-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, EwRWLwAhxe3rMtbksQlnrP6ocYAdqj8l3O/LiMSET2VFvWOHngQ01JTreivOuDvX uelLvw0R3X5w9LI78MZQSw== 0000950005-99-000397.txt : 19990504 0000950005-99-000397.hdr.sgml : 19990504 ACCESSION NUMBER: 0000950005-99-000397 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19990131 FILED AS OF DATE: 19990503 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SHARPER IMAGE CORP CENTRAL INDEX KEY: 0000811696 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-MISCELLANEOUS SHOPPING GOODS STORES [5940] IRS NUMBER: 942493558 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-15827 FILM NUMBER: 99608499 BUSINESS ADDRESS: STREET 1: 650 DAVIS ST CITY: SAN FRANCISCO STATE: CA ZIP: 94111 BUSINESS PHONE: 4154456000 MAIL ADDRESS: STREET 2: 650 DAVIS STREET CITY: SAN FRANCISCO STATE: CA ZIP: 94111 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ( X ) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended January 31, 1999 or ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _______ Commission File Number 33-12755 SHARPER IMAGE CORPORATION (Exact name of registrant as specified in its charter) Delaware 94-2493558 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 650 Davis Street, San Francisco, California 94111 (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code: (415) 445-6000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ____ The aggregate market value of the voting stock held by non-affiliates of the Registrant as of April 15, 1999 was $42,462,174. The number of shares of Common Stock, with $.01 par value, outstanding on April 15, 1999 was 8,959,648 shares. Documents incorporated by reference: Portions of Registrant's Annual Report to Stockholders for the fiscal year ended January 31, 1999 are incorporated by reference into Parts II and IV of this Report. Portions of Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held June 7, 1999 are incorporated by reference into Part III of this report. 1 PART 1 This Annual Report on Form 10-K and the documents incorporated herein by reference of Sharper Image Corporation (referred to as the "Company" or "The Sharper Image") contain forward-looking statements that have been made pursuant to the provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates, and projections about the Company's industry, management's beliefs and certain assumptions made by the Company's management. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," or variations of such words and similar expressions, are intended to identify such forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under "Factors Affecting Future Operating Results" on pages 10 through 16, as well as those noted in the documents incorporated herein by reference. Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the statements set forth in other reports or documents the Company files from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K. Item 1. Business Overview The Sharper Image Corporation is a specialty retailer which introduces and sells quality, innovative, useful and entertaining products through The Sharper Image stores, monthly mail-order catalog, Internet, and other marketing channels. The Company was founded in 1977 by Richard Thalheimer, who continues as Chairman and Chief Executive Officer. First mailed in 1981, The Sharper Image Catalog found success in the growing field of mail-order shopping. Expansion of The Sharper Image concept to retail stores began in 1984, and as of January 31, 1999, the Company operated 87 The Sharper Image stores in the United States and licensees operated six stores internationally and two airport stores in the United States. The typical Sharper Image stores range from approximately 2,200 to 2,500 selling square feet in size, with several larger size stores that have 3,000 to 5,000 selling square feet. During the fiscal year ended January 31, 1999 (fiscal 1998), the Company opened four new stores of The Sharper Image concept and format. Two Sharper Image stores were closed at the maturity of their leases. The Company plans to open three to five new stores during the fiscal year ending January 31, 2000 (fiscal 1999). Lease terms for certain of the existing The Sharper Image store locations will be maturing during fiscal 1999 and these locations may be relocated or closed. The Company employs approximately 1,300 employees in twenty-eight states and the District of Columbia. In addition to serving as the primary advertising vehicle for the Company's stores, The Sharper Image Catalog generated approximately 29% of total revenues in fiscal 1998. The monthly catalog, which ranged from 52 to 124 pages in fiscal 1998, is recognized for creative excellence within the catalog industry. Worldwide, the Company mailed approximately 41 million of The Sharper Image Catalogs in fiscal 1998. The Company's Internet sales in fiscal 1998 increased over 200 percent to $4.9 million from $1.6 million in the fiscal year ended January 31, 1998 (fiscal 1997). The Company believes the Internet is a significant marketing and sales opportunity. The Sharper Image Catalog is on the World Wide Web at http://www.sharperimage.com. While this sales channel is still emerging, the Company is encouraged with the sales growth in the Internet marketplace and expects to continue be a leader as this market continues its dynamic growth. Other Internet sales channels currently used by the Company include America Online's Shopping Channel, Microsoft Plaza, Yahoo Stores, @ Home Network, Catalog City and PC World Shopping. The Company is known for its varied product mix and a merchandising philosophy focusing on innovative, well-designed, high-quality products that are developed by The Sharper Image, exclusive to The Sharper Image, or in limited 2 distribution. In product lines where the Company competes directly with other retailers, it chooses to sell the best version of the product with the most advanced features. The Company is frequently sought after by manufacturers and inventors to launch technologically innovative products with features that are unique and surprising. During fiscal 1998, the Company continued the development of its in-house Sharper Image Design product development function. The percentage of sales attributable to Sharper Image Design proprietary products increased from eight percent in fiscal 1997 to 18 percent in fiscal 1998. This increase was the primary reason that the gross margin percentage rate improved by 2.7 percentage points in fiscal 1998. The Company's goal is to continue to increase the proportion of sales from Sharper Image Design proprietary products. The Company's business is highly seasonal, with sales peaks at the holiday periods of Father's Day and Christmas. See "Seasonality." Historically, the typical Sharper Image demographic mix has been upper income. In addition to its primary businesses, The Sharper Image leverages its brand name and reputation through a corporate marketing program, wholesale sales of Sharper Image brand products, which include Sharper Image Design proprietary products and private-labeled products, and a product licensing program with selected businesses. Wholesale sales are made primarily to fine department stores and to international retailers. Store Operations The Sharper Image stores are located throughout the United States-typically in densely populated downtown financial districts and business centers, upscale shopping malls and drive-up suburban locations. Each store is generally staffed with approximately six to eight employees, including a manager, an assistant manager, a senior sales associate, sales associates, and other support staff. A few of the Company's high volume stores are staffed with 11 to 15 associates. Current store personnel compensation structure is based largely on commission and is closely monitored in relation to sales. The Company expends considerable effort to train its sales associates on the many new, and often technically oriented products, in order to maintain a high customer service level. The Sharper Image stores are designed by the Company's design staff at the Company's headquarters to standardize layout, where possible, so as to simplify their operations. The stores are operated according to standardized procedures for customer relations, merchandise display and pricing, product demonstration, inventory maintenance, personnel training, administration and security. The Company's original Sharper Image stores typically have 2,200 to 2,500 square feet of selling space and approximately 1,300 to 2,200 square feet of storage and administrative space. The cost of leasehold improvements, fixtures and other equipment associated with the opening of a new Sharper Image store has averaged approximately $350,000 to $450,000. Initial inventory for a new Sharper Image store has generally cost approximately $200,000. Outlet stores are approximately half the cost of the original Sharper Image stores. The Company also operates a second retail format of Sharper Image Design stores which are approximately half the size of the original stores with between 1,000 to 1,200 of selling square feet, and feature higher margin proprietary products in addition to other top selling merchandise. At the end of fiscal 1998, the Company had 77 The Sharper Image stores, eight Sharper Image Design stores, and two outlet locations. In fiscal 1997 the Company retained a leading design firm to update the look and appeal of its retail stores. During fiscal 1998 the Company opened four new stores and remodeled four stores utilizing the new look. The Company is currently evaluating the financial results of the new prototype in the new stores and remodeled stores. The Sharper Image Catalog The Sharper Image Catalog is a full-color catalog that is mailed to an average of approximately 3 million individuals each month. The catalog is also the primary source of advertising for the Company's retail stores. During fiscal 1998, the Company mailed approximately 41 million of The Sharper Image Catalogs to over 6 million different individuals. Circulation and number of pages of The Sharper Image Catalog is under continual review to balance the costs of mailing the catalogs with the revenues generated. The mailings increase at Father's Day and Christmas reflecting the seasonal nature of the Company's business. The Sharper Image Catalog is designed and produced by the Company's in-house staff of writers and production artists. The Company utilizes free-lance photographers on an as needed basis. The catalog is electronically produced in-house on a network of computers using the latest desktop publishing software. This enables the Company to maintain quality control and shorten the 3 lead-time needed to produce the catalog. The monthly production and distribution schedule permits frequent changes in the product selection. During fiscal 1998, The Sharper Image Catalog typically contained from 52 to 84 pages for non-peak months and between 76 and 124 pages for the peak seasons of Father's Day and Christmas. The Sharper Image catalog design uses dramatic visuals and benefit-oriented clever product descriptions. The catalog design features the most important products prominently. The number of items featured each month ranges between 180 and 250 products during the first three quarters of the year, increasing to more than 300 products during the fourth quarter. During fiscal 1998, the Company discontinued its test mailing of catalogs for The Sharper Image Home Collection concept. The Company mailed over 3 million Sharper Image Home Collection catalogs during fiscal 1998. The Company collects customer names through mail and Internet order processing and the electronic point-of-sale registers in its retail stores. The names and associated sales information are merged daily into the Company's customer master file. This daily merge process provides a constant source of current information to help assess the effectiveness of the catalog as a form of retail advertising, identify new customers that can be added to the in-house mailing list without using customer lists obtained from other catalogers, and identify the "best customers." The Company's addition of names to the in-house mailing list enhances its value for list rental purposes. Periodically, the Company mails promotional material to these best customers, which is designed to produce incremental sales. Internet Operations The Sharper Image was one of the first specialty retailers to enter the world of electronic commerce. The Company's revenue from its Internet operations increased over 200 percent in fiscal 1998 to $4.9 million from $1.6 million in fiscal 1997. The Company has participated in online shopping since 1994 and has maintained its own site on the World Wide Web at http://www.sharperimage.com since 1995. In addition other Internet sales channels used by the Company include America Online's Shopping Channel, Microsoft Plaza, Yahoo Stores, Catalog City and PC World Shopping. The Company believes that one of the advantages of the Internet is the ability to introduce and/or market merchandise at a relatively low cost. The Company can present a full spectrum of styles or models and in-depth promotions at reasonable cost, especially compared to the higher cost of a comparable presentation in The Sharper Image Catalog. The Company recently introduced an auction site at its sharperimage.com web site. Unlike most other auction sites on the Internet, the Company's auction site is a transaction between an established retailer and the consumer and the auctions feature both new and refurbished products with return privileges. The Company has been able to develop and expand its Internet business without incurring high start-up costs because of its market leadership position, its brand name and its strategic alliances. In addition, the Company leverages its experience in order processing, fulfillment and customer service gained in over 20 years of mail order catalog operations. Other Operations Corporate Marketing During fiscal 1998, the Company's corporate marketing sales continued to grow. The incentive and gifting programs are designed by the corporate marketing unit to be used by client companies to increase their sales, or to motivate and reward their high achievers and best customers. The Sharper Image stores and catalog are the primary means of offering and conveniently delivering the incentives and gifts. The Company sells incentive and gift merchandise certificates to the client companies who in turn distribute them under their programs. The certificates are redeemable for Sharper Image merchandise through its retail stores, by mail, or over the telephone through the catalog telemarketing group. The Company is also developing the Internet channel for this area of the business. The Company intends to continue to grow this area of its business. Wholesale Operations The Company's Business Development department is the primary group responsible for marketing to other retailers, including fine department stores in the U.S. as well as retailers in other countries. Wholesale sales increased from $3.2 million in fiscal 1997 to $3.5 million in fiscal 1998. Wholesale sales increased during fiscal 1998 primarily as result of increased sales of Sharper Image Design proprietary products. 4 Licensed Operations The Company has exclusive licensing agreements in Japan, Switzerland and Saudi Arabia, as well as for non-duty free airport locations in the United States. Under the international license agreements, the licensee is granted the right to use the trademarked name, "The Sharper Image," in their country in connection with The Sharper Image retail store and catalog operations. The Company will assist the licensee by producing a foreign language edition of The Sharper Image catalog, with economies of scale but at the expense of the licensees who then print and distribute locally. There are currently six Sharper Image retail stores operated by the foreign licensees, two in Switzerland, three in Saudi Arabia and one in Dubai. The Company receives royalties on sales by the licensees. Licensees purchase products from the Company or directly from manufacturers, maintain their own supply of inventory, and establish their own product prices. The airport licensee is entitled to utilize The Sharper Image trademark and trade dress in designated airport locations, the design of which is subject to the approval of the Company. There are two locations -- one at Dallas-Fort Worth and a second location at Detroit Metropolitan. The Company continues to pursue additional licensing and wholesale opportunities in foreign countries. Merchandising, Product Selection and Development Merchandising The Company's merchandise mix emphasizes innovative products that are new to market, and unique products, which are proprietary, available exclusively through The Sharper Image, or are not available in broad distribution. The Company's sales are driven by individual products, focusing on offering items that are innovative and high quality, as distinguished from a broad assortment of categories of merchandise. As individual items come to market or are developed internally by the Company that fit the criteria for new products, the Company's buying and merchandise mix will change to emphasize those products. As a result of such shifting emphasis among individual items, the mix of sales by category changes from time to time. The effect, from year to year, can be to increase or decrease the merchandise gross margin rates since some categories of merchandise sustain traditionally higher margins and some traditionally sustain lower margin rates. The Company's current merchandise strategy is to offer an assortment with emphasis on Sharper Image Design proprietary and private label products. The Company intends to focus on offering products in the $50 to $300 price range to appeal to a wide customer base. While these proprietary and private-labeled products offer important sales and gross margin growth opportunities for all the revenue generating areas of the Company, there are certain risks associated with these internally developed products, such as possible manufacturing constraints, delays in bringing these products to market and cost increases. See "Factors Affecting Future Operating Results." The Company generates information on merchandise orders and inventory, which is reviewed daily by the Company's buyers, its senior merchandising staff and top management. The Company generally replaces approximately 10% to 25% of its product offerings each month. The Company carefully considers which products will not be offered in future months based upon numerous factors, including revenues generated, gross margins, the cost of catalog and store space devoted to each product, product availability and quality. The Company has developed a proprietary automatic replenishment system (ARS) which is used to maximize sales with minimal inventory investment. Under ARS, information on merchandise inventory and sales by each store location is generated and reviewed daily. Sales information by product and location is systematically compared daily to each product's "model stock" to determine store shipment quantities and frequency. The ARS computes any adjustments to the model stock level based on factors such as sales history by location in relation to total Company sales of each product. Under this system, the model stock is continually revised based on this analysis. Recommended adjustments to model stock levels and recommended shipment amounts are reviewed daily by the Company's group of store distributors and merchandising managers who are responsible for allocating inventory to stores. Product Selection The process of finding new products involves the Company's buyers reviewing voluminous product literature, traveling extensively throughout the United States and the Far East to attend trade shows and exhibitions, and meeting with manufacturers. The Company enjoys relationships with many major manufacturers who use The Sharper Image regularly to introduce their newest products in the United States. See "Factors Affecting Future Operating Results." 