Sharper Image Q3 2007 Earnings Call Transcript

Sharper Image Corporation (SHRP)

Q3 2007 Earnings Call

December 11, 2007 8:00 am ET

Executives

Tersh Barber – Vice President of Finance

Steven Lightman – President, Chief Executive Officer & Director

Rebecca Roedell – Chief Financial Officer

Analysts

[David Leemer – Bowlit Capital]

Evren Dogan Kopelman – JP Morgan

[Lance Edis] – Mortar Rock Capital Management

Pamela K. Wilson – WL Ross & Co LLC

Scott Tilghman – Hudson Square Research

Randy Saluck – Mortar Rock Capital Management

[Kurt Wortman – Rev Cap Partners]

Presentation

Operator

Good morning. My name is Michelle and I will be your conference operator today. At this time I would like to welcome everyone to the Sharper Image Third Quarter Operating Results Conference Call. (Operator Instructions) I would now like to turn the call over to Tersh Barber, VP of Finance. Sir, you may begin your conference.

Tersh Barber

Thank you, Michele. Good morning, ladies and gentlemen and thank you for joining us on Sharper Image’s third quarter operating results conference call. With me on the call are Steven Lightman, Chief Executive Officer and Rebecca Roedell, Chief Financial Officer. Today’s conference call is also being broadcast live through an audio webcast. An additional replay of this call will be available through December 18, 2007. To access the audio webcast go to our website www.SharperImage.com. Once you’re on our home page, please click on the investor relations button and you will find the link to the broadcast.

During the course of this conference call we may make forward looking statements regarding future events or the future performance of the company. Actual events or results could, of course, differ materially. Moreover, we are not undertaking any obligation to provide updates in the future. We refer you to the documents the company files from time to time with the Securities & Exchange Commission [inaudible] the company’s most recent Form 10K. These documents contain and identify important factors that could cause actual result to differ materially from those contained in any forward looking statements. With that concluded, I’d like to turn the call over to Rebecca Roedell.

Rebecca Roedell

Thanks Tersh and good morning everyone. I’d like to share a few highlights from our third quarter results that were filed yesterday in our 10Q. For the three months ended October 31, 2007, total company revenues were $69.5 million compared to $106.2 million in the previous year, a decrease of 35%. The company reported a net loss for the third quarter of $22.7 million, or a loss of $1.50 per share compared to a net loss of $22.1 million or a loss of $1.48 per share in the prior third quarter period.

Sales by segment are as follows for the three months ending October 31, 2007. Total store sales for the third quarter were $46 million which were down $9.1 million or 15.5%. Comparable sales were down 15% in the quarter. Catalog and direct marketing sales were $4.6 million down $13.4 million or 76%. Excluding the $10 million in infomercials sales from 2006, catalog and direct sales were down $3.4 million or 43%. Internet sales were $8 million, down $7 million or 47%. Wholesale sales were $8.8 million, down $6.3 million or 42%. Our 10Qs MD&N discusses the sales decline in depth.

As mentioned in the 10Q, a significant portion of the decrease is related to the decline in air purification product sales. Infomercial advertising was discontinued in October of last year after an analysis determined that these sales incurred net losses. Additionally, the company has significantly reduced sales of refurbished products, particularly in the Ionic Breeze line. The company spent $8.99 million in advertising in the third quarter which was down $9.6 million or 52% from last year’s third quarter. $6.9 million of the $9.6 decrease was due to our discontinuation of infomercial advertising and $1.8 million due to our decrease in Solar Miller advertising.

Next, I’d like to give you an update on liquidity. As of October 31^st outstanding borrowings on the revolving credit facility were $62.1 million. Our borrowing base access availability was $12.4 million. This does not include the end funded $10 million of the $20 million term loan to be made available upon completion of the syndication of the facility. The due date for the syndication related obligations was extended to January 15, 2008. Thank you for time and attention. I’d like to turn our call over to Steven Lightman.

Steven Lightman

Thank you Becky and thank you all for joining us for this update. Becky just ran you through Q3 numbers and just last week we updated you with our November results. The holiday season officially kicked off on Black Friday and we were pleased with the results through the Thanksgiving weekend. This is our first indication of future holiday sales potential and we are encouraged. We reported November sales down 8% and same store sales down 6%. Looking at the Thanksgiving weekend, our same store sales for the entire weekend were flat. Our website sales from Black Friday through Cyber Monday were positive and we’re pleased to see our efforts on the website are starting to show improving results. In mid October we updated our website aligning it with the look and feel of our catalog and our stores. The design is clear and sophisticated and it represents a much more technologically savvy Sharper Image look. The category pages are much more editorial, helping the customer to understand our merchandise more clearly. We have enhanced the shopping cart experience so that our customers can easily complete their purchase. The site design is a continual work in progress. We will also be watching how the customer shops and where they go with their clicks, making adjustments as we go along based on actual behavior. We managed to accomplish this within the structure of our existing site code and with internal staff efforts and, most importantly, without a big expenditure on a re-platform or a re-skin.

