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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended April 30, 2005

or

For the transition period from                      to                     

Commission File Number: 0-15827

SHARPER IMAGE CORPORATION

(Exact name of registrant as specified in its charter)

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, 15,033,610 shares as of June 6, 2005

Table of Contents

SHARPER IMAGE CORPORATION

FORM 10-Q

For the Quarter Ended April 30, 2005

INDEX

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Sharper Image Corporation

Condensed Balance Sheet

(In thousands, except share amounts)

See Notes to Condensed Financial Statements

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Sharper Image Corporation

Condensed Statements of Operations

(In thousands, except share and per-share amounts)

See Notes to Condensed Financial Statements

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Sharper Image Corporation

Condensed Statements of Cash Flows

(In thousands)

See Notes to Condensed Financial Statements

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PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Sharper Image Corporation

Notes to Condensed Financial Statements

Three-month periods ended April 30, 2005 and 2004

NOTE A- Interim Financial Statements

Basis of Presentation

The condensed balance sheets at April 30, 2005 and 2004, the related condensed statements of operations and cash flows for the three-month periods ended April 30, 2005 and 2004 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, 2005 and 2004, and for the three-month period then ended. The balance sheet at January 31, 2005, presented herein, has been derived from the audited balance sheet of the Company.

Certain information and footnote disclosures normally included in the notes to annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted from these interim financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, these interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K filed with the SEC for the fiscal year ended January 31, 2005, which includes additional disclosures, including the Company’s significant accounting policies.

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 lower 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.

Reclassifications

The April 30, 2004 investments in auction rate securities of $33.4 million have been reclassified from cash and cash equivalents to short-term investments on the Company’s Condensed Balance Sheet and Statement of Cash Flows. The reclassification was effected as the securities had stated maturities beyond three months but were priced and traded as short-term investments due to the liquidity provided through the interest rate reset mechanism of approximately every 35 days. The purchase and sale of short-term investments previously presented as cash and cash equivalents have been reclassified to investing activities in the Company’s condensed Statements of Cash Flows. The effect of this reclassification resulted in an increase in net cash provided by investing activities of $15.3million for the three months ended April 30, 2004.

Use of Estimates

The preparation of condensed financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ materially from estimates and assumptions made.

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New Accounting Standards

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”) which replaces SFAS No. 123, supercedes Accounting Principles Board (APB) No. 25 and related interpretations and amends SFAS No. 95, “Statement of Cash Flows.” The provisions of SFAS No. 123R are similar to those of SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statement as compensation cost based on their fair value on the date of the grant. The fair value of the share-based awards will be determined using an option-pricing model on the grant date. SFAS No. 123R is effective at the beginning of the first fiscal year beginning after June 15, 2005. The Company will adopt SFAS No. 123R no later than the first quarter of fiscal 2006.

In November 2004, the FASB issued SFAS No.151, “Inventory Costs—An Amendment of Accounting Research Bulletin No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. The provisions in SFAS No. 151 must be applied prospectively to the Company’s inventory costs incurred after January 1, 2006. The adoption of SFAS No. 151 is not expected to have an impact on the Company’s financial statements.

Note B—Restatement of Condensed Financial Statements

On February 7, 2005, the Office of the Chief Accountant of the SEC issued a letter in which it expressed its views regarding certain operating lease accounting issues and their application under GAAP. The Company’s management subsequently reviewed its lease-related accounting practices and determined that a correction was required to the way it accounted for its leases, specifically the accounting for rent holidays. Before this correction, the Company recognized the straight-line expense for leases beginning on the commencement date of the lease, generally the store opening date; this had the effect of excluding the stores’ construction and pre-opening periods from the total time over which the Company expensed rent. As a result, the Company corrected its accounting to include the construction and pre-opening period in determining its straight-line rent and to capitalize rent expense during the stores’ construction period and to amortize that capitalized rent over the lease period or the life of the leasehold improvements, whichever is shorter.

In addition, as part of the Company’s self-assessment and self-testing of its internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002, management identified an error in certain accounts within accounts payable, as reported in its previously issued financial statements. The error occurred in certain calculations and inventory valuation adjustments, resulting in an understatement of accounts payable and an overstatement of net income.

