September 14, 1998
SHARPER IMAGE CORP (SHRP)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
RESULTS OF OPERATIONS
The following table is derived from the Company's Statements of Operations and shows the results of operations for the
periods indicated as a percentage of total revenues.
Percentage of Total Revenues
----------------------------
Three Months Ended Six Months Ended
July 31, July 31,
-------- ---------
1998 1997 1998 1997
---- ---- ---- ----
Revenues:
Net store sales 68.8% 71.7% 67.9% 71.3%
Net catalog sales 29.7 26.2 30.4 26.6
Net wholesale sales 0.9 1.3 0.8 1.2
Other revenue 0.6 0.8 0.9 0.9
----- ----- ----- -----
Total Revenues 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Cost of products 52.1 54.2 52.1 54.1
Buying and occupancy 12.6 13.3 14.1 14.4
Advertising and promotion 13.9 10.8 12.8 10.4
General, selling
and administrative 25.0 27.1 26.9 28.6
Other Expense 0.4 0.3 0.4 0.2
----- ----- ----- -----
Loss Before Income Tax Benefit (4.0) (5.7) (6.3) (7.7)
Income Tax Benefit (1.6) (2.3) (2.5) (3.1)
----- ----- ----- -----
Net Loss (2.4)% (3.4)% (3.8)% (4.6)%
===== ===== ===== =====
REVENUES
Net sales for the three-month and six-month periods ended July 31, 1998, increased $6,233,000, or 14.5%, and
$9,590,000, or 12.2%, from the comparable periods of the prior year. Returns and allowances for the three-month and
six-month periods ended July 31, 1998, were 11.1% and 12.0% of sales, as compared with 11.9% and 12.4% of sales for
the comparable prior year periods. For the three-month and six-month periods ended July 31, 1998, as compared with the
same periods last year, net store sales increased $2,981,000, or 9.6%, and $3,845,000, or 6.8%, comparable store sales
increased by 7.2% and 4.3%, and net catalog sales increased $3,349,000 or 29.5%, and $5,970,000 or 28.2%. The
increase in net store sales for the three-month period ended July 31, 1998 as compared with the same prior year period
reflects an 11.8% increase in total store transactions, which was partially offset by a 2.2% decrease in average revenue per
transaction. Total store transactions increased 3.9% for the six-months ended July 31, 1998, with a 2.7% increase in
average revenue per transaction, compared with the same prior year period. The increase in net store sales for the
three-month and six-month periods ended July 31, 1998 is also attributable to the opening of five new stores since July 31,
1997, partially offset by three stores that closed during that same period. The increase in net catalog sales for the three-month
and six-month periods ended July 31, 1998 reflects an increase of 55.9% and 45.0% in total catalog orders, partially offset
by a 16.9% and 11.6% decrease in average revenue per order, compared to the same prior year periods. The increase in net
catalog sales is due to increases in sales for both The Sharper Image and The Sharper Image Home Collection catalogs,
reflecting increased circulation and improved productivity. In addition, the increase in net catalog sales reflects an increase in
sales from the Company's Internet site, sharperimage.com. The increase in The Sharper Image store and catalog sales also
reflects the emphasis and the increase in sales of the Company's Sharper Image Design proprietary products.
COST OF PRODUCTS
Cost of products for the three-month and six-month periods ended July 31, 1998 increased $2,308,000, or 9.8%, and
$3,487,000, or 8.1%, from the comparable prior year periods. The increase in cost of products is due to the higher sales
volume compared to the same periods last year. The gross margin rate for the three-month period ended July 31, 1998 was
47.6% which was 2.2 percentage points better than the comparable prior period. The gross margin rate for the six-month
period ended July 31, 1998 was 47.4% which was 2.0 percentage points better than the comparable prior period. The higher
gross margin rates reflect an increase in sales of the Sharper Image Design proprietary products, which generally carry
higher margins.
BUYING AND OCCUPANCY
Buying and occupancy costs for the three-month and six-month periods ended July 31, 1998 increased $478,000, or 8.3%,
and $1,109,000, or 9.7% from the comparable prior year periods. The increase primarily reflects the occupancy costs
associated with the five new stores opened since July 31, 1997, which was partially offset by the elimination of the
occupancy costs of the three Sharper Image stores closed during that same period.
ADVERTISING AND PROMOTION EXPENSES
Advertising and promotion expenses for the three-month and six-month periods ended July 31, 1998 increased $2,189,000,
or 46.4%, and $3,155,000, or 38.2% from the comparable prior year periods. The increase in advertising and promotion
expenses for the three-month period ended July 31, 1998 reflects a 21.2% increase in pages circulated, including an 8.0%
increase in circulation, for The Sharper Image catalog, an increase in catalog paper prices as compared with the prior year,
and higher other advertising costs. The increase in advertising and promotion expenses for the six-month period ended July
31, 1998 reflects a 16.3% increase in pages
circulated, including a 6.7% increase in circulation, for The Sharper Image catalog, increased circulation of the Sharper
Image Home Collection catalog, an increase in catalog paper prices as compared with the prior year, and higher other
advertising costs associated with the introduction of new products.
