contained in
this Form 10-Q that are not purely historical are forward-looking statements
within the meaning of the federal securities laws. Such forward-looking
statements may include but are not limited to statements regarding our future
products and enhancements, business, financial condition, results of operations
and prospects. Words such as "expects," "anticipates," "intends," "plans,"
"believes," "seeks," "estimates" and similar expressions or variations of such
words are intended to identify forward-looking statements, but are not the
exclusive means of identifying forward-looking statements in this Form 10-Q.
Additionally, statements concerning future matters such as the development of
new products or enhancements, possible changes in legislation and other
statements regarding matters that are not historical are forward-looking
statements. All forward-looking statements in this Form 10-Q are based upon
information available to us as of the date hereof, and we assume no obligation
to revise or update any such forward-looking statements in order to reflect any
event or circumstance that may arise after the date of this Form 10-Q. Actual
results could differ materially from our current expectations. Factors that
could cause or contribute to such differences include, but are not limited to
those set forth under "Factors Affecting Future Operating Results" below in this
Quarterly Report, and elsewhere in this Quarterly Report.
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 through our
wholesale operations.
Our total revenues increased 34.5% to $156.4 million in the quarter ended April
30, 2004 from $116.3 million in the quarter ended April 30, 2003. This increase
was due primarily to the popularity of our Sharper Image Design and Sharper
Image branded products, including our air purification line of products, the
opening of 29 new stores since April 30, 2003, a comparable store sales increase
of 7.8%, 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
52.0% and 55.7% of total revenues for the quarter ended April 30, 2004 and 2003,
respectively. As of April 30, 2004, we operated 154 The Sharper Image stores in
37 states and the District of Columbia. As part of our growth strategy, we plan
to have a 15-20% unit growth in the number of new stores opened for this fiscal
year with a target of 26 new stores. We believe we are on track to reach our
targeted goal. Our catalog and direct marketing operations, including revenue
generated directly from catalogs, print advertising, single product mailers and
television infomercials, generated 24.4% and 26.4% of our total revenues for the
quarter ended April 30, 2004 and 2003, respectively. Our Internet operations
generated 16.8% and 14.2% of total revenues in the quarter ended April 30 2004
and 2003, respectively. Our wholesale operations generated 4.4% and 1.3% of
total revenues in the quarter ended April 30, 2004 and 2003, respectively.
One of our goals is to continue 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
9
percentage of our total revenues attributable to Sharper Image Design and
Sharper Image branded products was approximately 81% in the quarter ended April
30, 2004 from approximately 79% in the quarter ended April 30, 2003.
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 revenues, and all or most
of our net earnings, occur in our fourth fiscal quarter ending January 31. 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 the quarter ended April 30, 2004 reflect certain
reclassifications made to prior year financial statements in order to conform to
the April 30, 2004 financial statements.
10
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth the results of operations expressed as a
percentage of total revenues for the periods indicated.
Three Months Ended
April 30,
------------------
Percentage of Total Revenues 2004 2003
- ---------------------------- ----- -----
Revenues:
Net store sales 52.0% 55.7%
Net catalog and direct marketing sales 24.4 26.4
Net Internet sales 16.8 14.2
Net wholesale sales 4.4 1.3
Delivery and other 2.4 2.4
----- -----
Total Revenues 100.0% 100.0%
Costs and Expenses:
Cost of products 39.9 40.9
Buying and occupancy 10.3 11.2
Advertising 23.7 22.0
General, selling and administrative 23.9 24.8
Other income (expense) 0.1 (0.1)
----- -----
Earnings before income tax expense 2.3 1.0
Income tax benefit 0.9 0.4
----- -----
Net Earnings 1.4% 0.6%
===== =====
The following table sets forth the components of total revenues for the periods
indicated.
Three Months Ended
April 30,
-----------------------
2004 2003
-------- --------
Revenues (dollars in thousands)
- --------
Net store sales $ 81,362 $ 64,786
Net catalog and direct marketing sales 38,246 30,703
Net Internet sales 26,245 16,571
Net wholesale sales 6,858 1,468
-------- --------
Total Net Sales 152,711 113,528
Delivery and other 3,694 2,781
-------- --------
Total Revenues $156,405 $116,309
======== ========
11
Revenues
- --------
Net sales for the three-month period ended April 30, 2004 increased $39.2
million, or 34.5%, from the comparable three-month period of the prior year.