As a result, the accompanying historical financial statements as of and for the three months ended April 30, 2004 have been restated from the amounts previously reported. A summary of the effects of the restatement is as follows:

Balance Sheet

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Statement of Operations

NOTE C - 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 and cancellations 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:

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In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”) which replaces SFAS No. 123, supersedes Accounting Principles Board (APB) No. 25 and related interpretations and amends SFAS No. 95, “Statement of Cash Flows.” The provisions of SFAS No. 123R are similar to those of SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements as compensation cost based on their fair value on the date of the grant. The fair value of the share-based awards will be determined using an option-pricing model on the grant date. SFAS No. 123R is effective at the beginning of the first fiscal year beginning after June 15, 2005. The Company is currently evaluating the provisions of SFAS No. 123R and will be adopting it no later than the first fiscal quarter of 2006.

NOTE D - Earnings per Share

Basic earnings per share is computed as net income available to common stockholders divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur from common shares to be issued through stock options.

The potential effects of stock options were excluded from the diluted earnings per share for the three-month period ended April 30, 2005 because their inclusion in net loss periods would be anti-dilutive to the earnings per share calculation. Options to purchase 2,700,927 shares of common stock were outstanding as of April 30, 2005.

Had the Company been in a net income position, 1,021,140 stock options for the three months ended April 30, 2005 would have been excluded from the diluted earnings per share calculation because the option exercise price exceeded the average stock price for those periods. There were no options excluded from the computation of diluted earnings per share for the quarter ended April 30, 2004.

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NOTE E - Revolving Loan and Notes Payable

The Company has a revolving secured credit facility with Wells Fargo Bank, National Association. The credit facility has a maturity date of October 31, 2006, and allows 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) on a rolling 12-month basis 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, 2005, letter of credit commitments outstanding under the credit facility were $2.7 million and there were no borrowings outstanding. The Company believes that it is in compliance with all of its debt covenants as of April 30, 2005.

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NOTE F – 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.

On and after April 18, 2005 a number of purported stockholder class action lawsuits have been commenced in the United States District Court for the Northern District of California on behalf of purchasers of the Company’s common stock during the period of February 5, 2004 and August 4, 2004 (the “Class Period”). The complaints allege that during the Class Period, the Company and certain of its officers and employee-directors made false and misleading statements regarding the Company’s business and business prospects. The Company believes these lawsuits are without merit and intends to defend itself vigorously. The Company does not believe that the ultimate resolution of these lawsuits will have a material adverse effect on the financial position of the Company, although an adverse effect on one or more of these lawsuits could have a material impact on the results of operations.

NOTE G – Stockholders’ Equity

In October 2004, the Board of Directors authorized a stock repurchase program to acquire up to one million shares of outstanding common stock in the open market. Through April 30, 2005, the Company repurchased 710,000 shares under this authorization at a total cost of $11.1 million. All of the shares repurchased during the quarter ended April 30, 2005 were under the approved authorization by the Board of Directors.

NOTE H - 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 2004 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:

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PART I - FINANCIAL INFORMATION

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 Results of Operations and Financial Condition 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.

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OVERVIEW

The Sharper Image is a multichannel 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 decreased 7.4% to $144.9 million in the quarter ended April 30, 2005 from $156.4 million in the quarter ended April 30, 2004. This decrease was due primarily to a decrease in the sale of our Sharper Image Design and Sharper Image branded products, a comparable store sales decrease of 16.0% and lower levels of advertising.

Our store operations generated the highest proportion of our sales, representing 54.0% and 52.0% of total revenues for the quarters ended April 30, 2005 and 2004, respectively. As of April 30, 2005, we operated 180 The Sharper Image stores in 37 states and the District of Columbia. As part of our growth strategy, we plan to open approximately 18-24 new stores for this fiscal year. 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 19.3% and 24.4% of our total revenues for the quarters ended April 30, 2005 and 2004, respectively. Our Internet operations generated 16.0% and 16.8% of total revenues in the quarters ended April 30 2005 and 2004, respectively. Our wholesale operations generated 8.2% and 4.4% of total revenues in the quarters ended April 30, 2005 and 2004, 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 percentage of our total revenues attributable to Sharper Image Design and Sharper Image branded products was approximately 72% in the quarter ended April 30, 2005, decreasing from approximately 81% in the quarter ended April 30, 2004.