5 The Company purchases merchandise from numerous foreign and domestic manufacturers and importers. None of the Company's suppliers accounted for more than 10% of the dollar amount of the Company's purchases during fiscal 1998. Of the products offered by the Company in the past fiscal year, approximately 75% were manufactured in the Far East, approximately 20% were manufactured within the United States, approximately 3% were manufactured in Europe, and approximately 2% were manufactured in Mexico and Canada. The Company expects these percentages to vary as new products are introduced. See "Factors Affecting Future Operating Results." Product Development In addition to finding new products from outside sources, the Company's product development group conceives, designs and produces Sharper Image Design proprietary products. The new product development group meets regularly with the merchandising staff to review new product opportunities, product quality, and customer feedback. From these creative sessions product ideas are put into development, design and production. Successful product introductions during the past two years include the Ionic Breeze silent air purifier, CD Radio/Alarm Clock with Sound Soother, Weebot, the Electronic Pet, Personal Cooling System, Turbo Groomer, Truth Quest, Ionic Hair Wand, Stereo Sound Soother, Shower Companion Plus, and the portable Sound Soother. The Company believes that this proprietary product development function, in addition to increasing its sales and gross margins and adding incremental wholesale sales, will favorably impact the Company's increasing flow of unique and exclusive products in The Sharper Image stores, catalog and our Internet site sharperimage.com. The Company believes that the appeal of these proprietary products is also serves as a key driver in broadening its customer base and enhancing its brand appeal. The Company's goal is to significantly increase the proportion of sales and margin contributions from these proprietary products. However, there is no assurance that the Company will be able to continue the growth of gross margin and sales related to these proprietary products. See "Factors Affecting Future Operating Results." Sharper Image Design proprietary products are produced for the Company on a contract basis by manufacturers in the Far East. The Company provides all product specifications to the contract manufacturers. Development lead-time is generally in the range of 12 to 18 months. However, certain product introductions may require longer lead time. Customer Service The Company seeks to hire and retain qualified sales and customer service representatives in both its mail-order catalog and store operations and to train them thoroughly. Each new store manager undergoes an intensive program during which the manager is trained in all aspects of the Company's business. Sales personnel are trained during the first two weeks of employment, or during the weeks before a new store opens. Training focuses primarily on acquiring a working knowledge of the Company's products and on developing selling skills and an understanding of the Company's high customer service standards. Each sales associate is trained to adhere to the Company's philosophy of "taking ownership" of every customer service issue that may arise. The Company has also developed ongoing programs conducted at each store that are designed to keep each salesperson up to date on each new product offered. The Company's customer service and catalog sales group at the corporate headquarters and at the Little Rock distribution center provides personal attention to customers who call toll free to request a catalog subscription, place an order, or inquire about a product. The Company also contracts with third party contract call centers to provide twenty-four hour coverage for customer services and catalog sales. The Company's Customer Service group is also responsible for resolving customer problems promptly and to the customer's complete satisfaction. The Company is committed to providing its customers with courteous, knowledgeable, and prompt service. Advertising While the catalog remained the Company's primary advertising vehicle during fiscal 1998, the Company also utilized newspaper, leading consumer magazine and airline magazine inserts to advertise specific products. The Company plans to continue these efforts in fiscal 1999. The Company also tested televised "infomercials" in fiscal 1998 and plans to increase the number of infomercials in fiscal 1999. The Company believes these advertisements generate store sales as well as mail-order sales. 6 Catalog Order Fulfillment and Distribution The Company has a single distribution facility in Little Rock, Arkansas of approximately 110,000 square feet. The Company's merchandise generally is delivered to the catalog and Internet customers and to The Sharper Image stores directly from the Company's distribution facility. A number of products are shipped directly from the vendor to the customer or to the stores. The shipment of products directly from vendors to the stores and customers reduces the level of inventory required to be carried at the distribution center, freight costs, and the lead-time required to receive the products. Each catalog order is received via remote terminal at the distribution facility after the order has been approved for shipment. The Company's goal is to ship catalog orders within 48 hours after the order is received. Store customers generally take their purchase with them. The Company is evaluating the need to increase the capacity of the distribution facility in Little Rock to provide for projected business growth. Sales and inventory information about catalog and store operations is provided on an ongoing basis to the Company's merchandising staff and to top management for review. The Company's stores are equipped with electronic point-of-sale registers that communicate daily with the main computer system at corporate headquarters, transmitting sales, inventory and customer data as well as receiving data from the Company's headquarters. The sales, inventory, and customer data enables sales and corporate personnel to monitor sales by item on a daily basis, provides the information utilized by the ARS for inventory allocations, provides management with current inventory and merchandise information, and enables our in-house mailing list to be updated regularly with customer names and activity. Information Systems The Company continually evaluates and enhances its computer systems and information technology in connection with providing additional and improved management and financial information. In fiscal 1998 and 1999, technology development and enhancement initiatives for the Company's web site are also part of the key objectives of its information systems team. 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 Company has reviewed 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 the Company interfaces is ongoing. Competition The Company operates in a highly competitive environment. The Company principally competes with a diverse mix of department stores, sporting goods stores, discount stores, specialty retailers and other catalogs that offer products similar to or the same as some of those offered by the Company. Many of the Company's competitors are larger companies with greater financial resources, a wider selection of merchandise and a greater inventory availability. Although the Company attempts to market products not generally available elsewhere and has emphasized exclusive products in its merchandising strategy, many of its products or similar products can also be found in other retail stores or through other catalogs or on-line. The Company offers competitive pricing where other retailers market certain products identical to the Company's at lower prices. In addition, a number of other companies have attempted to imitate the presentation and method of operation of the Company's catalog and stores, and the Company's proprietary designed products. The Company competes principally on the basis of product exclusivity, selection, quality and price of its products, merchandise presentation in the catalog, stores, and on the Internet, its customer list, name recognition, and the quality of its customer service. The Company is committing additional resources to its internal product development group to create and produce proprietary products exclusively available from the Company. The Company believes that these proprietary products provide a competitive advantage for the Company in its merchandising offering. Trademark Licenses In the opinion of management, the Company's registered service mark and trademark, "The Sharper Image," and the brand name recognition that it has developed, are of significant value. The Company currently licenses the use of its trademarked name in connection with the production and circulation of foreign language editions of The Sharper Image catalog in Japan and Switzerland and in connection with The Sharper Image stores in Switzerland, Saudi Arabia and Dubai in consideration for royalties and other fees. In addition to these international licensees, the Company has also entered into a license for the right to operate Sharper Image stores in domestic non-duty free airport locations as well as various product license agreements which grant the right to licensees to manufacture and sell products bearing the Company's trademark. 7 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. In addition, as the proportion of the Company's revenues derived from store sales has grown, the impact of seasonal fluctuations on the Company's sales and earnings has increased. As a result, a substantial percentage of the Company's total revenues and all or most of the Company's net earnings occur in its fourth fiscal quarter ending January 31. The Company generally experiences lower revenues 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 these interim quarters may not be representative of the results for the full fiscal year. In addition, like many retailers, the Company makes merchandising and inventory decisions for the Christmas season well in advance of the Holiday selling season. Accordingly, unfavorable economic conditions and/or deviations from projected demand for products during the fourth quarter could have a material adverse affect on the Company's results of operations for the entire fiscal year. During fiscal years 1998 and 1997, the Company's total revenues for the fourth quarter ended January 31 accounted for more than 40% of total revenues for the fiscal year. Legal Proceedings The Company is party to various legal proceedings arising from normal business activities. Management believes that the resolution of these matters will not have an adverse material effect on the Company's financial position and results of operations. Employees As of January 31, 1999, the Company employed approximately 1,300 associates, approximately 60% of whom were full-time. The Company considers its employee relations to be good. 8 Executive Officers of the Registrant Set forth below is a list of the executive officers of the Company, together with brief biographical descriptions. Name Position Age - ---- -------- --- Richard Thalheimer Founder, Chairman of the Board, 51 and Chief Executive Officer Barry Gilbert Vice Chairman, 48 Chief Operating Officer Tracy Wan Executive Vice President, 39 Chief Financial Officer, and Corporate Secretary Davia Kimmey Senior Vice President, 45 Marketing Shannon King Senior Vice President, 43 Merchandising Anthony Farrell Senior Vice President, 49 Creative Richard Thalheimer is the founder of the Company and has served as the Chief Executive Officer and as a Director of the Company since 1978 and as Chairman of the Board of Directors since 1985. Mr. Thalheimer also served as the Company's President from 1977 through July 1993. Barry Gilbert has been the Company's Vice Chairman and Chief Operating Officer since December 1996. Prior to joining the Company, Mr. Gilbert was with Warner Bros. Studio Stores, where he served as Senior Vice President of International Franchise Operations from 1994 to 1996, and as Senior Vice President of Stores from 1990 to 1994. Tracy Wan has been the Company's Executive Vice President, Chief Financial Officer since August 1998. Ms. Wan served as Senior Vice President from February 1995 through August 1998, Vice President, Chief Financial Officer from September 1994 through February 1995, as Vice President, Controller from November 1991 through September 1994, and as Controller from July 1989 through November 1991. Ms. Wan is a certified public accountant. Davia Kimmey has been the Company's Senior Vice President, Marketing since June 1997. Prior to joining the Company, Ms. Kimmey was with Spiegel Inc. where she served as Corporate Vice President, Advertising from 1995 to 1997 and as Vice President, Advertising from 1992 to 1995. Shannon King has been the Company's Senior Vice President, Merchandising, since February 1995. Ms. King served as the Company's Vice President, Merchandising from March 1993 through February 1995, and as Director of Merchandising from July 1988 through March 1993. Anthony Farrell has been the Company's Senior Vice President, Creative Services, since July, 1998. Mr. Farrell was a consultant to the Company from April 1998 through July 1998. Prior to joining the Company, Mr. Farrell was with SelfCare Catalog, where he served as Senior Vice President, Merchandising from March 1991 through December 1997. 9 Factors Affecting Future Operating Results The provisions of the Private Securities Litigation Reform Act of 1995 (the "Act"), which became law in late December 1995, provide companies with a "safe harbor" when making forward-looking statements. This "safe harbor" encourages companies to provide prospective information about their companies without fear of litigation. The Company wishes to take advantage of the new "safe harbor" provisions of the Act and is including this section in its Annual Report on Form 10-K in order to do so. Statements that are not historical facts, including statements about management's expectations for fiscal year 1999 and beyond, are forward-looking statements and involve various risks and uncertainties. Factors that could cause the Company's actual results to differ materially from management's projections, forecasts, estimates and expectations include, but are not limited to, the following: We May Not Successfully Offer Attractive Merchandise to Our Customers In order to meet our strategic goals, we must successfully locate and offer to our customers new, innovative and high quality products. Our product offerings must be affordable, useful to the customer, well made, distinctive in design, and not widely available from other retailers. We can not predict with certainty that we will successfully offer products that meet these requirements in the future. If other retailers, especially department stores or discount retailers, offer the same or similar products 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 less of our products or if we have to reduce our prices, our revenues and profits will decline. In addition, we must offer 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 peak selling seasons. Our future results may be affected if we are not successful in achieving these goals. Our Quarterly Operating Results are Subject to Significant Fluctuations and Seasonality Our business is highly seasonal, reflecting the general pattern of peak sales and earnings for the retail industry during the Christmas season. A substantial portion of our total revenues and all or most of our net earnings occur during our fourth quarter ending January 31. In anticipation of increased sales activity during the fourth quarter, we incur significant additional expenses, including significantly higher inventory costs and the cost of hiring a substantial number of temporary employees to supplement our permanent store staff. If for any reason our sales were to be substantially below those normally expected during the winter quarter of our fiscal year, our annual 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. Our operating results during the other quarters of the year are generally lower and we have experienced losses in such periods. It is possible that we may experience similar losses in the future in such periods. 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 for the Christmas season well in advance of the holiday selling season. As a result, poor economic conditions and/or differences from projected customer demand for our products during the fourth quarter could result in lower revenues. During our 1998 and 1997 fiscal years, our total revenues for the fourth quarter ending January 31 accounted for more than 40% of total revenues for the full fiscal year. We May Not Successfully Design and Develop Proprietary Products We are increasingly dependent on the success of the proprietary products that we have designed and developed for our customers. We must design products that meet the demands of our customers and manufacture these products cost-effectively. In addition, we must rely on contracted manufacture resources to produce these products in sufficient quantities to meet customer demand and deliver these products in a timely manner to our customers. We rely solely on our contracted manufacturers to produce and timely deliver these proprietary products. If we are unable to successfully design, develop, and timely deliver our proprietary products, our operating results may be materially adversely affected. 