GENERAL, SELLING AND ADMINISTRATIVE EXPENSES
General, selling and administrative expenses for the three-month and six-month periods ended July 31, 1998 increased
$644,000, or 5.5%, and $1,270,000, or 5.6% from the comparable prior year periods. The increase was primarily due to
increases in overall selling expenses related to the increase in net sales.
LIQUIDITY AND CAPITAL RESOURCES
The Company met its short-term liquidity needs and its capital requirements in the six-month period ended July 31, 1998
with available cash, trade credit, and borrowings under the credit facility. During the six-month period ended July 31, 1998,
the Company's cash decreased by $2,908,000 to $593,000 primarily due to the funding of working capital during the
period.
The Company has a revolving secured credit facility with The CIT Group/Business Credit, Inc. (CIT) which expires
September 2003. The credit facility has been amended on several occasions and, as of July 31, 1998, the agreement allows
the Company borrowings and letters of credit up to a maximum of $28 million for the period from October 1, 1998 through
December 31, 1998, and $20 million for other times of the year based on inventory levels. The credit facility is secured by
the Company's inventory, accounts receivable, general intangibles and certain other assets. Borrowings under this facility
bear interest at either prime plus 0.50% per annum or at LIBOR plus 2.50% per annum. The credit facility contains certain
financial covenants pertaining to interest coverage ratio and net worth and contains limitations on operating leases, other
borrowings, dividend payments and stock repurchases. For the period ended July 31, 1998, the Company was in
compliance with all covenants. At July 31, 1998, the Company had $2.0 million outstanding on its revolving credit facility.
Letter of credit commitments outstanding under the credit facility were $3.7 million. Based on financial performance,
effective September 1, 1998, interest on borrowings under the credit facility will be lowered to either prime plus 0.25% per
annum or LIBOR plus 2.25% per annum. Future interest rates may stay at this lower level if certain financial performance
criteria are met.
In addition, the credit facility provides for term loans for capital expenditures (Term Loans) up to an aggregate of $4.5
million. Amounts borrowed under the Term Loans bear interest at a variable rate of either prime plus 0.75% per annum or at
LIBOR plus 2.75% per annum. Each Term Loan is to be repaid in 36 equal monthly principal installments. Notes payable
included a Term Loan which bears interest at a variable rate of prime plus 0.75%, provides for monthly principal payments
of $55,555 plus the related interest payment, and matures in October 1999. At July 31, 1998, the balance of the Term Loan
was $0.8 million. Based on financial performance, effective September 1, 1998, interest on borrowings under the credit
facility will be lowered to either prime plus 0.50% per annum or LIBOR plus 2.50% per annum. Future interest rates may
stay at this lower level if certain financial performance criteria are met.
Notes payable also included two mortgage loans collateralized by certain property and equipment. In connection with the
expansion of the Company's distribution center in 1995, the Company refinanced the mortgage loan. This $3.0 million note
bears interest at a fixed rate of 8.40%, provides for monthly payments of principal and interest in the amount of $29,367,
and matures in January 2011. The other note bears interest at a variable rate equal to the rate on 30-day commercial paper
plus 3.82%, provides
for monthly payments of principal and interest in the amount of $14,320, and matures in January 2000. The respective
balance of each note payable at July 31, 1998 is $2.7 million and $0.2 million. During the six-month period ended July 31,
1998, the Company closed two stores located in Escondido, California and Gurnee Mills, Illinois. The Company is currently
evaluating its plan to open four to eight new Sharper Image stores during fiscal 1998. Total capital expenditures estimated
for the new and existing stores, including the remodel of a number of existing stores, corporate headquarters, and the
distribution center for fiscal 1998 are between $6 million to $8 million.
The Company believes it will be able to fund its cash needs for the remainder of the fiscal year through internally generated
cash, trade credit and the credit facility.
SEASONALITY
The Company's business is highly seasonal, reflecting the general pattern associated with the retail industry of peak sales
and earnings during the Christmas season. The secondary peak period for the Company is June, reflecting the gifting for
Father's Day and graduations. A substantial portion of the Company's total revenues and all or most of the Company's net
earnings occur in the fourth quarter ending January 31. The Company generally experiences lower revenues and earnings
during the other quarters and, as is typical in the retail industry, 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.
YEAR 2000 MATTERS
The Company recognizes that the arrival of the year 2000 poses a unique worldwide challenge to the ability of all systems to
recognize the date change from December 31, 1999 to January 1, 2000. The year 2000 issue could result, at the Company
and elsewhere, in system failures or miscalculations causing disruptions of operations, including, among other things, a
temporary inability to process transactions or to engage in other normal business activities. The company has assessed its
computer and business processes and is reprogramming its computer applications to provide for their continued
functionality. An assessment of the readiness of the external entities with which it interfaces is ongoing.