Returns and allowances for the three-month period ended April 30, 2004, were
10.9% of sales, as compared to 11.4% for the comparable prior year period. The
increase in net sales for the three-month period ended April 30, 2004 compared
to the same period last year was primarily attributable to increases in net
sales from stores of $16.6 million; catalog and direct marketing of $7.5
million; Internet operations of $9.7 million; and wholesale operations of $5.4
million.
The increase in total revenues for the first quarter of fiscal 2004, as compared
to the first quarter of fiscal 2003 was due primarily to the popularity of our
Sharper Image Design proprietary products and Sharper Image brand products,
which continues to be a key factor in the increases in net sales in all selling
channels. Sharper Image Design proprietary products and private label products
increased from approximately 79% of net sales in the first quarter of fiscal
2003 to approximately 81% in the first quarter of fiscal 2004. We believe that
the continued development and introduction of new and popular products is a key
strategic objective and important to our future success. Also contributing to
the increase in total revenues was a comparable store sales increase of 7.8% and
the opening of 29 new stores since the first quarter of fiscal 2003. We believe
the increased investment in our advertising initiatives in fiscal 2003 and the
first quarter of fiscal 2004, including the significant increase in television
infomercial advertising, internet search engine placement advertising, and
single product mailers highlighting primarily selected Sharper Image Design
products, contributed to the higher revenues in all selling channels.
For the three-month period ended April 30, 2004, as compared with the same
period last year, net store sales increased $16.6 million, or 25.6% while
comparable store sales increased by 7.8%. The increase in net store sales for
the three-month period ended April 30, 2004 was primarily attributable to the
popularity of Sharper Image Design proprietary and Sharper Image brand products,
the increased television infomercial advertising and the opening of 29 new
stores, partially offset by the closing of two stores at lease maturity since
April 30, 2003. The opening of 29 new stores, offset by the two store closures,
resulted in an incremental increase to net store sales of $10.3 million from the
same prior year period. The increase in net store sales for the three-month
period ended April 30, 2004 as compared with the same prior year period reflects
a 9.1% increase in average revenue per transaction and a 15.9% increase in total
store transactions.
Comparable store sales are not a measure that has been defined under generally
accepted accounting principles. We define comparable monthly store sales as
sales from stores where selling square feet did not change by more than 15% in
the previous 12 months and which have been open for at least 12 months. Stores
generally become comparable once they have 24 months of comparable sales for our
annual calculation. We believe that comparable store sales, which excludes the
effect of a change in the number of stores open, provides a more useful measure
of the performance of our store sales channel than does the absolute change in
aggregate net store sales.
For the three-month period ended April 30, 2004, net catalog and direct
marketing sales, which includes sales generated from catalog mailings, single
product mailers, print advertising and television infomercials, increased $7.5
million, or 24.6%, as compared with the same period last year. This increase was
driven primarily by a 44.5% increase in television infomercial advertising
spending, a 15.1% increase in single product mailers circulated and a 34.5%
increase in The Sharper Image catalog pages circulated, which includes a 17.3%
increase in The Sharper Image catalogs circulated. The increase in net catalog
and direct marketing sales for the first quarter of fiscal 2004 reflects
increases of 16.5% in transactions and 5.3% in average revenue per transaction
as compared with the same prior year period.
For the three-month period ended April 30, 2004, Internet sales from our
sharperimage.com Web site, which includes the Sharper Image and eBay auction
sites, increased $9.7 million, or 58.4% from the same period last year. This
increase was attributable to a 5.2% increase in average revenue per transaction
12
and an increase of 46.8% in transactions as compared to the same quarter last
year. These increases in Internet sales and transactions were in large part
driven by a 209.7% increase in Internet advertising, primarily through search
engine placement and affiliate revenue share programs.
For the three-month period ended April 30, 2004, wholesale sales increased $5.4
million, or 367.2% from the same period of the prior year. 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 will continue to grow,
strengthening our brand name and broadening our customer base. We also believe
that although the additional wholesale business should add to overall company
sales and profitability, this additional wholesale business may put pressure on
our own Sharper Image sales increases and may reduce gross margin rate
performance.
Cost of Products
- ----------------
Cost of products for the three-month period ended April 30, 2004 increased $14.8
million, or 31.1%, from the comparable prior year period. The increase in cost
of products is due to the higher sales volume compared to the same period last
year. The gross margin rate for the first quarter of fiscal 2004 was 60.1%,
compared to 59.0% in the same period of the prior year due a shift in sales to
Sharper Image Design proprietary and Sharper Image brand products which
generally have higher gross margin rates. The gross margin rate improvement was
negatively impacted by delivery expense of $4.8 million which was $1.2 million
in excess of delivery income collected. Delivery expense exceeded delivery
income by $0.7 million in the comparable prior year period.