Our 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 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 approximately 40% of total revenues in both fiscal 2004 and 2003. In addition, the fourth quarter accounted for substantially all of our net earnings in 2004 and 2003.

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RESULTS OF OPERATIONS

A summary of our operating results is presented below. This discussion includes our results presented on the bases required by GAAP.

The following table sets forth the components of total revenues for the periods indicated.

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Revenues

Net sales for the three-month period ended April 30, 2005 decreased $11.5 million, or 7.5%, from the comparable three-month period of the prior year. Returns and allowances for the three-month period ended April 30, 2005 were 12.5% of sales, as compared to 10.9% for the comparable prior year period. The decrease in net sales was primarily attributable to decreases in net sales from stores of $3.1 million; catalog and direct marketing of $10.3 million; and Internet operations of $3.1 million. These decreases were partially offset by a $5.0 million increase in net wholesale sales. The increase in the returns and allowances percentage was due primarily to a reduction in sales and an increase in returns of our air purification line of products.

The decrease in total revenues for the first quarter of fiscal 2005, as compared to the first quarter of fiscal 2004 was due primarily to a decrease in comparable store sales of 16.0%, a decrease in the sales of our Sharper Image Design proprietary products and Sharper Image branded products, a decrease in our advertising expenses which generally increases traffic in all selling channels, partially offset by the opening of 29 new stores since the first quarter of fiscal 2004 and increases in sales in the electronics and massage chair categories. Sharper Image Design proprietary products and private label products decreased from the record level of approximately 81% of net sales in the first quarter of fiscal 2004 to approximately 72% in the first quarter of fiscal 2005. We believe that the continued development and introduction of new and popular products is a key strategic objective and important to our future success.

For the three-month period ended April 30, 2005, as compared with the same period last year, net store sales decreased $3.1 million, or 3.8% while comparable store sales decreased by 16.0%. The opening of 29 new stores, offset by the three store closures, resulted in an incremental increase to net store sales of $8.6 million from the same prior year period. The decrease in net store sales for the three-month period ended April 30, 2005 as compared with the same prior year period reflects 0.3% decrease in transactions, partially offset by a 3.6% increase in average revenue per transaction.

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, 2005, net catalog and direct marketing sales, which includes sales generated from catalog mailings, single product mailers, print advertising and television infomercials, decreased $10.3 million, or 27.0%, as compared with the same period last year. This decrease was driven primarily by a 20.2% decrease in television infomercial advertising spending, a 24.4% decrease in single product mailers circulated and a 54.4% decrease in radio advertising, and a 10.0% decrease in The Sharper Image catalog pages circulated, although we had a 9.0% increase in The Sharper Image catalogs circulated. The decrease in net catalog and direct marketing sales for the first quarter of fiscal 2005 reflects a decrease of 26.1% in transactions, partially offset by a 6.4% increase in average revenue per transaction as compared with the same prior year period.

For the three-month period ended April 30, 2005, Internet sales from our sharperimage.com Web site, which includes the Sharper Image and eBay auction sites, decreased $3.1 million, or 11.8% from the same period last year. This decrease was attributable to a 13.5% decrease of transactions, partially offset by a 0.7% increase in average revenue per transaction as compared to the same quarter last year. The decreases in Internet sales and transactions were also due to a 7.7% decrease in Internet advertising which includes paid-for search engine key word placement and revenue share costs incurred for affiliate programs.

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For the three-month period ended April 30, 2005, wholesale sales increased $5.0 million, or 72.4% 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, test programs with new wholesale customers and a shift in the timing of customer purchases from the second fiscal quarter in to the first fiscal quarter of the current year. We believe that the wholesale business will continue to strengthen our brand name and broaden 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, 2005 increased $3.6 million, or 5.7%, from the comparable prior year period. The gross margin rate for the first quarter of fiscal 2004 was 54.2%, compared to 59.9% in the same period of the prior year due to a decrease in sales of Sharper Image Design proprietary and Sharper Image branded products which generally have higher gross margin rates and an increase in sales of electronics, which generally have lower gross margin rates. The gross margin rate decline was partially offset by the positive impact of delivery expense of $4.2 million which was $0.8 million in excess of delivery income collected. Delivery expense exceeded delivery income by $1.2 million in the comparable prior year period.