Our multi channel marketing strategy is in place. I am pleased with our progress towards having a consistent value proposition across all channels and excited by the opportunity to have to continue to improve. You can see, for example, pages from the catalog and 8x10 displays as a marketing medium in the stores. You’ll find consistent products and pricing at the stores, in the catalogs and online. I spent the week after Thanksgiving visiting 26 stores in five cities and did see some opportunities to do some things better. For example, not all stores have the consistent look and feel. I heard that not all stores have the direction they need and we at corporate take responsibility for that. We’re moving quickly to implement a new training program for store associates emphasizing superior strong product knowledge and customer service components.

We launched a private label credit card in October with Alliance Data Systems in our stores, online and in the catalog. This program is an important new marketing initiative for us. It will serve as a loyalty program to our best customers and entice new customer to buy while delivering income to the bottom line to encouraging incremental sales. The benefits to the customers include a 15% initial discount, 5% rewards program, opportunities to earn additional rewards and discounts and not to mention, a really cool looking card. As the year goes on and we have more cardholders, we’ll be supporting additional special cardholder offers such as in store events, double reward days and more. We’ve asked stores to focus on acquiring new cardholders and we are supporting these efforts with great in store signage. We also sent out pre-approved offers to our best customers with the November Catalog. Customers in all channels have been responding. Since the launch on November 1^st, we have acquired over 25,000 cardholders, ahead of our expectations and the average ticket is well above our storewide average.

The licensing group which was launched at the beginning of the year has now announced 10 licensees to date in categories as diverse as upscale kitchen electronics to handheld GPS navigation devices to self installed home surveillance and security systems. Our feedback from licensees and potential licensees is that there is an untapped opportunity to leverage our brand name in additional upscale retail products in channels. A number of licensed products can be found in our stores for the holidays including, our Sharper Image umbrella line through licensee Futai USA and Sharper Image unlocked cell phones. Our licenses are providing exclusivity periods for these products and much of the inventory risk is mitigated.

We’ve made another key hire and announced last month that Joyce Maruniak joined us as Senior Vice President of Operations. Joyce comes to us from Best Buy and has in depth experience at enhancing inventory supply chain processes from vendor to consumer. We encourage you to visit our stores, browse our website and page through our catalog. We welcome you to comment and impressions. We invite you to come see our new and exciting products including digital photo frames and robotic toys such as Roboquad and R2D2. We invite you to pick up a light saber or get a demonstration of how our GPS units work. We know, as we’ve shared before, we still have a long way to go and the opportunity to take advantage of but, we feel that we’ve been successful in our first six months and we’re excited for you to see additional improvements that will serve our customers and deliver to our bottom line and shareholders. We are all energized about the opportunity to perform for the customers this holiday. Early indications are encouraging and I look forward to updating you on our progress. Thanks for your time. Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

At this time, I’d like to remind everyone if you would like to ask a question, press star then the number one on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster. And, your first question comes from the line of [David Leemer of Bowlit Capital].

[David Leemer – Bowlit Capital]

I noticed in looking at your Q that it looks like your accounts payable were up pretty significantly as a percentage of revenue. So, I guess, what lead to that and are you having any problems with any of your vendors with the expanded terms? And then, I have one other question too.

Rebecca Roedell

Okay, Dave your first question is AP as a percentage of revenue is the revenue decline but, AP on a seasonality basis is pretty relative to the inventory levels that we’re carrying so we can support the holiday inventory levels that we need.

[David Leemer – Bowlit Capital]

So, there haven’t been any issues with any, I guess, you haven’t been getting any grief from any of your vendors that payment terms are a bit longer?

Rebecca Roedell

We continually reach out to our vendors. We’re really working hard to put together vendor relationships and the company in the past really was managed by a few relationships not at the merchandise level and the CFO level and even at Steve Lightman’s level. And so, we’ve had several meetings, we’ve had several vendor summits and we’ve reached out to try and establish those open door policies that really try to take advantages of those relationships and formulate a win-win for both sides.