Our gross margin rate fluctuates with the changes in our merchandise mix,
primarily Sharper Image Design proprietary and Sharper Image brand products,
which changes as we make new items available in various categories or introduce
new proprietary products. The variation in merchandise mix from category to
category from year to year is characteristic of our sales results being driven
by individual products rather than by general lines of merchandise.
Additionally, the auction sites and other selected promotional activities, such
as free shipping offers, will, in part, tend to offset the rate of increase in
our gross margin rate. Our gross margins may not be comparable to those of other
retailers, since some retailers include the costs related to their distribution
network in cost of products while we 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 proprietary and Sharper Image brand
products to capitalize on the higher margins realized on these products.
Buying and Occupancy
- --------------------
Buying and occupancy costs for the three-month period ended April 30, 2004
increased $3.0 million, or 23.2%, from the comparable prior year period. The
increase reflects the occupancy costs associated with the 29 new stores opened
since April 30, 2003 and rent increases associated with lease renewals,
partially offset by the occupancy costs of the two Sharper Image stores closed
at lease maturity since April 30, 2003. Buying and occupancy costs as a
percentage of total revenues decreased to 10.3% for the first quarter of 2004
from 11.2% for the first quarter of 2003 due to increasing leverage on store
sales. Our goal is to continue to grow the number of new stores by 15%-20% on an
annual basis, but we cannot assure you we will achieve this goal.
Advertising
- -----------
Advertising for the three-month period ended April 30, 2004 increased $11.5
million, or 45.0%, from the comparable prior year period. The increase in
advertising expense was attributable primarily to a 44.5% increase in television
infomercial advertising expense and a 209.7% 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
15.1% increase in the number of single product mailers circulated and a 34.5%
increase in the number of The Sharper Image catalogs pages circulated, which
includes a 17.3% increase in the number of The Sharper Image catalogs
circulated. Additionally, we continued our other multimedia advertising
initiatives, which included radio and newspaper advertising, among others.
13
Although we believe they contributed to the increase in sales in the stores,
catalog and direct marketing, Internet and wholesale operation channels, there
can be no assurance of the continued success of these advertising initiatives.
Advertising expenses as a percentage of total revenues increased to 23.7% in the
first quarter of fiscal 2004 from 22.0% in the first quarter of fiscal 2003.
Although there is usually a declining marginal benefit obtained by increasing
advertising expenditures, we monitor the effectiveness of our advertising in
order to achieve a reasonable return on our investment in advertising.
We believe that the expansion of our multimedia advertising initiatives
contributed to the sales increases for the first fiscal quarter of 2004 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 to
increase advertising costs dollars to be higher in fiscal 2004 over fiscal 2003,
although not the level of percentage increase experienced in the first quarter
ended April 30, 2004.
General, Selling and Administrative Expenses
- --------------------------------------------
General, selling and administrative, or GS&A, expenses for the three-month
period ended April 30, 2004 increased $8.5 million, or 29.4%, from the
comparable prior year period. Contributing to this increase was an increase of
$2.8 million due primarily to variable expenses from increased net sales. Also
contributing to the increase were increases of $0.3 million for health care and
insurance, $0.9 million for distribution center shipping costs incurred for
product delivery to our stores primarily due to the increase of 27 net new
stores since April 30, 2003, and $1.7 million related to professional fees. GS&A
expenses for the three-month period ended April 30, 2004 decreased as a
percentage of total revenues to 23.9% from 24.8% for the comparable prior year
period.
Other Income and 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. The decrease in other expense relates
to a decrease in loss on the disposal of assets.
Liquidity and Capital Resources
- -------------------------------
We met our short-term liquidity needs and our capital requirements in the
three-month period ended April 30, 2004 with cash generated by operations, trade
credit and existing cash balances.
Net cash provided by operating activities totaled $0.2 million for the first
quarter of fiscal 2004, an increase of $15.0 million from the first quarter of
fiscal 2003. The increase in net cash provided by operating activities is
primarily due to increases in net earnings and tax benefits from stock option
exercises and a decrease in merchandise inventory levels from the end of fiscal
2003, offset by increases in prepaid expenses and accounts payable.