Our gross margin rate fluctuates with our merchandise mix, primarily Sharper Image Design proprietary 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 lines of merchandise. Additionally, use of 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 branded products to capitalize on the higher gross margins realized on these products.

Buying and Occupancy

Buying and occupancy costs for the three-month period ended April 30, 2005 increased $2.8 million, or 17.3%, from the comparable prior year period. The increase reflects the occupancy costs associated with the 29 new stores opened since April 30, 2004 and rent increases associated with lease renewals, partially offset by the occupancy costs of the three Sharper Image stores closed at lease maturity since April 30, 2004. Buying and occupancy costs as a percentage of total revenues increased to 13.0% for the first quarter of 2005 from 10.3% for the first quarter of 2004 due to decreasing leverage on store sales. Our current goal is to open approximately 18-24 new stores on an annual basis, but we cannot assure you we will achieve this goal.

Advertising

Advertising for the three-month period ended April 30, 2005 decreased $4.6 million, or 12.4%, from the comparable prior year period. The decrease in advertising expense was attributable primarily to a 20.2% decrease in television infomercial advertising expense, a 7.7% decrease in Internet advertising, which includes search engine key word placement and revenue share costs incurred for affiliate programs and a 54.4% decrease in radio advertising. Also contributing to the decrease in advertising is a 24.4% decrease in the number of single product mailers circulated and a 10.0% decrease in the number of The Sharper Image catalog pages circulated, although we had a 9.0% increase in the number of The Sharper Image catalogs circulated.

Advertising expenses as a percentage of total revenues decreased to 22.4% in the first quarter of fiscal 2005 compared to 23.7% in the first quarter of fiscal 2004. Our advertising strategy will continue to be an important factor in our future revenue growth. However, we expect to review the return on investment of our advertising campaigns to ensure that advertising costs are reasonable and effective for us. We expect to continue to spend on advertising and marketing at significant levels in fiscal 2005, but atlower levels than fiscal 2004.

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General, Selling and Administrative Expenses

General, selling and administrative, or GS&A, expenses for the three-month period ended April 30, 2005 decreased $2.4 million, or 6.5%, from the comparable prior year period. Contributing to this was a decrease of $2.7 million due primarily to variable expenses from decreased net sales, offset by an increase of $1.7 million in variable expenses related to the 29 new stores opened after April 30, 2004. Also contributing to the decrease were decreases of $0.5 million of professional fees, $0.1 million for distribution center shipping costs incurred for product delivery to our stores and $0.1 million related to travel expenses.

Other Income and Expense

The increase in interest income is primarily due to higher interest rates earned on our cash and investment balances. The increase in other expense relates to an increase in losses related to 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, 2005 with existing cash and investment balances.

Net cash used by operating activities totaled $15.4 million for the first quarter of fiscal 2005. Net cash used by operating activities increased by $15.6 million from the first quarter of fiscal 2004, which was due to a decrease in net earnings, a decrease in accounts payable and accrued expenses balances, and a decrease in the reduction of inventory balances between our fiscal year end and the first quarter.

Net cash provided by investing activities totaled $26.0 million for the first quarter of fiscal 2005, which was primarily due to net redemptions of short-term investments of $36.0 million. We also used $10.0 million for capital expenditures relating to new and remodeled stores, technological enhancements and tooling costs for Sharper Image Design products.

Net cash used by financing activities totaled $9.1 million during the first quarter of fiscal 2005, which primarily resulted from the repurchase of our Common Stock.

For fiscal 2005, we plan to open approximately 18-24 new stores and the remodel of five to eight of our existing store locations. We plan to continue our capital investment in tooling costs for proprietary products and continue the enhancement of our technological systems at a more moderate pace than the two previous years. We believe that our total capital expenditures for fiscal 2005 will be approximately $37 million to $42 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.