10 We Face Certain Risks Associated with Expansion We plan to continue to increase the number of Sharper Image stores in the future in order to grow our revenues. Our ability to expand will depend in part on the following factors: o the availability of attractive store locations; o our ability to negotiate favorable lease terms; o our ability to identify customer demand in different geographies; o general economic conditions; and o the availability of sufficient funds for expansion. As we continue to expand, we have started to and may continue to become 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 or existing store sales in a specific region may decrease as a result of new store openings. In order to continue our expansion, 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 fulfill additional stores. We may not be able to manage this increased inventory without decreasing our profitability. We may need additional financing in excess of our current credit facility to be used for new store openings. Furthermore, our current credit facility has various loan covenants we must comply with in order to maintain the credit facility. We cannot predict with certainty that we will be successful in obtaining additional funds or new credit facilities on favorable terms or at all. We Are Dependent on the Success of our Advertising Efforts Our revenues depend in part on our ability to effectively market and advertise our products through The Sharper Image catalog and other advertising vehicles. Increases in advertising, paper costs or postage may limit our ability to advertise without reducing our profitability. If we decrease our advertising efforts due to increased advertising costs or for any other reason, our future operating results may be materially adversely affected. We are also testing other advertising media such as television (infomericals) and the Internet. Expenditures on these and other media may not produce a sufficient level of sales to cover such expenditures, which would reduce our profitability. We Rely on Our Catalog Operations Our success depends in part on the success of our catalog operations. We believe that successful catalog operations will depend in part on the following factors: o the efficient targeting of our mailings; o productive prospect mailing; o appropriate shifts in our merchandise mix; and o our ability to achieve adequate response rates to our mailings. Catalog 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. 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 and changes in the merchandise mix, several 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. 11 Our Catalog Operating Costs are Unpredictable Historically, significant portions of our revenues have been from purchases made by customers from The Sharper Image catalog. Increases in the costs of producing and distributing the catalog may reduce the profitability of our catalog sales. Specifically, we may experience increases in postage, paper or shipping costs due to factors beyond our control. As a result, our future results may be adversely affected. We maintain a contract with a major package carrier for the delivery of our merchandise. There can be no assurance that, once this contract expires or is terminated, we will be able to negotiate similar or better terms with this major carrier or another shipping company or that the resulting contract(s)will be on terms favorable to us. Our inability to secure suitable or commercially favorable contracts for the delivery of our merchandise could have an adverse effect on our future results. Our New Business Lines and Internet Strategy May Not Succeed In the past we have tested new lines of business that have not always proven profitable. We continually examine and evaluate all revenue channels for profitability. We may decide to develop new business lines or to acquire additional businesses in the future, and we cannot predict whether such efforts will be successful. The failure of new business lines or acquisitions could hurt future results. We believe that we need to reach our current customers and generate new customers through methods other than regular catalog mailings. We are pursuing opportunities to sell our products over the Internet through our own web site http://www.sharperimage.com and other interactive shopping media including on-line computer networks such as America Online's Shopping Channel, Microsoft Plaza, Yahoo Stores, Catalog City and PC World Shopping. This is a new business and marketing strategy for us and involves certain risks and uncertainties. We may not succeed in achieving profitable operations in marketing our products over the Internet. We Depend on Our Vendors Our performance depends on our ability to purchase our products in sufficient quantities at competitive prices and on our vendors' ability to make and deliver high quality products in a cost effective, timely manner. Some of our smaller vendors have limited resources, 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 cannot assure you that we will be able to acquire the products we desire in sufficient quantities or on terms that are acceptable to us in the future. In addition, we cannot assure you that our vendors will make and deliver high quality products in a cost effective, timely manner. We may also be unable to develop relationships with new vendors. Also all products we purchase from vendors in the Far East must be shipped to our distribution centers by freight carriers and we cannot assure you that we will be able to obtain sufficient capacity 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 impact on our business. We Face Certain Risks Relating to Customer Service Our ability to provide customer service depends, to a large degree, on the efficient and uninterrupted operation of our two call centers and contracting services with the third party call centers. Any material disruption or slowdown in our order processing systems resulting from labor disputes, telephone down times, electrical outages, mechanical problems, human error or accidents, fire, natural disasters, or comparable events could cause delays in our ability to receive and distribute orders and may cause orders to be lost or to be shipped or delivered late. As a result, customers may cancel orders or refuse to receive goods on account of late shipments, which would result in a reduction of net sales and could mean increased administrative and shipping costs. We cannot assure you that telephone call volumes will not exceed our present telephone system capacity. If this occurs, we could experience telephone answer delays and delay in placing orders. Because our strategies depend in part on maintaining our reputation for superior levels of customer service, any impairment of our customer service reputation could have an adverse effect on our business. 12 We Face Risks Associated with Distribution We conduct all of our distribution operations and all of our catalog and Internet order processing fulfillment functions from a single facility in Little Rock, Arkansas. We also use contract warehouse facilities for additional seasonal requirements. Any disruption in the operations at the distribution center, particularly during the Christmas season, could have a negative impact on our business. 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 facility, particularly during busy periods such as the Christmas season and while new stores are opening. 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. Results for Our Comparable Store Sales May Fluctuate Our comparable store sales are affected by a variety of factors, including, among others: o customer demand in different geographies; o our ability to efficiently source and distribute products; o changes in our product mix; o impact of competition; and o general economic conditions. Our comparable store sales have fluctuated significantly in the past and we believe that such fluctuations may continue. Our historic comparable store net sales changes were as follows: Percentage Fiscal Year Increase (Decrease) ----------- ------------------- 1995 3.3 1996 (2.1) 1997 1.1 1998 5.3 These historic results are not necessarily indicative of future results, and we cannot assure you that our comparable store sales results will not decrease in the future. Any changes in our comparable store sales results could impact our future operating performance and cause the price of the common stock to fluctuate. We Experience Intense Competition in Our Markets 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 a greater inventory availability. If we experience increased competition, our business and operating results could be adversely affected. We May Fail to Anticipate and Adapt to Changing Consumer Trends Our success depends on our ability to anticipate and respond to changing product trends and consumer demands in a timely manner. Our products must appeal to a broad range of consumers whose preferences cannot always be predicted with certainty and may change between sales seasons. If we misjudge either the market for our products or our customers' purchasing habits, our sales may decline or we may be required to sell our products at lower prices. This would result in a negative impact on our business. 13 We May be Subject to State Sales and Use Tax or Internet Regulation Our business may be affected by the adoption of new regulations or rules governing the sale of our products, particularly with regard to state sales and use taxes. Any unfavorable change in the state sales and use taxes, which affect our catalog and retail store sales could adversely affect our business and results of operations. In addition, the Internet at present is largely unregulated and we are unable to predict whether significant regulations or taxes will be imposed on Internet commerce in the near future. Because our Internet business is still in its initial stages, we are unable to predict how such regulations could affect the further development of our Internet business. Poor Economic Conditions May Hurt Our Business Certain economic conditions affect the level of consumer spending on our products, including, among others, the following: o general business conditions; o interest rates; o taxation; and o consumer confidence in future economic conditions. Our business could be negatively impacted by a recession or poor economic conditions and any related decline in consumer demand for discretionary items such as our products. Because we purchase merchandise from foreign entities and use foreign manufacturers on a contract basis for Sharper Image Design proprietary products and other private label products, we are subject to risks resulting from fluctuations in the economic conditions in foreign countries. The majority of our foreign vendors and manufacturers are located in the Far East, and as a result, our business may be particularly impacted by changes in the political, social, legal, and economic conditions in the Far East. Additionally, foreign weather and product transportation problems could affect our ability to maintain adequate inventory levels and adversely affect our future results. We are Dependent on Certain Key Personnel Our success depends to a significant extent upon the abilities of our senior management, particularly Richard Thalheimer, our founder, President 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. We maintain key man insurance on Mr. Thalheimer in the amount of $15 million. In addition, our performance will depend upon our ability to attract and retain qualified management, merchandising and sales personnel. There can be no assurance that Mr. Thalheimer and the other members of our existing management team will be able to manage our company or our growth or that we will be ability to attract and hire additional qualified personnel as needed in the future. We are Controlled by a Single Stockholder As of April 15, 1999, Richard Thalheimer will beneficially own approximately 55.1% of all of the outstanding shares of the common stock of our company. As a result, Mr. Thalheimer will continue to be able to elect the entire Board of Directors and control the corporate actions of our company. 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 the common stock without regard to our operating performance. In addition, we believe that among other factors, any of the following factors could cause the price of the common stock to fluctuate substantially: o quarterly fluctuations in our comparable store sales; o announcements by other accessory and gift item retailers; o the trading volume of our common stock in the public market; o general economic conditions; and o financial market conditions. 14 Failure of Our Computer Systems to Recognize Year 2000 Could Negatively Affect Our Business We recognize 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. We have assessed our computer and business processes and we are reprogramming our computer applications to provide for their continued functionality. We are currently assessing the readiness of our vendors and other third parties with which we interface. We are presently unable to assess the likelihood that we will experience operational problems due to unresolved year 2000 problems of third parties that we do business with. We cannot assure you that other entities will achieve timely year 2000 compliance; and if they do not, year 2000 problems could have an adverse impact on our operations. Where commercially reasonable to do so, we intend to assess our risks with respect to failure by third parties to be year 2000 compliant and to seek to mitigate those risks. If we cannot achieve such mitigation, year 2000 problems could have an adverse impact on our operations. The estimated cost for this project is between $400,000 and $600,000, and is being funded through operating cash flows. We will incur operating costs related to year 2000 compliance projects over several quarters and we will expense such costs as incurred. Through January,31, 1999, we have incurred approximately $300,000 on work related to year 2000 compliance. Our 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, we cannot assure you 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 following: o the availability and cost of personnel trained in year 2000 remediation work; o the ability to locate and correct all computer codes; o our vendors and suppliers success in reaching year 2000 readiness; and o the timely availability of necessary replacement items. We presently believe that the most reasonably likely worst-case scenarios that we might confront with respect to year 2000 issues have to do with third parties not being year 2000 compliant. We are presently evaluating vendor and customer compliance and will develop contingency plans, such as alternate vendor opportunities, after obtaining compliance evaluations. We intend to develop contingency plans by September 1999. Merchandise Returns As part of our customer service commitment, we maintain a liberal merchandise return policy, which allows customers to return most merchandise. As with industry practice, we make allowances for catalog sales in our financial statements for anticipated merchandise returns 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, changes in the 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 adversely affect our future results. Our Charter Documents and Delaware Law May Prohibit a Takeover 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 contain certain provisions that 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 shareholders for their common stock. 15 We must Successfully Respond to Changes in the Retail Industry The United States retail industry, and the specialty retail industry in particular, are dynamic by nature and have undergone significant changes over the past several years. The Company's ability to anticipate and successfully respond to continuing challenges is critical to achieving its expectations. 16 Item 2. Properties The Company occupies approximately 50,000 square feet of office space for its corporate headquarters in San Francisco, CA, under a lease scheduled to expire on January 31, 2001, with an option to extend for two additional five-year periods. As of January 31, 1999, the Company operated 87 The Sharper Image stores under leases covering a total of approximately 202,000 square feet of net selling space. The Company's operates a 110,000 square foot distribution facility located in Little Rock, Arkansas. All of the Company's distribution functions are conducted through this facility and other seasonally occupied space rented by the Company in close proximity thereto. Item 3. Legal Proceedings The Company is party to various legal proceeding arising from normal business activities. In the opinion of management, resolution of these matters will not have a material adverse effect on the Company's financial position and results of operations. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters The information set forth under "Note D -- Revolving Loan and Notes Payable" in the Notes to Financial Statements on page 21 and the information set forth under the caption "Common Stock Market Prices and Dividend Policy" on page 27 of the Sharper Image Corporation 1998 Annual Report to Stockholders is incorporated herein by reference. As of April 15, 1999 there were 490 holders of record of the Registrant's Common Stock. Item 6. Selected Financial Data The information set forth under the caption "Financial Highlights" on page 3 of the Sharper Image Corporation 1998 Annual Report to Stockholders is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition The information set forth under the caption "Management's Discussion and Analysis of Results of Operations and Financial Condition" on pages 10 to 15 of the Sharper Image Corporation 1998 Annual Report to Stockholders is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The information set forth under the caption "Quantitative and Qualitative Disclosure About Market Risk" on pages 13 and 14 of the Sharper Image Corporation 1998 Annual Report to Stockholders is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The financial statements and independent auditors' report set forth on pages 16 through 27 of the Sharper Image Corporation 1998 Annual Report to Stockholders are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 17 PART III Item 10. Directors and Executive Officers of the Registrant Information with respect to the directors of the Registrant is incorporated herein by reference to the Registrant's 1998 Proxy Statement to Stockholders, pages 3. Information with respect to the executive officers of the Registrant is contained in Part I of this Annual Report on Form 10-K. Item 11. Executive Compensation Information with respect to executive compensation is incorporated herein by reference to the Registrant's 1999 Proxy Statement, pages 18 to 19. Item 12. Security Ownership of Certain Beneficial Owners and Management Information with respect to security ownership of beneficial owners and management is incorporated herein by reference to the Registrant's 1998 Proxy Statement, pages 16 to 17. Item 13. Certain Relationships and Related Transactions None. Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K (a)1. List of Financial Statements. The following Financial Statements and Notes thereto set forth on pages 16 through 27 of the Sharper Image Corporation 1998 Annual Report to Stockholders are incorporated by reference as Exhibit 13.1 to this Report on Form 10-K: Independent Auditor's Report Statements of Operations for the years ended January 31, 1999, 1998 and 1997. Balance sheets at January 31, 1999 and 1998 Statements of Stockholders' Equity for the years ended January 31, 1999, 1998 and 1997 Statements of Cash Flows for the years ended January 31, 1999, 1998 and 1997 Notes to Financial Statements. (a)2. List of Financial Statement Schedule. The following are filed as part of this Report: Independent Auditors' Report on Schedule. Schedule II - Valuation and Qualifying Accounts Schedules other than those listed are omitted for the reason that they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto, contained in, or incorporated by reference into, this Report. 18 (b) Reports on Form 8-K. No reports on Form 8-K were filed with the Securities and Exchange Commission during the last quarter of the period covered by this Report. For the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows: Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the 1933 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of the expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered on the Form S-8 identified below, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1933 Act and will be governed by the final adjudication of such issue. The preceding undertaking shall be incorporated by reference into registrant's Registration Statement on Form S-8 (Registration No. 33-12755). (c) List of Exhibits. Incorporated herein by reference is a list of the Exhibits contained in the Exhibit Index which begins on page 27 of this report. 19 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SHARPER IMAGE CORPORATION SHARPER IMAGE CORPORATION By: /s/ Richard J. Thalheimer By: /s/ Tracy Y. Wan ----------------------- ------------------------ Richard J. Thalheimer Tracy Y. Wan Chief Executive Executive Vice President, Officer, Chairman Chief Financial Officer (Principal Executive Officer) (Principal Financial and Accounting Officer) POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard Thalheimer and Tracy Wan, and each of them, as such person's true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for such person and in such person's name, place, and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ Richard J. Thalheimer Chief Executive April 28, 1999 - ---------------------------- Officer, Chairman Richard J. Thalheimer (Principal Executive Officer) /s/ Tracy Y. Wan Executive Vice President, April 28, 1999 - ---------------------------- Chief Financial Officer Tracy Y. Wan Corporate Secretary (Principal Financial and Accounting Officer) /s/ Alan Thalheimer Director April 28, 1999 - ---------------------------- Alan Thalheimer /s/ Maurice Gregg Director April 28, 1999 - ---------------------------- Maurice Gregg /s/ Gerald Napier Director April 28, 1999 - ---------------------------- Gerald Napier /s/ Morton David Director April 28, 1999 - ---------------------------- Morton David