Net cash used in investing activities, primarily capital expenditures for new
stores, tooling costs for proprietary products and technological upgrades to our
operational infrastructure, totaled $12.0 million in the first quarter of fiscal
2004 compared to $5.0 million in the same period of fiscal 2003. During the
first quarter of fiscal 2004, we opened five new stores and began the
configuration of the distribution center located in Richmond, VA.
Net cash provided by financing activities totaled $2.6 million during the first
quarter ended April 30, 2004, which was the result of the proceeds from the
issuance of common stock in connection with our stock option plan.
On October 31, 2003, we terminated our secured credit facility and entered into
a new revolving secured credit facility ("Credit Facility") with Wells Fargo
Bank, National Association. The 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 Credit Facility is
secured by our inventory, accounts receivable, and specified other assets.
Borrowings under the Credit Facility bear interest at either the adjusted LIBOR
rate plus 1.50% or at Wells Fargo's prime rate less 0.25%. The Credit Facility
14
contains financial covenants that only apply during an event of default or when
the borrowing base is drawn below a specified level. These financial covenants
require us to maintain a minimum EBITDA (as defined) on a rolling 12-month basis
of $35 million and to maintain capital expenditures below a specified level
based on our projections. The Credit Facility contains limitations on incurring
additional indebtedness, making additional investments and permitting a change
of control. As of April 30, 2004, letter of credit commitments outstanding under
the Credit Facility were $3.6 million which includes a $1.9 million backstop
letter of credit to cover credit commitments outstanding under the Company's
former secured credit facility.
For the remainder of 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 by increasing our distribution center
capabilities and continue our enhancement of our technology systems. We believe
that our total capital expenditures for fiscal 2004 will be approximately $35
million to $40 million.
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.
Seasonality
- -----------
Our business is highly seasonal, reflecting the general pattern associated with
the retail industry of peak sales and earnings during the Holiday shopping
season. In the past years, a substantial portion of our total revenues and all
or most of our net earnings occur in the fourth quarter ending January 31. The
results of operations for these interim periods are not necessarily indicative
of the results for the full fiscal year.
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.
15
If we fail to continuously offer new merchandise that our customers
find attractive, the demand for our products may be limited.
In order to meet our strategic goals, we must successfully offer our customers
new, innovative and high quality products on a continuous basis. Our product
offerings must be affordable, useful to the customer, well made, distinctive in
design and not widely available from other retailers. We cannot predict with
certainty that we will successfully offer products that meet these requirements
in the future. Some products or a group of related products usually 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 2002, 2003 and the first quarter of fiscal 2004, 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
16
the market price of our common stock. We may not be able to accurately
anticipate the magnitude of these effects on future quarterly results.
Our success depends in part on our ability to 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.
17
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
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
18
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, advertising and our wholesale
operations. Although we believe it is sound business strategy to take advantage
of broadening our customer base and to leverage our brand and advertising
through the increase in our wholesale business, the impact of selling our
Sharper Image Design proprietary and Sharper Image brand products through an
increased number of other selected retailers may put pressure on our own
comparable store sales increase percentage.
Our comparable store sales have fluctuated significantly in the past and we
believe that such fluctuations may continue. Our historic comparable net store
sales changes from the prior fiscal year were as follows:
Fiscal year Percentage increase (decrease)
----------- ------------------------------
2000 29.0
2001 (16.0)
2002 13.6
2003 15.3
2004 (First three months) 7.8
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.
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, single product
mailings and other print media. Our advertising expenditures increased by
approximately $26.0 million or 26.7% in fiscal 2003 from the prior fiscal year.
19
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;
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.
20
In order to continue our expansion of stores, we will need to hire additional
management and staff for our corporate offices and employees for each new store.
We must also expand our management information systems and distribution systems
to serve these new stores. If we are unable to hire necessary personnel or grow
our existing systems, our expansion efforts may not succeed and our operations
may suffer.
Some of our expenses will increase with the opening of new stores. If store
sales are inadequate to support these new costs, our profitability will
decrease. For example, inventory costs will increase as we increase inventory
levels to supply additional stores. We may not be able to manage this increased
inventory without decreasing our profitability. We may need financing in excess
of that available under our current credit facility. Furthermore, our current
credit facility has various loan covenants we must comply with in order to
maintain the credit facility. We cannot predict whether we will be successful in
obtaining additional funds or new credit facilities on favorable terms or at
all.
We rely on our catalog operations which could have significant cost
increases and could have unpredictable results.