New Accounting Standards

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123R”) which replaces SFAS No. 123, supercedes Accounting Principles Board (APB) No. 25 and related interpretations and amends SFAS No. 95, “Statement of Cash Flows.” The provisions of SFAS No. 123R are similar to those of SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statement as compensation cost based on their fair value on the date of the grant. The fair value of the share-based awards will be determined using an option-pricing model on the grant date. SFAS No. 123R is effective at the beginning of the first fiscal year beginning after June 15, 2005. The Company will adopt SFAS No. 123R no later than the first quarter of fiscal 2006.

In November 2004, the FASB issued SFAS No.151, “Inventory Costs—An Amendment of Accounting Research Bulletin No. 43, Chapter 4” (“SFAS No. 151”). SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. The provisions in SFAS No. 151 must be applied prospectively to the Company’s inventory costs incurred after January 1, 2006. The adoption of SFAS No. 151 is not expected to have an impact on the Company’s financial statements.

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.

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CERTAIN ADDITIONAL BUSINESS RISK FACTORS

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 Certain Additional Business Risk Factors) 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 Results of Operations and Financial Condition” 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.

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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 do not maintain sufficient inventory levels, if we are unable to deliver our products to our customers in sufficient quantities, or if our inventory levels are too high, 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 season. 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. If our inventory levels are too high, we may recognize lower gross margins in order to sell through this inventory. 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, fiscal 2004, and through the first quarter of fiscal 2005, 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 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, increasing gas prices, 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 conditions on future quarterly results.

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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. 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, 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 Chinese Yuan (“CNY”), to float against the U.S. Dollar (“USD”). Although substantially all of our supply contracts in China are denominated in USD, our suppliers could attempt to renegotiate these contracts and increase costs to us if the CNY/USD exchange rate were to change.

We had a single supplier for a number of our products, located in Asia, that provided approximately 28% of the net merchandise purchases in fiscal 2004 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 also may be unable to develop relationships with new vendors.

We depend on our vendors’ ability to timely deliver sufficient quantities of products and our business can be harmed by work stoppages or other interruptions to delivery of products.

All products we purchase from our vendors in Asia must be shipped to our distribution centers by freight carriers and we cannot assure you that we will be able to obtain sufficient freight capacity on a timely basis and at favorable rates. Our inability to acquire suitable products in a cost-effective, timely manner or the loss of one or more key vendors or freight carriers could have a negative effect on our business.

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Many of our shipments that come from Asia move through the West Coast ports that have been negatively impacted by the West Coast port slowdown. During the second half of fiscal 2004, this slowdown caused our airfreight costs to increase as we used alternative delivery methods to mitigate some of the impacts of the slowdown. The increased usage of air freight transportation had a negative impact on our gross margins. We are anticipating continuing congestion at West Coast ports through 2005, which may increase our transportation costs and have a negative effect on our gross margins and profits.

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 house marks “The Sharper Image”, “sharperimage.com”, “Sharper Image Design” and “Sharper Image” as well as the trademark fame that we have established are of significant value. We actively pursue and protect, domestically and internationally, not only all of our corporate trademarks, but other intellectual property rights including patents, copyrights and trade secrets to ensure that the quality of our brand and the value of our proprietary rights are maintained. We protect our proprietary marketing strategies, illustrative catalogs and product packaging through numerous copyright registrations. We also seek patents to establish and protect our proprietary rights relating to the technologies and products we have developed, are in the process of developing, or that we may develop in the future. 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 58 U.S. utility patents and 100 U.S. design patents.

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.

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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 approximately 40% of total revenues in both fiscal 2004 and 2003. In addition, the fourth quarter accounted for substantially all of our net earnings in fiscal 2004 and 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, 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 and Sharper Image branded 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:

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.

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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 decreased by approximately $4.6 million or 12.4% for the three months ended April 30, 2005 from the same prior fiscal year period. 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. We expect to continue to spend on advertising and marketing at significant levels in fiscal 2005, but at slightly lower levels than fiscal 2004. We may not be able to continue to produce a sufficient level of sales to cover such expenditures, which would reduce our profitability.

The continued growth of our wholesale sales presents certain risks that could adversely affect our profitability.