20 SHARPER IMAGE CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS -------------------------------------- ($000)
COLUMN COLUMN COLUMN COLUMN COLUMN A B C D E - ---------------------------------------------------------------------------------------------------------------------------- Balance at Additions Balance Beginning Charged to at End of DESCRIPTION of Period Costs & Exp. Deductions Period - ---------------------------------------------------------------------------------------------------------------------------- INVENTORY YEAR ENDED JANUARY 31, 1999: - ---------------------------- Inventory Obsolescence $1,486 $1,298 $ 846 $1,938 YEAR ENDED JANUARY 31, 1998: - ---------------------------- Inventory Obsolescence $1,509 $ 678 $ 701 $1,486 YEAR ENDED JANUARY 31, 1997: - ---------------------------- Inventory Obsolescence $1,449 $1,681 $1,621 $1,509 OTHER YEAR ENDED JANUARY 31, 1999: - ---------------------------- Other $ 508 $ 830 $ 534 $ 804 YEAR ENDED JANUARY 31, 1998: - ---------------------------- Other $ 505 $ 321 $ 318 $ 508 YEAR ENDED JANUARY 31, 1997: - ---------------------------- Other $ 461 $ 351 $ 307 $ 505
21 INDEPENDENT AUDITORS' REPORT ON SCHEDULE Board of Directors and Stockholders of Sharper Image Corporation We have audited the financial statements of Sharper Image Corporation as of January 31, 1999 and 1998 and for each of the three years in the period ended January 31, 1999, and have issued our report thereon dated March 26, 1999; such financial statements and report are included in your 1998 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Sharper Image Corporation, listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, whom considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Deloitte & Touche LLP San Francisco, California March 26, 1999 EXHIBIT INDEX 3.1 Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to Registration Statement on Form S-1 (Registration No. 33-12755).) 3.2 Bylaws. (Incorporated by reference to Exhibit 3.2 to Registration Statement on Form S-1 (Registration No. 33-12755).) 10.1 Amended and Restated Stock Option Plan. (Incorporated by reference to appendix to Proxy Statement for annual meeting to be held June 7, 1999) 10.2 1994 Non-Employee Director Stock Option Plan dated October 7, 1994, as amended. (Incorporated by reference to appendix to Proxy Statement for annual meeting to be held June 7, 1999) 10.3 Cash or Deferred Profit Sharing Plan, as amended. (Incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-1 (Registration No. 33-12755).) 10.4 Cash or Deferred Profit Sharing Plan Amendment No. 3. (Incorporated by reference to Exhibit 10.15 to Form 10-K for fiscal year ended January 31, 1988.) 10.5 Cash or Deferred Profit Sharing Plan Amendment No. 4. (Incorporated by reference to Exhibit 10.16 to Form 10-K for fiscal year ended January 31, 1988.) 10.6 Form of Stock Purchase Agreement dated July 26, 1985 relating to shares of Common Stock purchased pursuant to exercise of employee stock options. (Incorporated by reference to Exhibit 10.3 to Registration Statement on Form S-1 (Registration No. 33-12755).) 10.7 Form of Stock Purchase Agreement dated December 13, 1985 relating to shares of Common Stock purchase pursuant to exercise of employee stock options. (Incorporated by reference to Exhibit 10.4 to Registration Statement on Form S-1 (Registration No. 33-12755).) 10.8 Form of Stock Purchase Agreement dated November 10, 1986 relating to shares of Common Stock purchased pursuant to exercise of employee stock options. (Incorporated by reference to Exhibit 10.5 to Registration Statement on Form S-1 (Registration No. 33-12755).) 10.9 Form of Director Indemnification Agreement. (Incorporated by reference to Exhibit 10.42 to Registration Statement on Form S-1 (Registration No. 33-12755).) 10.10 Real Estate Installment Note and Mortgage dated October 4, 1993 among the Company and Lee Thalheimer, Trustee for the Alan Thalheimer Trust. (Incorporated by reference to Exhibit 10.20 to Form 10-K for fiscal year ended January 31, 1994) 10.11 Financing Agreement dated September 21, 1994 between the Company and CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.12 to Form 10-Q for the quarter ended October 31, 1994) 10.12 The Sharper Image 401(K)Savings Plan (Incorporated by reference to Exhibit 10.21 to Registration Statement of Form S-8 (Registration No. 33-80504) dated June 21, 1994)) 10.13 Chief Executive Officer Compensation Plan dated February 3, 1995. (Incorporated by reference to Exhibit 10.24 to the Form 10-K for the fiscal year ended January 31, 1995.) 10.14 Annual Report for the Sharper Image 401(K) Savings Plan (Incorporated by reference to Form 11-K (Registration No. 33-80504) for the plan year ended December 31, 1995.) 10.15 Split-Dollar Agreement between the Company and Mr. R. Thalheimer, its Chief Executive Officer dated October 13, 1995, effective as of May 17, 1995 (Incorporated by reference to Exhibit 10.17 to Form 10-K for the fiscal year ended January 31, 1996). 10.16 Assignments of Life Insurance Policy as Collateral, both dated October 13, 1995, effective May 17, 1995 (Incorporated by reference to Exhibit 10.18 to Form 10-K for the fiscal year ended January 31, 1996). 22 10.17 Amendment to the Financing Agreement dated May 15, 1996 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.19 to the Form 10-Q for the quarter ended April 30, 1996). 10.18 Warrant to Purchase Common Stock Agreement dated May 15, 1996 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.20 to the Form 10Q for the quarter ended April 30, 1996). 10.19 CAPEX Term Loan Promissory note dated October 15, 1996 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.21 to the Form 10-Q for the quarter ended October 31, 1996). 10.20 Employment Agreement between the Company and Mr. Barry Gilbert, its Vice Chairman and Chief Operating Officer dated and effective December 2, 1996. (Incorporated by reference to Exhibit 10.20 to the Form 10-K for the year ended January 31, 1997). 10.21 Amendment to the Financing Agreement dated February 13, 1997 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.21 to the Form 10-K for the year ended January 31, 1997). 10.22 Warrant to Purchase Common Stock Agreement dated February 13, 1997 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.22 to the Form 10-K for the year ended January 31, 1997). 10.23 Amendment to the Financing Agreement dated March 24, 1997 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.23 to the Form 10-K for the year ended January 31, 1997). 10.24 Warrant to Purchase Common Stock Agreement dated April 6, 1998 between the Company and The CIT Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.24 to the Form 10-K for the year ended January 31, 1998). 10.25 Amendment to the Financing Agreement dated April 6, 1998 between the Company and The Cit Group/Business Credit Inc. (Incorporated by reference to Exhibit 10.25 to the Form 10-K for the year ended January 31, 1998). 10.26 Amendment to Employment Agreement between the Company and Mr. Barry Gilbert, its Vice Chairman and Chief Operating Officer dated and effective November 30, 1998. 11.1 Statement Re: Computation of Earnings per Share. 13.1 1998 Annual Report to Stockholders. 23.1 Independent Auditors' Consent. 27.0 Financial Data Schedule. EX-10.26 2 EMPLOYMENT AGREEMENT FIRST AMENDMENT TO THE EMPLOYMENT AGREEMENT OF BARRY GILBERT THIS FIRST AMENDMENT TO THE EMPLOYMENT AGREEMENT (this "Amendment No. 1") has been entered into effective as of November 30, 1998, by and between SHARPER IMAGE CORPORATION, a Delaware corporation (the "Company") and BARRY GILBERT ("Executive"). RECITALS The Company had entered into an Employment Agreement with Barry Gilbert on December 2, 1996 (the "Original Agreement"). The Original Agreement provides that the Agreement shall continue in effect unless terminated by the Company or Executive. Executive has advised the Company of his desire to actively seek a Chief Executive Officer position at another company, and to allow the Company time to arrange a management transition. The Company wishes to accommodate Executive's objectives, and both parties wish to modify the Original Agreement to provide for this change in circumstances. AGREEMENT NOW, THEREFORE, in consideration of the mutual agreement herein contained, intending to be legally bound, the Company and Executive agree as follows: 1. Term of Employment. All of Sections 2 and 7 of the original Agreement are deleted and the following is substituted in their place; 2. Term of Employment. Executive's employment with the Company pursuant to this Agreement as amended shall continue through May 31, 1999, unless such employment is sooner terminated as hereinafter provided. The period during which this Agreement continues in effect shall constitute the "Employment Period." Executive may terminate employment at any time prior to May 31, 1999 by providing not less than fourteen (14) days prior written notice to the Company. Executive's employment may not be terminated by the Company except for cause. Executive shall not receive any severance benefits upon termination of employment, whether such termination results from a voluntary termination by Executive, termination for cause by the Company, or the expiration of the term of this Agreement. 2. Compensation. All of Sections 4(d) and (4)(g) of the Original Agreement shall remain unchanged. Sections 4(a), (b), (c), (e), and (f) are deleted and the following are substituted in their place: 4(a) Salary. The Company shall pay Executive an annual base salary ("Base Salary") payable at periodic intervals in accordance with the payroll practices of the Company for salaried employees. The Base Salary of Executive shall be Three Hundred Twenty-Five Thousand Dollars ($325,000) for the period from the commencement of the employment of Executive and continuing until the last day of Executive's employment. 1 4(b) Bonuses. In addition to Base Salary, Executive shall be entitled to receive a bonus payment of Fifty Thousand Dollars ($50,000) on December 5, 1998 and continuing until the last day of Executive's employment. Executive shall not be entitled to any further bonus thereafter. 4(f) Stock Option Grants. In addition to the other benefits to which the Executive shall be entitled under this Agreement, the Executive has received and exercised certain option grants, of which 50,000 shares vested on February 1, 1997, and 50,000 shares vested on February 1, 1998. The parties acknowledge and agree that Executive shall not receive any further option grants, and Executive agrees to, and does hereby, release all options previously granted but not yet exercised, including the option for 50,000 shares which would otherwise vest on February 1, 1999. 3. Whole Agreement. The original Agreement and this Amendment No. 1 constitute the entire agreement between the Company and Executive. No agreements, representations or understandings (whether oral or written and whether expressed or implied) which are not expressly set forth in this Agreement have been made or entered into by either party with respect to the subject matter hereof. 4. No Claims. The Company and Executive each acknowledge to the other that, except for obligations to be performed in the future under this Agreement, neither party is aware of any claim which it has against the other for any past performance or nonperformance of this Agreement, or any act or omission arising out of the employment relationship to date. 5. Confidentiality. The parties agree that this is a private agreement and that neither party will disclose its terms to anyone except their accountants, attorneys, governmental taxing authorities, or as required by subpoena or other process of law. In response to any inquiry regarding this matter, the parties shall state only that this matter has been resolved to the satisfaction of all parties. IN WITNESS WHEREOF, the parties have executed this Amendment No. 1 as of November 30, 1998. SHARPER IMAGE CORPORATION EXECUTIVE By: /s/ Richard Thalheimer By: /s/ Barry Gilbert ------------------------------ -------------------------- RICHARD THALHEIMER BARRY GILBERT Chairman of the Board and Chief Executive Officer 2 EX-11.1 3 COMPUTATION OF EARNINGS PER SHARE Exhibit 11.1 SHARPER IMAGE CORPORATION STATEMENTS RE: COMPUTATION OF EARNINGS PER SHARE
Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended January 31,1999 January 31,1998 January 31,1997 --------------- --------------- --------------- Net Earnings (Loss)($000) $ 4,602 $ 593 $ (4,345) Weighted average shares of common stock outstanding during the period 8,532,588 8,303,425 8,260,208 =========== =========== =========== Basic Income (Loss) per Share $ 0.54 $ 0.07 $ (0.53) =========== =========== =========== Weighted average shares of common stock outstanding during the period 8,532,588 8,303,425 8,260,208 Add: Incremental shares from assumed exercise of stock options 540,244 233,607 * ----------- ----------- ----------- 9,072,832 8,537,032 8,260,208 =========== =========== =========== Diluted Income (Loss) per Share $ 0.51 $ 0.07 $ (0.53) =========== =========== =========== *Incremental shares from assumed exercise of stock options are antidilutive for diluted loss per share, and therefore are not presented.
EX-13.1 4 1998 ANNUAL REPORT The Sharper Image 1998 Annual Report [graphic omitted] Corporate Profile Sharper Image Corporation is a multi-channel specialty retailer and product developer that is nationally and internationally renowned as a leading source of new, innovative, high-quality products that make life easier and more enjoyable. The Company enjoys an exceptionally strong brand identity and, in the consumer marketplace, The Sharper Image name is synonymous with fun and entertainment, design and creativity, uniqueness and technological innovation. A key strength is the Company's ability to create exclusive proprietary merchandise. These products, labeled Sharper Image Design, are highly marketable and form the foundation of the Company's success in diverse channels of distribution. The Company currently operates 89 stores in 28 states, and generates direct sales from its monthly Sharper Image print catalog and through its Internet Website, sharperimage.com. The Company also sells to other companies through its Corporate Marketing Incentives program and its Wholesale Division. Revenues (Millions) Fiscal 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Revenue from Sharper Image Design Products 10.4 13.8 15.1 17.6 43.4 Total Revenue 188.5 204.2 210.2 216.8 243.1 Internet Revenues (Millions) Fiscal 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Total Revenue 0 0.05 0.8 1.6 4.9 2 Financial Accomplishments Net earnings of $4.6 million, a 676 percent increase over the prior fiscal year. Record total net revenues of $243.1 million, a 12 percent increase. Record store sales of $162.4 million, a 7 percent increase. Record catalog sales of $70.8 million, a 20 percent increase. Record Internet sales of $4.9 million, a 201 percent increase. Gross margin rate increase of 2.7 percentage points, to 49.0 percent. Financial Highlights - ------------------------------------------------------------------------------------------------------------------------------------
Fiscal Year Ended January 31, ------------------------------------------------------------------------ 1999 1998 1997 1996 1995 (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) (Fiscal 1995) (Fiscal 1994) ------------------------------------------------------------------------ Operating Results Revenues $ 243,114 $ 216,815 $ 210,245 $ 204,184 $ 188,535 Provision for loss on the closure of the SPA Collection division -- -- (8,000) -- -- Earnings (loss) before income taxes 7,670 988 (7,241) 739 6,139 Net earnings (loss) 4,602 593 (4,345) 444 3,683 Net earnings (loss) per share - Basic $ 0.54 $ 0.07 $ (0.53) $ 0.05 $ 0.44 Diluted $ 0.51 $ 0.07 $ (0.53) $ 0.05 $ 0.41 Balance Sheet Data Working capital $ 16,003 $ 11,633 $ 9,429 $ 17,233 $ 23,011 Total assets 82,045 78,662 78,804 70,456 64,036 Long term notes payable 2,513 3,299 4,245 3,355 838 Stockholders' equity 36,649 29,156 28,449 32,758 32,792 Current ratio 1.40 1.27 1.22 1.56 1.85 Statistics Number of stores at year end 87 85 82(1) 78(1) 74 Comparable store sales 5.3% 1.1% (2.1%) 3.3% 17.8% Annualized net sales per square foot $ 484 $ 465 $ 458 $ 473 $ 468 Number of catalogs mailed 44,398,000(2) 44,544,000(2) 37,695,000(2) 32,780,000(2) 31,522,000 Number of catalog orders(3) 564,000 422,000 470,000 536,000 426,000 Average revenue per transaction: Stores $ 102 $ 104 $ 97 $ 106 $ 102 Catalog(3) $ 141(4) $ 158(4) $ 134(4) $ 122 $ 116 Returns on average stockholders' equity 14.0% 2.1% N/A 1.4% 11.8% Book value per share $ 4.30 $ 3.51 $ 3.44 $ 3.97 $ 3.96 Weighted average number of shares outstanding - Basic 8,532,588 8,303,425 8,260,208 8,249,259 8,294,378 Diluted 9,072,832 8,537,032 8,260,208 8,682,078 8,899,289 Dollars are in thousands except Net earnings (loss) per share and Statistics. (1) Excludes six and four SPA Collection stores at January 31, 1997 and 1996. (2) Includes 3,060,000, 6,283,000 and 2,900,000 of The Sharper Image Home Collection catalogs mailed for January 31, 1999, 1998 and 1997, respectively. Excludes SPA Collection catalogs mailed for January 31, 1997 and 1996. (3) Includes Internet transactions. (4) Excludes The Sharper Image Home Collection which had average revenue per order of $717, $678 and $577 for January 31, 1999, 1998 and 1997, respectively.