Our success depends in part on the success of our catalog operations. We believe
that the success of our catalog operations depends on the following factors:
o our ability to achieve adequate response rates to our
mailings;
o our ability to continue to offer a merchandise mix that is
attractive to our mail order customers;
o our ability to cost-effectively add new customers;
o our ability to cost-effectively design, produce and deliver
appealing catalogs; and
o timely delivery of catalog mailings to our customers
Catalog production and mailings entail substantial paper, postage, merchandise
acquisition and human resource costs, including costs associated with catalog
development and increased inventories. We incur nearly all of these costs prior
to the mailing of each catalog. As a result, we are not able to adjust the costs
being incurred in connection with a particular mailing to reflect the actual
performance of the catalog. Increases in costs of mailing, paper or printing
would increase costs and would adversely impact our earnings if we were unable
to pass such increases directly on to our customers or offset such increases by
raising prices or by implementing more efficient printing, mailing, delivery and
order fulfillment systems. If we were to experience a significant shortfall in
anticipated revenue from a particular mailing, and thereby not recover the costs
associated with that mailing, our future results would be adversely affected. In
addition, response rates to our mailings and, as a result, revenues generated by
each mailing are affected by factors such as consumer preferences, economic
conditions, the timing and mix of catalog 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.
21
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 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.
22
We may be subject to risks associated with our products, including
product liability or patent and trademark infringement claims.
Our current and future products may contain defects, which could subject us to
product liability claims and product recalls. Although we maintain limited
product liability insurance, if any successful product liability claim or
product recalls is not covered by or exceeds our insurance coverage, our
business, results of operations and financial condition would be harmed.
Additionally, third parties may assert claims against us alleging infringement,
misappropriation or other violations of patent, trademark or other proprietary
rights, whether or not such claims have merit. Such claims can be time consuming
and expensive to defend and could require us to cease using and selling the
allegedly infringing products, which may have a significant impact on total
company sales volume, and to incur significant litigation costs and expenses.
If we lose our key personnel, we may not be able to successfully
develop and merchandise our products.
Our success depends to a significant extent upon the abilities of our senior
management, particularly Richard Thalheimer, our Founder, Chairman and Chief
Executive Officer. The loss of the services of any of the members of our senior
management or of certain other key employees could have a significant adverse
effect on our business, financial condition and operating results. We maintain
key man life insurance on Mr. Thalheimer in the amount of $15 million. The terms
of Mr. Thalheimer employment are governed by an employment agreement. Our future
performance will depend upon our ability to attract and retain qualified
management, merchandising and sales personnel. There can be no assurance that
the members of our existing management team will be able to manage our company
or our growth or that we will be able to attract and hire additional qualified
personnel as needed in the future.
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 June 7, 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.
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
23
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.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risks, which include changes in interest rates
and, to a lesser extent, foreign exchange rates. The Company does not engage in
financial transactions for trading or speculative purposes.
The interest payable on the Company's credit facility is based on variable
interest rates and therefore affected by changes in market interest rates. If
interest rates on existing variable debt rose 0.38% (10% from the bank's
reference rate) during the period ending April 30, 2004, the Company's results
from operations and cash flows would not have been materially affected. In
addition, the Company has fixed and variable income investments consisting of
cash equivalents and short-term investments, which are also affected by changes
in market interest rates. The Company does not use derivative financial
instruments in its investment portfolio.
The Company enters into a significant amount of purchase obligations outside of
the U.S. that are settled in U. S. dollars, and therefore, has only minimal
exposure to foreign currency exchange risks. The Company does not hedge against
foreign currency risks and believes that foreign currency exchange risk is
immaterial.
ITEM 4. CONTROLS AND PROCEDURES
(a) Our Chief Executive Officer and our Chief Financial Officer, after
evaluating the effectiveness of the Company's "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 ("Exchange Act")
Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this
quarterly report, have concluded that our disclosure controls and procedures are
effective based on their evaluation of these controls and procedures required by
paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
(b) Changes in internal control over financial reporting. There were no changes
in our internal control over financial reporting identified in connection with
the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15
that occurred during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1 Lease agreement dated May 11, 2004 between the Company and Sri Hills
Plaza Venture LLC.
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.
(b) Reports on Form 8-K
We did not file any report on Form 8-K during the three months ended
April 30, 2004.
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SHARPER IMAGE CORPORATION
Date: June 9, 2004 By: /s/ Tracy Y. Wan
---------------------------------
Tracy Y. Wan
President
Chief Operating Officer
By: /s/ Jeffrey P. Forgan
----------------------------------
Jeffrey P. Forgan
Executive Vice President
Chief Financial Officer