We sell products through a multichannel strategy. While we believe that our wholesale sales offer growth opportunities and exposure to a greater customer base, this growth could adversely impact our business. In general, depending on product mix, our sales to wholesale partners carry lower gross margins than sales made through our other channels. In addition, these sales could shift sales from our higher margin sales channels, particularly our retail and catalog channels. Wholesale customers may also decide to decrease or eliminate their level of purchases.

Our business will be harmed if we are unable to successfully implement our growth strategy.

Our growth strategy primarily includes the following components:

Any failure on our part to successfully implement any or all components of our growth strategy 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 open approximately 18-24 new stores in fiscal 2005. 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:

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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.

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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:

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.

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 make it difficult to meet customer demand.

We conduct the majority of our distribution operations and all of our catalog and Internet order processing fulfillment functions from our own facility in Little Rock, Arkansas; and leased facilities in Little Rock, Arkansas; Ontario, California; and Richmond, Virginia. We also use contract fulfillment and warehouse facilities for additional seasonal requirements. Any disruption in the operations at any distribution center, particularly during the holiday shopping season, could result in late delivery of products and make it difficult to meet customer demand for our products.

In addition, we rely upon third party carriers for our product shipments, including shipments to and from all of our stores. As a result, we are subject to certain risks, including employee strikes and inclement weather, associated with such carriers’ ability to provide delivery services to meet our shipping needs.

We are also dependent on temporary employees to adequately staff our distribution facilities, particularly during busy periods such as the holiday shopping season. We cannot assure you that we will continue to receive adequate assistance from our temporary employees, or that we will continue to have access to sufficient sources of temporary employees.

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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 product 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 the 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 affect on our future results.

We may be subject to risks associated with our products, including product liability or patent and trademark infringement claims.

Our current and future products may contain defects, which could subject us to product liability claims and product recalls. Although we maintain limited product liability insurance, if any successful product liability claim or product recalls is not covered by or exceeds our insurance coverage, our business, results of operations and financial condition would be harmed. Additionally, third parties may assert claims against us alleging infringement, misappropriation or other violations of patent, trademark or other proprietary rights, whether or not such claims have merit. Such claims can be time consuming and expensive to defend and could require us to cease using and selling the allegedly infringing products, which may have a significant impact on total company sales volume, and to incur significant litigation costs and expenses.

If we lose our key personnel, we may not be able to successfully develop and merchandise our products.

Our success depends to a significant extent upon the abilities of our senior management, particularly Richard Thalheimer, our Founder, Chairman and Chief Executive Officer. The loss of the services of any of the members of our senior management or of certain other key employees could have a significant adverse effect on our business, financial condition and operating results. We maintain key man life insurance on Mr. Thalheimer in the amount of $15 million. The terms of Mr. Thalheimer’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.

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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 April 30, 2005, 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 May 1, 2004 to April 30, 2005, the price per share of our common stock has ranged from a high of $31.68 to a low of $13.39. We believe that among other factors, any of the following factors could cause the price of our common stock to fluctuate substantially:

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Our charter documents, Delaware law, 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.

We face risks arising from the outcome of various litigation matters, including litigation associated with purported stockholder class actions.

We are involved in various litigation matters, including those arising in the ordinary course of business and those described under the caption “Legal Matters” in Item I of Part II of this Quarterly Report on Form 10-Q for the fiscal quarter ended April 30, 2005. Among these matters is litigation associated with purported stockholder class actions. While we do not believe that any of these litigation matters alone or in the aggregate will have a material adverse effect our financial position, an adverse outcome in one or more of these matters could be material to our results of operations for any one period. Further, litigation can consume substantial management resources and no assurance can be given that any adverse outcome would not be material to our financial position.

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PART I - FINANCIAL INFORMATION

ITEM 3. Quantitative and Qualitative Disclosure About Market Risk

The Company is exposed to market risks, which include changes in interest rates and, to a lesser extent, foreign exchange rates. The Company does not engage in financial transactions for trading or speculative purposes.