3 To Our Shareholders By every measure, 1998 was an excellent year for The Sharper Image. We generated record revenues of $243.1 million and significantly higher net earnings of $4.6 million, or $0.51 per share. Compared with the prior fiscal year, revenues grew 12%, from last year's $216.8 million, and net earnings increased sevenfold, from last year's $593,000, or $0.07 per share. Key to these achievements was the unprecedented popularity of Sharper Image Design proprietary products, which fueled a surge in fourth quarter sales and pushed the year's gross margin rate nearly three percentage points higher. Sharper Image Design's product development know-how -- combined with our brand's strength and our marketing competence in stores, catalog, and the Internet -- lays the foundation for our Company's bright future. I'm especially gratified that each area of our business performed at record levels. Store sales grew seven percent, to a record $162.4 million, as comparable store sales increased five percent. Sharper Image catalog sales gained 20 percent, to a record $70.8 million. Corporate Marketing achieved record revenues of $15 million, a 5 percent gain. (These sales are incorporated into the sales from our stores and catalogs.) And of greatest strategic importance, our Internet e-commerce generated sales of $4.9 million, a threefold increase over last year's $1.6 million. The efforts of our entire team of associates throughout the year led to a sensational holiday season and the highest fourth quarter revenues and highest fourth quarter earnings in our Company's history. This outstanding achievement gave us great momentum going into 1999. Sharper Image Design Our success in 1998 was significantly linked, in every instance, to our product development capabilities. The summer launch of the Personal Cooling System(TM) signaled a new level of consumer acceptance of Sharper Image Design's innovations. That invention -- a kind of wearable "air conditioner" with patented miniaturized evaporative technology -- is unusual but broadly appealing, affordable and can be found only at The Sharper Image. Its impressive debut was followed by even more successful introductions of a diverse assortment of products, including the Ionic Breeze(TM) Silent Air Purifier, with exclusive technology that circulates air in total silence; our CD Radio/Alarm Clock with Sound Soother(R), a portable bedside stereo; Weebot(TM) the Electronic Pet, holiday's runaway best-seller; and the Ionic Bath(TM) Pet Brush, for eliminating pet odors. Sharper Image Design products accounted for 18 percent of 1998 sales, up from 1997's eight percent. Our goal for 1999 is to increase to a 25 percent share and, combined with exclusive private-label merchandise, these high-margin items should account for more than 40 percent of sales. The Internet Opportunity We have a vision for our Company and it's simply stated: Sharper Image for everyone. To me, it means our products are useful, fun and of value to a much larger group of consumers than those we currently count as customers. The Internet, a powerful yet economical marketing channel for reaching a wider consumer base, gives us the best opportunity to realize our vision and become a much larger and more profitable company. We were early entrants to e-commerce and our strengths are ideally suited for success: our brand name, two decades of direct-marketing experience, and exclusive high-margin products with wide appeal. And I was thrilled to learn from our sales data that, during our record fourth quarter, 70 percent of our online buyers were "new to file," or first-time Sharper Image customers. We're devoting increased resources, commensurate with anticipated Internet sales growth, to make our Website a major Internet destination. Since the start of the new fiscal year, we've launched a product auction site, introduced 3D interactivity, redesigned our Website, accelerated e-mail promotions, and initiated an aggressive advertising program. Our goal in 1999 is to increase our Internet sales fourfold over 1998 and we're well on our way to achieving that. A Bright Future This remarkable year, the result of a carefully conceived and well-executed long-term strategy, demonstrated to me that our Company has an exceptionally bright future. My most sincere thanks go out to the great team of skilled, experienced, talented associates who made it happen. And on behalf of our entire Company, I want to express my heartfelt appreciation for your support. Sincerely, [Graphic Omitted] /s/ Richard Thalheimer - ----------------------- Richard Thalheimer Chairman, Founder and Chief Executive Officer 4 [Graphic Omitted] Our best-selling Ionic Breeze(TM) Silent Air Purifier was created by Sharper Image Design using exclusive patented technology that moves air electronically. It's the only air purifier that circulates air absolutely silently. 5 SHARPER IMAGE DESIGN Sharper Image Design products are conceived, designed, engineered, packaged, contract manufactured and marketed solely by the Company. This ability to create proprietary products is our greatest strategic advantage. Our exclusive merchandise is designed to have wide appeal and allows the Company to broaden its base of customers. Led by founder and CEO Richard Thalheimer, and Sharper Image Design Vice President, Charles Taylor, this experienced team has superior expertise and know-how in the development of a wide range of innovative, high quality products -- many incorporating patented technologies that are unavailable to competitors. More than a dozen Sharper Image Design products were introduced in 1998. Several had extraordinary debuts: The Personal Cooling System(TM) was the number-one seller in summer. The Ionic Breeze(TM) Silent Air Purifier, number one in fall. The CD Radio/Alarm Clock with Sound Soother(R), number one in November. The Weebot(TM) Electronic Pet, number one in December. Sharper Image Design was key to the year's exceptional financial performance, accounting for 18 percent of sales and an even greater share of gross margin. Our customers enjoy great value, utility and fun; we enjoy market exclusivity and much higher gross margins. We are accelerating the pace of product development because Sharper Image Design proprietary products are key to our sales and earnings growth. [Graphic Omitted] Ionic Shoe Freshener(TM) [Graphic Omitted] Dreamlight(TM) Sound-Activated Light Show [Graphic Omitted] PowerFlow(TM) Height-Enhancing Insoles [Graphic Omitted] Key Organizer with Clock and Calendar 6 [Graphic Omitted] Personal Cooling System(TM) [Graphic Omitted] Voice Activated Auto Dialer(TM) [Graphic Omitted] Ionic Clothes Freshener(TM) [Graphic Omitted] Personal Humidifier [Graphic Omitted] Telephone with Truth.Quest(TM) Function [Graphic Omitted] Ultra Heart and Sound Soother(R) [Graphic Omitted] Ionic Bath(TM) Pet Brush [Graphic Omitted] Ionic Closet Dry Cleaner(TM) [Graphic Omitted] AM/FM Companion(TM) with Smoke Alarm [Graphic Omitted] Shower Companion(TM) Plus [Graphic Omitted] Turbo-Groomer(TM) [Graphic Omitted] Digital Auto-Drive(R) Tie Rack 7 Sharper Image for Everyone More than two decades of visionary merchandising and imaginative marketing have made The Sharper Image one of the most widely recognized brands - -- an enduring American icon that conveys genuine enthusiasm for well-designed, technologically innovative products that make life easier and more enjoyable. Our aim is to build on our brand's strengths and multichannel know-how to reach a larger base of customers with proprietary Sharper Image Design products. These exclusive items are unique yet broadly appealing, fun yet useful, sophisticated yet affordable. [Graphic Omitted] Internet: sharperimage.com Our goal is to make our online store at sharperimage.com a leading Internet destination -- a fun, exciting place to visit, shop and buy. Increased 1998 exposure of our Website's Internet address in our stores, catalog and print advertising, plus a series of successful e-mail promotions to our online buyers, helped our Website achieve sales gains of 400 percent during the holiday season, driven by 70 percent new Sharper Image customers. Aggressive development efforts led to successful 1999 launches of a colorful new design for our Website, a dynamic Internet auction site, and, for Sharper Image Design products, 3D enriched presentations with interactivity and sound -- introduced with great fanfare at the global debut of the Intel(R) Pentium(R) III processor. The Internet is our fastest growing channel and our biggest opportunity, and we are seizing it aggressively with greater human and capital resources. All internal and external indicators point to an exceptional future in e-commerce. Sharper Image Catalog Our award-winning catalog is The Sharper Image to loyal customers around the world. The catalog was the key to building the brand, and direct mail is a large, profitable, thriving part of our business and our principal advertising vehicle. We mailed more Sharper Image catalogs than ever before in 1998 --more than 41 million -- and enjoyed significant increases in sales, orders and profitability. Sharper Image Stores Our 89 stores are a big and growing part of our business, accounting for nearly 70 percent of revenues. This year, we opened four new stores and remodeled four with a 8 [Graphic Omitted] great-looking new store design that feels fresh and inviting -- a welcome change that dramatically highlights our merchandise and appeals to both men and women shoppers. We plan to open five stores in 1999 and will continue to evaluate the remodel program. Corporate Marketing The Sharper Image cachet has made us a major player in the motivation and reward business. We design unique reward programs in partnership with a wide range of clients, including a number of major corporations. Advertising: Print and Infomercials To market our exclusive proprietary products to a wider audience, and to promote our stores and Website, we increased our advertising in major news publications like USA Today, The Wall Street Journal, The New York Times, and in regional newspapers and national magazines. We tested televised "infomercials" with positive results and plan to do more in the coming year. Strong brand. Proprietary products with wide appeal. Multiple channels. Broad consumer base. Our solid financial performance in 1998 was the result of a carefully conceived and well-executed strategy that lays out a clear path to profitable growth. [Graphic Omitted] Our new store design on New York's 57th Street. 9 Management's Discussion and Analysis of Results of Operations and Financial Condition - -------------------------------------------------------------------------------- Sharper Image Corporation Results Of Operations Percentage of Total Revenues - -------------------------------------------------------------------------------- Fiscal Year Ended Jan. 31, --------------------------------------------- 1999 1998 1997 (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) --------------------------------------------- Revenues: Net store sales 66.8% 69.9% 71.0% Net catalog sales 29.1 27.1 25.5 Net Internet sales 2.0 0.7 0.4 Net wholesale sales 1.4 1.5 1.9 List rental 0.5 0.5 0.6 Licensing 0.2 0.3 0.6 ----- ----- ----- Total Revenues 100.0% 100.0% 100.0% Costs and Expenses: Cost of products 50.6 53.3 51.8 Buying and occupancy 10.8 11.0 11.4 Advertising and promotion 11.2 10.5 12.2 General, selling, and administrative 24.3 24.5 24.1 Provision for loss due to closure of SPA Collection division -- 3.8 ----- ----- ----- Operating Income (Loss) 3.1 0.7 (3.3) Other Income (Expense) 0.1 (0.2) (0.2) ----- ----- ----- Earnings (Loss) Before Income Tax (Benefit) 3.2 0.5 (3.5) Income Tax (Benefit) 1.3 0.2 (1.4) ----- ----- ----- Net Earnings (Loss) 1.9% 0.3% (2.1)% ----- ----- ----- Revenues Fiscal Year Ended Jan. 31, -------------------------------------------------- 1999 1998 1997 Dollars in thousands (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) -------------------------------------------------- Net store sales $162,371 $151,589 $149,321 Net catalog sales 70,750 58,772 53,577 Net Internet sales 4,922 1,633 843 Net wholesale sales 3,464 3,199 4,029 -------- -------- -------- Total Net Sales 241,507 215,193 207,770 List rental 1,088 982 1,177 Licensing 519 640 1,298 -------- -------- -------- Total Revenues $243,114 $216,815 $210,245 ======== ======== ======== Net sales of $241,507,000 for fiscal 1998 increased $26,314,000, or 12.2%, from the prior fiscal year. Returns and allowances as a percentage of sales were 11.4% for fiscal 1998, compared to 12.2% for fiscal 1997. Net store sales increased $10,782,000, or 7.1%, comparable store sales increased 5.3%, net catalog sales increased $11,978,000, or 20.4%, net Internet sales increased $3,289,000, or 201%, and net wholesale sales increased $265,000, or 8.3%, as compared to fiscal 1997. Management believes that the introduction of new Sharper Image Design proprietary products was key to the achievement of the growth in total net sales. The increase in net store sales for fiscal 1998 was primarily attributable to an 8.7% increase in total store transactions, partially offset by a 1.3% decrease in average revenue per transaction. Also contributing to the increase was the fiscal 1998 opening of four new stores and annualized sales of six stores opened in fiscal 1997, partially offset by the 1998 closing of two stores at the maturity of the store leases. Net sales per average square foot increased to $484 for fiscal 1998, compared to $465 in fiscal 1997 and $458 in fiscal 1996. The Company's store sales productivity has increased over the past two years and compares favorably with the retail industry's specialty store (hard goods) average per square foot of $168 for fiscal 1997, $343 for fiscal 1996, and $252 for fiscal 1995 (statistical information per National Retail Federation-data for 1998 is not yet available). Net catalog sales were positively impacted by an increase of 34.7% in total catalog orders partially offset by a 10.6% decrease in average revenue per order. The increase in catalog orders was partially attributable to advertising campaigns in major consumer magazines and newspapers. The Company believes that the 8.0% increase in the number of catalogs and catalog pages circulated for the Sharper Image catalog during fiscal 1998 also contributed to increases in net store sales and comparable store sales. The Company's Internet sales increased to $4.9 million in fiscal 1998 from $1.6 million in fiscal 1997. Fiscal 1998 experienced a 139.1% increase in Internet orders and a 26.1% increase in average revenue per transaction from fiscal 1997. The threefold increase in sales reflects the increase in the number of on-line shoppers and the Company's commitment to grow its e-commerce. The Company's 10 Management's Discussion and Analysis (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Revenues (continued) e-commerce Website at sharperimage.com regularly undergoes design and technology enhancement to provide shoppers with easy and fun shopping experiences. Although the Company was in the forefront of electronic shopping and activated its Website in late fiscal 1995, Internet sales in 1996 were minimal due to the newness of the e-commerce industry. Internet sales increased 94% to $1.6 million in fiscal 1997, primarily due to Internet industry growth, continual improvements to the Website, and increased marketing emphasis. Net wholesale sales increased $264,000, or 8.3%, primarily due to the increased sales of the Company's Sharper Image Design proprietary products. Net sales of $215,193,000 for fiscal 1997 increased $7,423,000, or 3.6%, from fiscal 1996. Returns and allowances as a percentage of sales were 12.2% for fiscal 1997, compared to 12.3% for fiscal 1996. Net store sales increased $2,268,000, or 1.5%, comparable store sales increased 1.1%, net catalog sales increased $5,195,000, or 9.7%, and net wholesale sales decreased $830,000, or 20.6% as compared to fiscal 1996. The increase in net store sales for fiscal 1997 was primarily attributable to the addition of six stores opened during the year. The increase in net store sales also reflected a 7.2% increase in average revenue per transaction, to $104 from $97, and a 4.6% decrease in total store transactions. Strong comparable store sales increases of 7.3% and 3.4% in the third and fourth quarters of fiscal 1997 more than offset the comparable store sales decreases in the first half of the year. Management believes the increase in net sales benefited from new product introductions, including an increased selection of Sharper Image Design proprietary products and more optimal inventory levels during the second half of the year. Net catalog sales in fiscal 1997 were positively impacted by an increase in Sharper Image catalog average revenue per order to $183 from $140, advertising campaigns in major consumer magazines and newspapers, a 10.0% increase in the number of Sharper Image catalogs circulated, and a twofold increase in the number of catalogs circulated for the test concept Sharper Image Home Collection. The Company believes that the