In 1996, the Company developed a detailed year 2000 Conversion Project Plan ("Plan") to address the methods to correct
possible disruptions of operations due to the year 2000 issue. The Plan took into consideration the following items: (i)
identification and inventorying of hardware, application software, and equipment utilizing programmable logic chips to
control aspects of their operation, with potential year 2000 problems; (ii) assessment of scope of year 2000 issues for, and
assigning priorities to, each item based on its importance to the Company's operations; (iii) remediation of year 2000 issues
in accordance with assigned priorities, by correction, upgrade, replacement or retirement; (iv) testing for and validation of
year 2000 compliance; (v) determination of key vendor and customers and their year 2000 compliance. Because the
Company uses a variety of information technology systems, internally-developed and third-party provided software and
embedded chip equipment, depending upon business function and location, various aspects of the Company's year 2000
efforts are in different phases and are proceeding in parallel. At this time, the difficult and time consuming task of identifying
and inventorying hardware and application software with year 2000 issues and developing specific strategies for compliance
has been completed. The assessment process of internal operating systems is complete, with critical applications being
determined, planned for, and outlined. The Company's main operating system and hardware have been upgraded
for year 2000 compliance, with all critical application conversion work having begun. This critical conversion work is
scheduled to be tested and installed by January 1999. Non-critical system conversions have been identified and scheduled
for completion in June 1999. This conversion process encompasses all areas of operations of the Company, from
verification of the year 2000 compliance of the software accounting packages, to email systems, to telephone systems. Based
upon a detailed review and update of the Plan performed in June 1998, conversion of all critical and non-critical Company
programs are expected to be completed with full implementation by June 1999.
The Company's operations are also dependent on the year 2000 readiness of third parties who do business with the
Company. In particular, the Company's information technology systems interact with commercial electronic transaction
processing systems to handle customer credit card purchases and other point of sale transactions, and the Company is
dependent on third-party suppliers of such infrastructure elements as telephone services, electric power, water, and banking
facilities. The Company does not depend to any significant degree on any single merchandise vendor or upon electronic
transaction processing with individual vendors for merchandise purchases. The Plan includes identifying and initiating
formal communications with key third parties and suppliers and with significant merchandise vendors to determine the extent
to which the Company will be vulnerable to such parties' failure to resolve their own year 2000 issues. Although the
Company has not been put on notice that any known third party problem will not be resolved, the Company has limited
information and no assurance of additional information concerning the year 2000 readiness of third parties. The resulting
risks to the Company's business are very difficult to assess.
The estimated cost for this project is between $500,000 and $1,000,000, and is being funded through operating cash flows.
Operating costs related to year 2000 compliance projects will be incurred over several quarters and will be expensed as
incurred.
Based upon the planning and conversions completed to date, the Company believes that, with modifications to existing
software, conversions to new software, and appropriate remediation of embedded chip equipment, the year 2000 issue is not
reasonably likely to pose significant operational problems for the Company's information technology systems and embedded
chip equipment as so modified and converted.
The Company is presently unable to assess the likelihood that the Company will experience operational problems due to
unresolved year 2000 problems of third parties who do business with the Company. There can be no assurance that other
entities will achieve timely year 2000 compliance; if they do not, year 2000 problems could have a material impact on the
Company's operations. Where commercially reasonable to do so, the Company intends to assess its risks with respect to
failure by third parties to be year 2000 compliant and to seek to mitigate those risks. If such mitigation is not achievable, year
2000 problems could have a material impact on the Company's operations.
The Company's estimates of the costs of achieving year 2000 compliance and the date by which year 2000 compliance will
be achieved are based on management's best estimates, which were derived using numerous assumptions about future
events including the continued availability of certain resources, third party modification plans and other factors. However,
there can be no assurance that these estimates will be achieved, and actual results could differ materially from these
estimates. Specific factors that might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in year 2000 remediation work, the ability to locate and correct all computer codes,
the success achieved by the Company's suppliers in reaching year 2000 readiness, the timely availability of necessary
replacement items and similar uncertainties.
The Company presently believes that the most reasonably likely worst-case scenarios that the Company might confront with
respect to year 2000 issues have to do with third parties not being year 2000 compliant. The Company is presently
evaluating vendor and customer compliance and will develop contingency plans, such as alternate vendor opportunities, after
obtaining compliance evaluations. The Company timeline is to develop contingency plans by September 1999.
UNCERTAINTIES AND RISK
The foregoing discussion and analysis should be read in conjunction with the Company's financial statements and notes
thereto included with this report. The foregoing discussion contains certain forward-looking statements that are subject to
certain risks and uncertainties that could cause actual results to differ materially from those set forth in such forward-looking
statements. Such risks and uncertainties include, without limitation, risks of changing market conditions in the overall
economy and the retail industry, consumer demand, the opening of new stores, actual advertising expenditures by the
Company, the success of the Company's advertising and merchandising strategy, availability of products, transportation of
products, unforeseen difficulties arising from the Company or its vendors, suppliers or customers modifying their
information technology systems, software systems and embedded chip equipment to become year 2000 compliant, and other
factors detailed from time to time in the Company's annual and other reports filed with the Securities and Exchange
Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of
the date thereof. The Company undertakes no obligations to publicly release any revisions to these forward-looking
statements or reflect events or circumstances after the date hereof. |