The interest payable on the Company’s credit facility is based on variable interest rates and is therefore affected by changes in market interest rates. If interest rates on existing variable debt rose 0.55% (10% from the bank’s reference rate) during the period ended April 30, 2005, 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

Disclosure Controls and Procedures

Our Chief Executive Officer and our Chief Financial Officer, have evaluated 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. As described more fully below, because the Company has not substantially completed its remediation of the material weakness identified as of January 31, 2005, our Chief Executive Officer and our Chief Financial Officer have concluded that based on such evaluation, the Company’s disclosure controls and procedures were not effective as of April 30, 2005.

Internal Control over Financial Reporting

In connection with the preparation of the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2005, the Company conducted its assessment of the effectiveness of its internal control over financial reporting as of January 31, 2005, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer. In connection with this annual assessment management identified a material weakness and therefore concluded that as of January 31, 2005 the Company’s internal control over financial reporting was not effective. The material weakness was that as of January 31, 2005, the Company failed to design and implement appropriate controls regarding its accounting and disclosure for accounts payable that resulted in an understatement of accounts payable and an overstatement of net income, as well as a corresponding overstatement of stockholders’ equity, for fiscal 2003 and fiscal 2002 presented in the Company’s Annual Report on Form 10-K. Specifically, the Company failed to analyze and reconcile on a timely basis its liability for product received and yet to be invoiced. As a result, the Company was required to restate prior interim and annual financial statements. As a result of the material weakness identified within internal control over financial reporting, management also concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e)) were ineffective as of January 31, 2005.

As of the end of the period covered by this report, the Company has taken substantial steps towards improving the financial control related to the material weakness described above. The Company has hired outside consultants to assist in evaluating and enhancing the control process while educating and training the appropriate individuals within the accounting department. In addition, as an interim detective control, the Company has performed subsequent disbursement analysis and accounts payable reconciliation for the first quarter of fiscal 2005 and no exceptions were discovered. In addition, as a potential preventative control, the Company has began testing and implementing a new software system to assist in tracking activity in the affected accounts which allows for exception reporting and timely resolution of unmatched transactions.

The Company believes that these corrective actions have substantially remediated the material weakness described above, but is not yet in a position to conclude that the material weakness no longer exists.

There have been no other changes during the fiscal quarter ended April 30, 2005, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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first quarter of fiscal 2005 and no exceptions were discovered. In addition, the Company has began testing and implementing a new software system to assist in tracking activity in the affected accounts which allows for exception reporting and timely resolution of unmatched transactions.

The Company believes that these corrective actions have remediated the control deficiencies identified above. Because the Company has not yet completed testing the effectiveness of these actions, however, the Company’s management is not yet able to conclude that the Company’s internal control over financial reporting is not effective and, accordingly, has concluded that the Company’s disclosure controls and procedures (as defined) are not effective as of April 30, 2005. The Company plans to continue an on-going review and evaluation of its internal control over financial reporting.

Except as described above, during the first quarter ended April 30, 2005, there have been no significant changes to the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

ITEM 1. Legal Matters

On and after April 18, 2005 a number of purported stockholder class action lawsuits have been commenced in the United States District Court for the Northern District of California on behalf of purchasers of the Company’s common stock during the period of February 5, 2004 and August 4, 2004 (the “Class Period”). The complaints allege that during the Class Period, the Company and certain of its officers and employee-directors made false and misleading statements regarding the Company’s business and business prospects. The Company believes these lawsuits are without merit and intends to defend itself vigorously. The Company does not believe that the ultimate resolution of these lawsuits will have a material adverse effect on the financial position of the Company, although an adverse effect on one or more of these lawsuits could have a material impact on the results of operations for any one period. Further, litigation can consume substantial management resources and no assurance can be given that any adverse outcome would not be material to our financial position.

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

We made the following repurchases of our common stock during the quarter ended April 30, 2005:

In October 2004, the Board of Directors authorized a stock repurchase program to acquire up to one million shares of outstanding common stock in the open market. Through April 30, 2005, we repurchased 710,000 shares under this authorization at a total cost of $11.1 million. All of the shares repurchased during the quarter ended April 30, 2005 were under the approved authorization by the Board of Directors.

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ITEM 5. Other Information

The Company amended and restated its Bylaws, effective as of June 6, 2005, as follows:

The full text of the Amended and Restated Bylaws is attached as Exhibit 3.2 to this report.

ITEM 6. Exhibits

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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