increase in the number of catalogs and catalog pages circulated for the Sharper Image catalog during fiscal 1997 also contributed to the increases in net store sales and comparable store sales. Net wholesale sales decreased $830,000, or 20.6%, primarily due to a decrease in the number of products offered to wholesale customers both in the U.S. and internationally. For the purpose of determining comparable store sales, comparable stores are defined as those which were open during the entire comparable month of the previous year and are compared monthly for purposes of this analysis. Inflationary effects are not considered significant to the growth of sales. Cost of Products Cost of products increased $7,596,000, or 6.6%, in fiscal 1998 from fiscal 1997. The increase was primarily related to increases in net sales. The increase in cost of sales was lower than the increase in sales, reflecting the beneficial impact of the higher gross margin rate produced during fiscal 1998. The gross margin rate for fiscal 1998 was 49.0%, compared to 46.3% for fiscal 1997. The higher gross margin rate reflected an increase in the sales of Sharper Image Design proprietary products to 18% of total revenue from 8% for the prior fiscal year. These propriety products generally carry higher margins. Cost of products increased $6,736,000, or 6.2% , in fiscal 1997 from fiscal 1996. The increase was primarily related to increases in net sales and the higher cost of products related to the merchandise mix. The gross margin rate for fiscal 1997 was 46.3%, compared to 47.6% for fiscal 1996. The lower gross margin rate reflected an increase in sales of lower-margin products, such as certain state-of-the-art electronic items and games, partially offset by an increase in the Sharper Image Design proprietary products. The Company's gross margin rate fluctuates with the changes in its merchandise mix, which is affected by new items available in various categories. The variation in merchandise mix from category to category from year to year reflects the characteristic that the Company is driven by individual products, as opposed to general lines of merchandise. It is impossible to predict future gross margin rates although the Company's goal is to continue to increase the sales of Sharper Image Design proprietary products and other exclusive private label products, as these products generally carry higher margins. The popularity of these proprietary products contributed to the 2.7 percentage point increase in the gross margin rate for fiscal 1998, and should continue to have a positive impact on the Company's gross margin rate. 11 Management's Discussion and Analysis (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Buying and Occupancy Buying and occupancy expenses increased $2,249,000, or 9.4%, in fiscal 1998 from fiscal 1997. The increase primarily reflects a full year of occupancy cost of six new stores opened during fiscal 1997 and the cost of four new stores opened in fiscal 1998, partially offset by the 1998 closure of two stores at their lease maturity. Buying and occupancy expenses decreased $63,000, or 0.3%, in fiscal 1997 from fiscal 1996. The decrease primarily reflected lower buying costs and lower occupancy costs associated with the closure of the SPA Collection division and the elimination of the cost of two closed Sharper Image stores, partially offset by a full year of occupancy cost of eight new stores opened during fiscal 1996 and the cost of six new stores opened in fiscal 1997. Advertising and Promotion Advertising and promotion expenses for fiscal 1998 increased $4,601,000, or 20.2%, from fiscal 1997. The increase was primarily due to an 8.0% increase in the number of Sharper Image catalogs mailed and an 11.6% increase in the number of pages circulated, as compared with fiscal 1997. Other costs, such as advertising campaigns in major consumer magazines and newspapers; infomercials; and development of Internet marketing also contributed to the increased expenses in fiscal 1998. The increase was partially offset by the 51.3% decrease in mailings of the test concept Sharper Image Home Collection catalog. The test mailings of the Home Collection catalog were discontinued in fiscal 1998. The Company is currently evaluating a test of Home Collection products on the Internet. Advertising and promotion expenses for fiscal 1997 decreased $2,941,000, or 11.4%, from fiscal 1996. The decrease was primarily due to lower consumer magazine and newspaper advertising and the elimination of the SPA Collection catalog, partially offset by a 10% increase in the number of Sharper Image catalogs mailed and a 3% increase in the number of pages circulated, along with the twofold increase in mailings of the test concept Sharper Image Home Collection catalog. While the Sharper Image catalog serves as the primary source of advertising for its retail stores and mail order business, the Company continually evaluates its advertising strategies to maximize the effectiveness of its advertising programs. The Company plans to expand advertising for its e-commerce business as well as infomercials. The popularity and higher margins of Sharper Image Design proprietary products provide additional opportunities for the Company to fuel growth with these additional advertising media. General, Selling, and Administrative General, selling, and administrative (G S & A) expenses for fiscal 1998 increased $5,932,000, or 11.2%, from fiscal 1997, primarily due to increases in overall selling expenses related to the increase in net sales and related additional administrative support costs. The increase was partially offset by the improvement in net delivery income related to mail order shipments. G S & A expenses for fiscal 1997 increased $2,403,000, or 4.7%, from fiscal 1996, primarily due to increases in overall selling expenses related to the increase in net sales and higher net delivery expense related to mail-order shipments and certain additional administrative support costs, which were partially offset by the elimination of costs related to the closure of the SPA division. Other Income (Expense) Other income, net, for fiscal 1998 increased $761,000 from fiscal 1997, reflecting the gain on sale of certain equipment. Net other expense for fiscal 1997 increased $206,000 from fiscal 1996. The increase in other expense is primarily due to an increase in interest expense related to borrowings on the Company's credit facility, and a decrease in interest income from available cash. Income Taxes The effective tax rate for fiscal 1998, 1997, and 1996 was 40.0%. Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's consolidated financial statements or tax returns. In estimating future tax consequences, all expected future events then known to management are considered, other than changes in the tax law or rates. Liquidity and Capital Resources At January 31, 1999, the Company had cash and equivalents of $8,389,000, an increase of $4,888,000, as compared to $3,501,000 at January 31, 1998. During fiscal 1998, the Company met its short-term liquidity needs and its capital requirements with available cash, cash flow provided by operations, trade credit, 12 Management's Discussion and Analysis (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Liquidity and Capital Resources (continued) and the revolving and term loans. The increase in cash reflected the highest fourth quarter revenues and earnings in the Company's history. At January 31, 1999, the Company had no amounts outstanding on its revolving loan credit facility. The highest amount of direct borrowings under the revolving loan credit facility during fiscal 1998 was $14,288,000, compared with $14,672,000 in fiscal 1997. Letter of credit commitments outstanding at January 31, 1999 and 1998 were $4,108,000 and $2,321,000, respectively. The Company has a revolving secured credit facility with The CIT Group/Business Credit, Inc, which expires September 2003. The credit facility has been amended on several occasions and, as of January 31, 1999, the agreement allows Company borrowings and letters of credit up to a maximum of $30 million for the period from October 1, 1999 through December 31, 1999, and up to $20 million at 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 0.25% per annum or at LIBOR plus 2.25% per annum based on financial performance. 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 January 31, 1999, the Company was in compliance with all covenants. The credit facility allows for seasonal borrowings as follows: October 1 through December 31, 1999 $30 million 2001 $32 million 2000 $31 million 2002 $33 million 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 0.50% per annum or at LIBOR plus 2.50% per annum based on financial performance. Each Term Loan is to be repaid in 36 equal monthly principal installments. At January 31, 1999, notes payable included a $500,000 Term Loan which bears interest at a variable rate of prime plus 0.50%, provides for monthly principal payments of $55,555 plus the related interest payment, and matures in October 1999. At January 31, 1999, notes payable included a $2,648,000 mortgage loan collateralized by the Company's distribution center. This 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 Company's merchandise inventory at January 31, 1999 was approximately 5.6% lower than the prior fiscal year. The decrease in inventory reflected the Company's higher than planned increase of 15.4% in total net sales for the quarter ended January 31, 1999 as compared with the same quarter in 1998. The Company leases all of its offices, stores, and seasonal warehouse space. During the fiscal year ended January 31, 1999, the Company opened four Sharper Image stores located in Orlando, Florida; King of Prussia, Pennsylvania; West Nyack, New York; and Towson, Maryland. The Company closed two Sharper Image stores located in Escondido, California and Gurnee Mills, Illinois. The Company is currently planning to open five new Sharper Image stores during fiscal 1999. Total capital expenditures estimated for new and existing stores, corporate headquarters and the distribution center for fiscal 1999 are between $7 million and $8 million. The Company believes it will be able to fund its cash needs for fiscal 1999 through internally generated cash, trade credit, and the credit facility. Quantitative and Qualitative Disclosure About Market Risk The Company is exposed to market risks, which include changes in interest rates and, to a lesser extent, foreign exchange rates. The Company does not engage in financial transactions for trading or speculative purposes. The interest payable on the Company's credit facility is based on variable interest rates and therefore affected by changes in market interest rates. If interest rates on existing variable rate debt rose 0.8% (10% from the bank's reference rate) as of January 31, 1999, the Company's results from operations and cash flows would not be 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. which are settled in U.S. dollars and, therefore, has only minimal exposure to 13 Management's Discussion and Analysis (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Quantitative and Qualitative Disclosure About Market Risk (continued) foreign currency exchange risks. The Company does not hedge against foreign currency risks and believes that foreign currency exchange risk is immaterial. 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 Compliance The Company recognizes that the arrival of the year 2000 poses a unique worldwide challenge to the ability of many 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 the Company 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; and, (v) determination of key vendors 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 on 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 application conversion work nearing completion. Non-critical system conversions have been identified and scheduled for completion by 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 e-mail systems, to telephone systems. Based upon a detailed review and update of the Plan performed in January 1999, conversion of all Company programs is expected to be completed with full implementation by June 1999. In addition, a systemwide test will be completed by September 1999 to simulate the rollover to January 1, 2000, to ensure all critical systems supporting the business will remain operational. The Company's operations are also dependent on the year 2000 readiness of third parties that 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' 14 Management's Discussion and Analysis (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Year 2000 Compliance (continued) 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. Through January 31, 1999 the Company has incurred approximately $300,000 on work related to year 2000 compliance. The estimated cost for this project is between $400,000 and $600,000, and is being funded through operating cash flows. The total estimated cost for this project includes a provision for the potential costs associated with third party vendor or supplier failures. 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 that 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 alternative 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 , 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. 15 Statements of Operations - ------------------------------------------------------------------------------------------------------------------ Sharper Image Corporation
Fiscal Year Ended January 31, ----------------------------------------------------- 1999 1998 1997 Dollars in thousands except per share amounts (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) - ------------------------------------------------------------------------------------------------------------------ Revenues: Sales $ 272,721 $ 245,095 $ 236,844 Less: returns and allowances 31,214 29,902 29,074 ----------- ----------- ----------- Net Sales 241,507 215,193 207,770 List rental 1,088 982 1,177 Licensing 519 640 1,298 ----------- ----------- ----------- 243,114 216,815 210,245 ----------- ----------- ----------- Costs and Expenses: Cost of products 123,131 115,535 108,799 Buying and occupancy 26,153 23,904 23,967 Advertising and promotion 27,396 22,795 25,736 General, selling, and administrative 59,006 53,074 50,671 Provision for loss due to closure of SPA Collection division -- -- 8,000 ----------- ----------- ----------- 235,686 215,308 217,173 ----------- ----------- ----------- Other Income (Expense): Interest expense--net (645) (564) (391) Other--net 887 45 78 ----------- ----------- ----------- 242 (519) (313) ----------- ----------- ----------- Earnings (Loss) before Income Tax (Benefit) 7,670 988 (7,241) Income Tax (Benefit) 3,068 395 (2,896) ----------- ----------- ----------- Net Earnings (Loss) $ 4,602 $ 593 $ (4,345) ----------- ----------- ----------- Net Earnings (Loss) Per Share - Basic $ 0.54 $ 0.07 $ (0.53) ----------- ----------- ----------- Net Earnings (Loss) Per Share - Diluted $ 0.51 $ 0.07 $ (0.53) ----------- ----------- ----------- Weighted Average Number of Shares - Basic 8,532,588 8,303,425 8,260,208 ----------- ----------- ----------- Weighted Average Number of Shares - Diluted 9,072,832 8,537,032 8,260,208 ----------- ----------- ----------- See Notes to Financial Statements.
16 Balance Sheets - -------------------------------------------------------------------------------------------------------------------------- Sharper Image Corporation
Fiscal Year Ended January 31, ------------------------------ 1999 1998 Dollars in thousands except per share amounts (Fiscal 1998) (Fiscal 1997) - --------------------------------------------------------------------------------------------------------------------------- Assets Current Assets: Cash and equivalents $ 8,389 $ 3,501 Accounts receivable, net of allowance for doubtful accounts of $804 and $508 6,787 8,189 Merchandise inventories 32,598 34,534 Deferred catalog costs 2,454 4,982 Prepaid expenses and other 5,605 3,429 ------- ------- Total Current Assets 55,833 54,635 Property and Equipment, Net 22,513 20,842 Deferred Taxes and Other Assets 3,699 3,185 ------- ------- Total Assets $82,045 $78,662 ------- ------- Liabilities and Stockholders' Equity Current Liabilities: Accounts payable $11,653 $18,439 Accrued expenses 16,960 16,832 Deferred revenue 7,268 6,784 Income taxes payable 3,314 -- Current portion of notes payable 635 947 ------- ------- Total Current Liabilities 39,830 43,002 Notes Payable 2,513 3,299 Other Liabilities 3,053 3,205 Commitments and Contingencies -- -- ------- ------- Total Liabilities 45,396 49,506 Stockholders' Equity: Preferred stock, $0.01 par value: Authorized, 3,000,000 shares: Issued and outstanding, none Common stock, $0.01 par value: Authorized, 25,000,000 shares: Issued and outstanding, 8,916,995 and 8,356,280 shares 89 83 Additional paid-in capital 12,589 9,704 Retained earnings 23,971 19,369 Total Stockholders' Equity 36,649 29,156 ------- ------- Total Liabilities and Stockholders' Equity $82,045 $78,662 ------- ------- See Notes to Financial Statements.
17 Statements of Stockholders' Equity - ------------------------------------------------------------------------------------------------------------------------------------ Sharper Image Corporation
Additional Common Stock Paid-in Retained Dollars in thousands Shares Amount Capital Earnings Total - ----------------------------------------------------------------------------------------------------------------------------------- Balance at January 31, 1996 8,250,980 $ 82 $ 9,555 $ 23,121 $ 32,758 Issuance of common stock for stock options exercised, (net of income tax benefit) 15,960 1 35 36 Net loss (4,345) (4,345) ---------- ---------- ---------- ---------- ---------- Balance at January 31, 1997 8,266,940 83 9,590 18,776 28,449 Issuance of common stock for stock options exercised, (net of income tax benefit) 124,340 1 237 238 Repurchase of common stock (35,000) (1) (123) (124) Net earnings 593 593 ---------- ---------- ---------- ---------- ---------- Balance at January 31, 1998 8,356,280 83 9,704 19,369 29,156 Issuance of common stock for stock options and warrants exercised (net of income tax benefit) 560,715 6 2,885 2,891 Net earnings 4,602 4,602 ---------- ---------- ---------- ---------- ---------- Balance at January 31, 1999 8,916,995 $ 89 $ 12,589 $ 23,971 $ 36,649 ---------- ---------- ---------- ---------- ---------- See Notes to Financial Statements
18 Statements of Cash Flows - ------------------------------------------------------------------------------------------------------------------------------------ Sharper Image Corporation
Fiscal Year Ended January 31, ------------------------------------------- 1999 1998 1997 Dollars in thousands (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) - ------------------------------------------------------------------------------------------------------------------------------------ Cash was Provided by (Used for) Operating Activities: Net earnings (loss) $ 4,602 $ 593 $ (4,345) Adjustments to reconcile net earnings (loss) to net cash provided by (used for) operating activities: Depreciation and amortization 5,027 4,334 4,195 Deferred rent expense 78 151 142 Deferred income taxes (1,459) 1,614 (3,188) Gain on sale of equipment (840) -- -- Change in operating assets and liabilities: Accounts receivable 1,402 (2,274) (1,479) Merchandise inventories 1,936 (7,169) (3,052) Deferred catalog costs, prepaid expenses and other 1,298 (1,571) 54 Accounts payable and accrued expenses (5,822) 838 11,429 Deferred revenue and other liabilities 3,568 1,308 (508) -------- -------- -------- Cash Provided by (Used for) Operating Activities 9,790 (2,176) 3,248 -------- -------- -------- Cash was Provided by (Used for) Investing Activities: Property and equipment expenditures (8,431) (4,437) (6,579) Proceeds from sale of equipment 1,736 53 98 -------- -------- -------- Cash Used for Investing Activities (6,695) (4,384) (6,481) -------- -------- -------- Cash was Provided by (Used for) Financing Activities: Issuance of common stock for warrants and stock options exercised, (net of stock repurchases) 2,891 114 36 Proceeds from notes payable and revolving credit facility 46,921 27,761 25,665 Principal payments on notes payable and revolving credit facility (48,019) (28,687) (24,071) -------- -------- -------- Cash Provided by (Used for) Financing Activities 1,793 (812) 1,630 -------- -------- -------- Net Increase (Decrease) in Cash and Equivalents 4,888 (7,372) (1,603) Cash and Equivalents at Beginning of Period 3,501 10,873 12,476 -------- -------- -------- Cash and Equivalents at End of Period $ 8,389 $ 3,501 $ 10,873 -------- -------- -------- Supplemental Disclosure of Cash Paid for: Interest $ 813 $ 771 $ 700 Income Taxes $ -- $ 409 $ 459 See Notes to Financial Statements.
19 Notes to Financial Statements - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999, 1998, and 1997 Note A -- Summary of Significant Accounting Policies The Company is a leading specialty retailer which introduces and sells quality, innovative, and entertaining products. These products are sold through its retail stores, catalogs, Internet, and other marketing channels throughout the United States. The Company also has stores and catalog operations internationally through licensees. Additional revenue is derived from rental of the Company's mailing list and from licensing activities relating to the Company's trade name. Revenue Recognition: Catalog sales are recorded when merchandise is shipped and the Company provides for allowance for returns based upon historical returns rate. Deferred revenue represents merchandise certificates outstanding and unfilled cash orders at the end of the fiscal period. Mailing list rental revenue is recognized when the list is fulfilled. Accounting Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Fair Value of Financial Instruments: The carrying value of cash, accounts receivable, accounts payable and notes payable approximates the estimated fair value. Merchandise Inventories: Merchandise inventories are stated at lower of cost (first-in, first-out method) or market. Cash and Equivalents: Cash and equivalents represent cash and short-term, highly liquid investments with original maturities of three months or less. Deferred Catalog and Advertising Costs: Direct costs incurred for the production and distribution of catalogs are capitalized. Capitalized catalog costs are amortized, once the catalog is mailed, over the expected sales period which is generally three months. Other advertising costs are expensed as incurred and amounted to $4,470,000, $3,580,000, and $5,306,000, for the fiscal years ended January 31, 1999, 1998, and 1997. Start-Up Activities: All start-up and preopening costs that are not otherwise capitalizable as long-lived assets are expensed as incurred by the Company. Property and Equipment: Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the various assets which range from three to ten years for office furniture and equipment and transportation equipment, and 40 years for the building. Leasehold improvements are amortized using the straight-line method over the lesser of their estimated useful lives or the term of the applicable lease which ranges from 7 to 18 years. The Company manufactures its own proprietary products for sale through its stores and catalogs. Costs incurred for tooling, dies and package design are deferred and amortized over the estimated life of these products, which is generally two years. At January 31, 1999 and 1998, capitalized costs included in property and equipment, net of related amortization, were $2,239,000 and $1,566,000, respectively. The Company reviews its long-lived assets, including identifiable intangible assets, whenever events or changes indicate the carrying amount of such assets may not be recoverable. The Company's policy is to review the recoverability of all assets, at a minimum, on an annual basis. Based on the Company's review at January 31, 1999, no material adjustment was made to long-lived assets. Income Taxes: Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events then known to management that have been recognized in the Company's consolidated financial statements or tax returns. In estimating future tax consequences, all expected future events then known to management are considered other than changes in the tax law or rates. Stock-Based Compensation: The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with APB No. 25, Accounting for Stock Issued to Employees. Earnings Per Share: Basic earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding during each year of 8,532,588, and 8,303,425, and 8,260,208, for the fiscal years ended January 31, 1999, 1998, and 1997. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options. Weighted average number of common shares outstanding was adjusted for 540,244 and 233,607 incremental shares assumed issued on the exercise of common stock during the fiscal years ended January 31, 1999 and 1998. Stock options were excluded from the computation of diluted loss per share for the year ended January 31, 1997, as the effect would be anti-dilutive. Options for which the exercise price was greater than the average market price of common stock for the period were not included in the computation of diluted earnings per share. The number of such options for which the exercise price was greater than the average market price of $6.66 and $3.56 for the fiscal years ended January 31, 1999 and 1998, was 14,000 and 97,500. Comprehensive Income: In 1998, the Company implemented Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income. Comprehensive income consists of net earnings or loss for the current period and other comprehensive income (income, expenses, gains, and losses that currently bypass the income statement and are reported directly as a separate component of equity). Comprehensive income does not differ from net earnings (loss) for the Company for the years ended January 31, 1999, 1998, and 1997. New Accounting Standards: In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure these instruments at fair value. This statement is effective for years beginning after June 15, 1999 and is not applied retroactively to financial statements for prior periods. The Company believes that this statement will not have a material effect on its financial statements. Reclassification: Certain reclassifications have been made to prior years' financial statements in order to conform with the classifications of the January 31, 1999 financial statements. 20 Notes to Financial Statements (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999, 1998, and 1997 Note B -- Property and Equipment Property and equipment is summarized as follows: Fiscal Year Ended January 31, ----------------------------- 1999 1998 Dollars in thousands (Fiscal 1998) (Fiscal 1997) - -------------------------------------------------------------------------------- Leasehold improvements $25,419 $24,071 Office furniture and equipment 35,466 30,313 Transportation 16 2,439 Land 53 53 Building 2,874 2,874 ------- ------- 63,828 59,750 Less accumulated depreciation and amortization 41,315 38,908 ------- ------- $22,513 $20,842 ------- ------- Note C -- Other Assets The Company has an agreement under which it will advance the premiums on a split-dollar life insurance policy for its Chairman of the Board, Founder, and Chief Executive Officer. The Company has an interest in the insurance benefits equal to the amount of the premiums advanced. The amount receivable for premiums advanced as of January 31, 1999 and 1998 was $766,000 and $590,000, respectively. Note D -- Revolving Loan and Notes Payable The Company has a revolving secured credit facility with The CIT Group/Business Credit, Inc., which expires September 2003. The credit facility has been amended on several occasions and, as of January 31, 1999, the agreement allows Company borrowings and letters of credit up to a maximum of $30 million for the period from October 1, 1999 through December 31, 1999, and up to $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 0.25% per annum or at LIBOR plus 2.25% per annum based on financial performance. 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 January 31, 1999 and 1998, the Company was in compliance with all covenants. The credit facility allows for seasonal borrowings as follows: October 1 through December 31, 2000 $31 million 2001 $32 million 2002 $33 million At January 31, 1999 and 1998, the Company had no amounts outstanding on its revolving loan credit facility. Letter of credit commitments as of January 31, 1999 and 1998 were $4,108,000 and $2,321,000, respectively. 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 0.50% (8.25% at January 31,1999) per annum or at LIBOR plus 2.50% per annum based on financial performance. 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 0.50%, (8.25% at January 31, 1999) provides for monthly principal payments of $55,555 plus the related interest payment, and matures in October 1999. At January 31, 1999 and 1998, the balance of the Term Loan was $500,000 and $1,167,000, respectively. Notes payable included a mortgage loan collateralized by the Company's distribution center. This 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. At January 31, 1999 and 1998, the balance of this note was $2,648,000 and $2,772,000, respectively. At January 31, 1998, notes payable also included a mortgage loan collateralized by equipment. This note was paid off in fiscal 1998 with the proceeds from sale of the collateralized equipment. Future minimum principal payments on notes payable at January 31, 1999, are as follows: Dollars in thousands - -------------------------------------------------------------------------------- Fiscal Year Ending January 31, 2000 $ 635 2001 147 2002 160 2003 173 2004 189 Later years 1,844 ------ Total notes payable $3,148 ------ 21 Notes to Financial Statements (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999, 1998, and 1997 Note E -- Income Taxes Fiscal Year Ended January 31, ---------------------------------------------- 1999 1998 1997 Dollars in thousands (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) - -------------------------------------------------------------------------------- Currently payable (refundable): Federal $ 3,848 $(1,036) $ 248 State 679 (183) 44 ------- ------- ------- 4,527 (1,219) 292 Deferred: Federal (1,240) 1,372 (2,710) State (219) 242 (478) ------- ------- ------- (1,459) 1,614 (3,188) ------- ------- ------- $ 3,068 $ 395 $(2,896) ------- ------- ------- The difference between the effective income tax rate and the United States federal income tax rate is summarized as follows: Fiscal Year Ended January 31, ------------------------------------------ 1999 1998 1997 (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) - -------------------------------------------------------------------------------- Federal tax rate 34.0% 34.0% 34.0% State income tax, less federal benefit 6.0 6.0 6.0 ---- ---- ---- Effective tax rate 40.0% 40.0% 40.0% ---- ---- ---- Deferred taxes result from differences in the recognition of expense for income tax and financial reporting purposes. Temporary differences which give rise to deferred tax assets (liabilities) are as follows: Fiscal Year Ended January 31, ------------------------------ 1999 1998 Dollars in thousands (Fiscal 1998) (Fiscal 1997) - -------------------------------------------------------------------------------- Current: Nondeductible reserves $ 4,123 $ 3,809 Deferred catalog costs (981) (1,993) State taxes (755) (569) ------- ------- Current--net 2,387 1,247 ------- ------- Noncurrent: Deferred rent 1,198 1,429 Depreciation 2,967 2,356 Deductible software costs (1,127) (1,050) Other--net (173) (189) ------- ------- Noncurrent--net 2,865 2,546 ------- ------- Total $ 5,252 $ 3,793 ------- ------- Note F -- Leases The Company leases its offices, retail facilities, and equipment under operating leases for terms expiring at various dates through 2008. Under the terms of certain of the leases, rents are adjusted annually for changes in the consumer price index and increases in property taxes. The aggregate minimum annual lease payments under leases in effect at January 31, 1999, are as follows: Dollars in thousands - -------------------------------------------------------------------------------- Fiscal Year Ending January 31, 2000 $ 14,875 2001 13,392 2002 9,625 2003 9,411 2004 8,891 Later years 19,535 -------- Total minimum lease commitments $ 75,729 -------- Many of the Company's leases contain predetermined fixed escalations of the minimum rentals during the initial term. For these leases, the Company has recognized the related rental expense on a straight-line basis and has recorded the difference between the expense charged to income and amounts payable under the leases as deferred rent which is included in Other Liabilities. Some store leases contain renewal options for periods ranging up to five years. Most leases also provide for payment of operating expenses, real estate taxes, and for additional rent based on a percentage of sales. Net rental expense for all operating leases was as follows: Fiscal Year Ended January 31, ------------------------------------------------- 1999 1998 1997 Dollars in thousands (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) - -------------------------------------------------------------------------------- Minimum rentals $15,273 $13,812 $13,259 Percentage rentals and other charges 5,914 5,559 5,546 ------- ------- ------- $21,187 $19,371 $18,805 ------- ------- ------- 22 Notes to Financial Statements (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999, 1998, and 1997 Note G -- Stockholders' Equity Under the Company's stock repurchase program, the Company is authorized by its Board of Directors to repurchase up to $1,600,000 of common stock. Through January 31, 1999, the Company has repurchased a total of 186,100 shares at an average price of $5.95 per share, including 35,000 shares in fiscal 1997 for $124,000. Under the Company's 1985 Stock Option Plan, as amended, non-qualified options to purchase common stock are granted to officers, key employees and consultants, up to an aggregate 2,405,000 shares. Options generally vest over a four to six year period from the date of the grant and are priced at 100% of the fair market value at the date of the grant. The Stock Option Plan limits the maximum number of shares any one individual may be granted per fiscal year, and allows individuals owning more than 25% of the Company's common stock to receive stock options. Non-employee members of the Board are ineligible to receive stock option grants under this plan. The Company also has the 1994 Non-Employee Directors Stock Option Plan, as approved by stockholders, to allow for stock option grants of common stock to the non-employee members of the Board of Directors, up to an aggregate 50,000 shares. Options will be immediately exercisable, vest over one year of Board service from the date of the grant, and are priced at 100% of the fair market value at the date of the grant. Any shares purchased under the option plan will be subject to repurchase by the Company at the exercise price paid per share, upon the optionee's cessation of Board service prior to vesting. At January 31, 1999, the Company had reserved 403,500 shares and 19,000 shares, under the 1985 Stock Option Plan and the 1994 Non-Employee Directors Stock Option Plan, respectively, for the granting of additional stock options. Additional Stock Plan Information As discussed in Note A, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with Accounting Principles Board No. 25, Accounting for Stock Issued to Employees, and its related interpretations. Accordingly, no compensation expense has been recognized in the financial statements for employee stock arrangements. Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net earnings (loss) and earnings (loss) per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, five years from date of grant; stock volatility, 51% in both fiscal 1998 and 1997, and 45% in fiscal 1996; risk-free interest rates, 5.12% in fiscal 1998, 6.10% in fiscal 1997, and 6.21% in fiscal 1996; and no dividends during the expected term. The Company's calculations are based on a single option valuation approach, and forfeitures are recognized as they occur. If the computed fair values of the fiscal 1998, fiscal 1997, fiscal 1996 and fiscal 1995 awards had been amortized to expense over the vesting period of the awards, pro forma net earnings (loss) would have been $4,338,715 ($0.51 earnings per share - basic and $0.48 earnings per share -diluted) in fiscal 1998, $383,000 ($0.05 earnings per share - basic and $0.04 earnings per share - diluted) in fiscal 1997, and $(4,576,000) ($0.55 loss per share - basic and diluted) in fiscal 1996. However, the impact of outstanding non-vested stock options granted prior to fiscal 1995 has been excluded from the pro forma calculation; accordingly, the fiscal 1998, fiscal 1997, and fiscal 1996 pro forma adjustments are not necessarily indicative of future period pro forma adjustments, when the calculation will apply to all future applicable stock options. 23 Notes to Financial Statements (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999, 1998, and 1997 Note G -- Stockholders' Equity (continued) The following table reflects the activity under these plans:
Weighted Number of Average Options Exercise Price ------------------------------------- Balance at January 31, 1996 1,178,270 $ 4.03 Granted (weighted average fair value of $1.70) 951,800 3.54 Exercised (15,960) 4.39 Cancelled (609,610) 5.58 --------- Balance at January 31, 1997 1,504,500 3.13 Granted (weighted average fair value of $1.81) 129,300 3.24 Exercised (124,340) 1.92 Cancelled (71,260) 3.83 --------- Balance at January 31, 1998 1,438,200 3.21 Granted (weighted average fair value of $2.07) 463,000 4.05 Exercised (410,715) 2.39 Cancelled (345,380) 3.48 --------- Balance at January 31, 1999 1,145,105 $ 3.76 Exercisable at January 31, 1997 624,000 $ 2.49 --------- Exercisable at January 31, 1998 591,000 $ 2.73 --------- Exercisable at January 31, 1999 379,000 $ 3.58 ---------
Options Outstanding Options Exercisable - ------------------------------------------------------------------------------ ------------------------------- Number Weighted Average Weighted Average Number Weighted Range of of Options Remaining Contractual Exercise of Options Average Exercise Prices Outstanding Life (years) Price Exercisable Exercise Price - ------------------------------------------------------------------------------ ------------------------------- $1.16 - $1.99 9,995 2.9 $1.88 10,000 $1.88 2.00 - 3.99 976,470 8.5 3.58 326,000 3.40 4.00 - 7.94 158,640 8.9 4.99 43,000 5.33 --------- ------- $1.16 - $7.94 1,145,105 8.5 $3.76 379,000 $3.58 --------- -------
Note H -- 401k Savings Plan The Company maintains a defined contribution, 401k Savings Plan, covering all employees who have completed one year of service with at least 1,000 hours and who are at least 21 years of age. The Company makes employer matching contributions at its discretion. Company contributions amounted to $73,000, $77,000, and $81,000 for the fiscal years ended January 31, 1999, 1998, and 1997, respectively. Note I -- Provision for Loss Due to Closure of SPA Collection Division The Company critically evaluates the results and long-term potential of its current and test business concepts in order to determine which will generate the greatest return on its investments. As part of this process, in January 1997 the Company decided to close the unprofitable SPA Collection division. During the fourth quarter of fiscal 1996, the Company incurred a one-time charge related to the closure of the SPA Collection division of $8,000,000 ($4,800,000 net of the tax benefit, or 56 cents loss per share). The one-time charge primarily related to the lease commitments and the net book value of fixed assets related to the SPA Collection division. The liability related to this one-time charge at January 31, 1999, and January 31, 1998, in the amount of $200,000 and $3,822,000, respectively, was included in accrued expenses. Note J -- 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 an adverse material effect on the Company's financial position and results of operations. 24 Notes to Financial Statements (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999, 1998, and 1997 Note K -- Segment Information The Company classifies its business interests into two reportable segments: retail stores and catalog. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note A). The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income tax expense or benefit. The Company's reportable segments are strategic business units that offer the same products and utilize common merchandising, distribution, and marketing functions, as well as common information systems and corporate administration. The Company does not have intersegment sales, but the segments are managed separately because each segment has different channels for selling the products. Financial information for the Company's business segments is as follows:
Fiscal Year Ended January 31, ------------------------------------------------------------- 1999 1998 1997 Dollars in thousands (Fiscal 1998) (Fiscal 1997) (Fiscal 1996) - ------------------------------------------------------------------------------------------------------------------- Revenues Stores $ 162,371 $ 151,589 $ 149,321 Catalog 70,750 58,772 53,577 Other 9,993 6,454 7,347 --------- --------- --------- Total Revenues $ 243,114 $ 216,815 $ 210,245 --------- --------- --------- Operating Contributions Stores $ 19,405 $ 15,170 $ 7,634 Catalog 8,814 3,059 7,411 Unallocated (20,549) (17,241) (22,286) --------- --------- --------- Earnings (Loss) Before Income Tax (Benefit) $ 7,670 $ 988 $ (7,241) --------- --------- --------- Depreciation and Amortization Stores $ 2,812 $ 2,516 $ 2,692 Catalog -- -- -- Unallocated 2,215 1,818 1,503 --------- --------- --------- Total Depreciation and Amortization $ 5,027 $ 4,334 $ 4,195 --------- --------- --------- Asset Expenditures Stores $ 5,988 $ 2,722 $ 4,104 Catalog -- -- -- Unallocated 2,443 1,715 2,475 --------- --------- --------- Total Asset Expenditures $ 8,431 $ 4,437 $ 6,579 --------- --------- --------- Assets Stores $ 13,673 $ 11,564 $ 14,434 Catalog -- -- -- Unallocated 68,372 67,098 64,370 --------- --------- --------- Total Assets $ 82,045 $ 78,662 $ 78,804 --------- --------- ---------
25 Notes to Financial Statements (continued) - -------------------------------------------------------------------------------- Sharper Image Corporation Fiscal Years Ended January 31, 1999 and 1998 Note L -- Quarterly Financial Information (Unaudited)
Dollars in thousands except per share amounts Three Months Ended ---------------------------------------------------------------------- April 30, July 31, October 31, January 31, Fiscal Year Ended January 31, 1999 1998 1998 1998 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Revenues $ 39,751 $ 49,532 $ 42,955 $ 110,876 Expenses Cost of products 20,743 25,780 22,404 54,204 Buying and occupancy 6,337 6,261 6,397 7,158 Advertising and promotion 4,512 6,904 4,906 11,074 General, selling and administrative 11,646 12,383 12,285 22,692 Other income (expense) (163) (176) 603 (22) Earnings (loss) before income tax (benefit) (3,650) (1,972) (2,434) 15,726 Income tax (benefit) (1,460) (789) (974) 6,291 Net earnings (loss) $ (2,190) $ (1,183) $ (1,460) $ 9,435 Net earnings (loss) per share - Basic(1) $ (0.26) $ (0.14) $ (0.17) $ 1.08 Diluted(2) $ (0.26) $ (0.14) $ (0.17) $ 0.98 Dollars in thousands except per share amounts Three Months Ended ---------------------------------------------------------------------- April 30, July 31, October 31, January 31, Fiscal Year Ended January 31, 1999 1997 1997 1997 1998 - ----------------------------------------------------------------------------------------------------------------------------------- Revenues $ 36,273 $ 43,340 $ 41,106 $ 96,096 Expenses Cost of products 19,563 23,472 22,115 50,385 Buying and occupancy 5,707 5,783 5,946 6,468 Advertising and promotion 3,546 4,715 4,036 10,498 General, selling and administrative 11,021 11,739 11,429 18,885 Other income (expense) (45) (118) (198) (158) Earnings (loss) before income tax (benefit) (3,609) (2,487) (2,618) 9,702 Income tax (benefit) (1,443) (995) (1,047) 3,880 Net earnings (loss) $ (2,166) $ (1,492) $ (1,571) $ 5,822 Net earnings (loss) per share - Basic(1) $ (0.26) $ (0.18) $ (0.19) $ 0.70 Diluted(2) $ (0.26) $ (0.18) $ (0.19) $ 0.67 (1) Basic earnings per share is calculated for interim periods including the effect of stock options exercised in prior interim periods. Basic earnings per share for the fiscal year is calculated using weighted shares outstanding based on the date stock options were exercised. Therefore, basic earnings per share for the cumulative four quarters may not equal fiscal year basic earnings per share. (2) Diluted net earnings per share for the fiscal year and for quarters with net earnings are computed based on weighted average common shares outstanding which include common stock equivalents (stock options). Net loss per share for quarters with net losses is computed based solely on weighted average common shares outstanding. Therefore, the net earnings (loss) per share for each quarter do not sum up to the earnings per share for the full fiscal year.
26 Corporate Data - -------------------------------------------------------------------------------- Sharper Image Corporation Board of Directors - -------------------------------------------------------------------------------- Richard Thalheimer Morton David Founder Retired Chairman, President, and Chairman of the Board Chief Executive Officer Chief Executive Officer Franklin Electronic Publishers, Inc. Alan Thalheimer Gerald Napier Retired Business Executive Retired President of I. Magnin and Company Maurice Gregg Retail Financial Consultant Officers - -------------------------------------------------------------------------------- Richard Thalheimer Joe Williams Founder Senior Vice President Chairman of the Board Loss Prevention Chief Executive Officer Roger Bensinger Barry Gilbert Vice President Vice Chairman Business Development Chief Operating Officer Barry Jacobsen Tracy Wan Vice President Executive Vice President Distribution Chief Financial Officer Corporate Secretary Ralph Odom Vice President Greg Alexander Stores Senior Vice President Management Information Systems Mary Tanner Vice President Tony Farrell Human Resources Senior Vice President Creative Services Charles Taylor Vice President Davia Kimmey Sharper Image Design Senior Vice President Marketing Robert Thompson Vice President Shannon King Merchandising Senior Vice President Merchandising Corporate Headquarters - -------------------------------------------------------------------------------- Corporate Headquarters SEC Form 10-K 650 Davis Street A copy of the Company's annual San Francisco, CA 94111 report to the Securities and Telephone (415) 445-6000 Exchange Commission of Form FAX: (415) 445-1574 10-K (exclusive of exhibits) is available without charge upon Transfer Agent and written request to: Registrar Investor Relations Chase Mellon Shareholder The Sharper Image Services LLC 650 Davis Street 85 Challenger Road San Francisco, CA 94111 Overbeck Center Ridgefield Park, NJ 07660 Annual Meeting The Annual Meeting of Corporate Counsel Stockholders of Sharper Image Brobeck, Phleger & Harrison LLP Corporation will be held on One Market Monday, June 7, 1999, at 10 am Spear Street Tower at the World Trade Club, San Francisco, CA 94105 Ferry Building, San Francisco, California. Independent Auditors Deloitte & Touche LLP 50 Fremont Street San Francisco, CA 94105 Common Stock Market Prices and Dividend Policy - -------------------------------------------------------------------------------- The common stock of Sharper Image Corporation is traded in the Nasdaq National Market under the symbol SHRP. The following table sets forth, for the periods indicated, the range of high and low prices reported for the common stock. The Company has not paid cash dividends to holders of its common stock. Fiscal Year 1998 Fiscal Year 1997 High Low High Low First Quarter 11 5/8 4 1/16 4 3/4 3 Second Quarter 8 3/8 4 11/16 4 2 7/8 Third Quarter 5 5/8 2 1/2 3 7/8 2 13/16 Fourth Quarter 25 3 3/4 4 3/8 2 7/8 Independent Auditors' Report - -------------------------------------------------------------------------------- Board of Directors Sharper Image Corporation San Francisco, California We have audited the accompanying balance sheets of Sharper Image Corporation as of January 31, 1999 and 1998, and the related statements of operations, stockholders' equity and cash flows for each of the three fiscal years in the period ended January 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements present fairly, in all material respects, the financial position of Sharper Image Corporation as of January 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three fiscal years in the period ended January 31, 1999 in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP [Deloitte & Touche LLP Logo] San Francisco, California March 26, 1999 27 [graphic omitted] Our stereo CD Radio/Alarm Clock with Sound Soother(R) was created by Sharper Image Design. Introduced in 1998, it was an imediate top seller. Sharper Image Corporation 650 Davis Street San Francisco, CA 94111 www.sharperimage.com (R)The Sharper Image is a registered trademark of Sharper Image Corporation. (TM)Sharper Image Design is a trademark of Sharper Image Corporation. EX-23.1 5 INDEPENDENT AUDITORS REPORT Exhibit 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 33-12755, No. 33-80504 and No. 33-3327 of Sharper Image Corporation on Form S-8 of our reports dated March 26, 1999, appearing in and incorporated by reference in this Annual Report on Form 10-K of Sharper Image Corporation for the year ended January 31, 1999. San Francisco, California April 30, 1999 EX-27 6 FINANCIAL DATA SCHEDULE
5 12-MOS JAN-31-1999 FEB-01-1998 JAN-31-1999 8,389 0 7,591 (804) 32,598 55,833 63,828 41,315 82,045 39,830 2,513 0 0 89 36,560 82,045 272,721 243,114 123,131 235,686 (887) 0 645 7,670 3,068 4,602 0 0 0 4,602 0.54 0.51
-----END PRIVACY-ENHANCED MESSAGE-----