[David Leemer – Bowlit Capital]

Okay. And then, my second question is with regard to the $10 million of the term loan that has yet to be syndicated. I guess, the syndication time has been pushed back twice. What’s leading, I guess, to the delay and getting that syndicated? Are you still confident that you’ll get it in January?

Rebecca Roedell

Well, we’ve pushed it back a couple of times. The first time was a matter of timing and getting documents closed and getting the right parties to the table. The second time was really once we had hit the holiday period there was no sense of urgency to get that $10 million so we pushed that back into January really so the potential syndication group could see the holiday results as well. So, we’re working with our bank very closely and we have a great relationship there and we continue to look at that $10 million and our needs and we’re continuing to address that.

[David Leemer – Bowlit Capital]

You say, so, it sounds like your comments, it sounds like you think you might not need that $10 in January.

Rebecca Roedell

We’re continually looking at our sensitivity analysis until I have, you know, where we fall out in holidays on our comp sales, that’s our biggest indication of what kind of cash flows we have coming forward. So, the $10 million is kind of a moving target of when we really want to close that. Of course, this is the best brush just so we can get that out of the way and the syndication group is done and we can focus on the strategies of the company rather than just managing debt agreements and trying to get those things closed.

[David Leemer – Bowlit Capital]

Okay. Thank you.

Rebecca Roedell

You’re welcome Dave.

Operator

Your next question comes from the line of Evren Kopelman of JP Morgan.

Evren Dogan Kopelman – JP Morgan

Yes. Hi, thanks. Could you guys talk a little bit more about the Thanksgiving weekend comp, you said were flat. You must be very pleased. It sounds very impressive given the trend. So, can you talk first a little bit about the, maybe, the air purifier and massage chair and excluding those maybe what comps were? How sales were? And, if you don’t want to give numbers, maybe just give us some color. And secondly, maybe talk about how promotional you were to drive that comp, if gross profit dollars or merchandise margins were up or down? Just, if you can give more color behind that, that would be great. Thanks.

Steven Lightman

I’ll address that one. From a merchandising standpoint what we’ve noticed and what we’re very excited about as we went through the Black Friday weekend and as we go into the holiday season is that a lot of this new product that we’ve been talking about for the last two or three calls has finally come in, has showed up at the stores and is performing very well. Things like the Philips digital picture frames, the R2D2s, the USB turntables, the new Panasonic chairs that we brought in, all the new Bluetooth technology, the gaming chairs and the whip sticks, just to name a few items and categories that were new and exciting, are all really increasing our sales and doing very well, are selling through the stores. From a promotional standpoint through Black Friday and the Thanksgiving weekend, we were no more promotional really than anyone else out there. From a margin standpoint, it didn’t really impact from what we had budgeted or planned or prior years. So, we didn’t give away the store. What we really saw was customers coming in, finding the new exciting products that we were finally getting out on the floor and really buying them.

Evren Dogan Kopelman – JP Morgan

Great. And, the second question is on the credit card and I’m sorry if you mentioned this and I missed it, do you get, for each customer you sign up, did you say you get a certain dollar amount that goes to either your other income line or top line? Can you talk about kind of that agreement?

Rebecca Roedell

Evren Dogan Kopelman – JP Morgan

I can speak to that. Part of our agreement for the proprietary card is that we have a couple more steps with our IT for perfect implementation in our stores and once we complete that which we think is done within the next six months then it really makes the transaction of applying for the card seamless whereas right now we need to go to a website base. But, once that is complete we will and do expect about half of a point that comes in to us. But, at this point we don’t have that reimbursement coming to our financial statements yet.

Evren Dogan Kopelman – JP Morgan

Okay. And, finally, can you talk a little bit about maybe plans for your marketing spend for next year. It’s clearly early but, if you expect it to be flat, down, up? Maybe some color and if you don’t want to give any, that would be fine.

Steven Lightman

I think it’s a little too early to get into the details for what our plan is for next year because, we’re waiting to see the results of the holiday season based on several fronts. We’re waiting to see how the new look and feel of the catalogs since the December catalog is our biggest catalog of the year works so we have some time to make decisions and how that multi channel marketing strategy all fits together from the catalog, to the website, to the retail store. We’re also looking and waiting to experience and, it’s going to take us probably 60 days to understand it, the impact on the proprietary credit card. I’d mentioned in my earlier comments that there’s a tremendous lift in the average order value with the proprietary credit card versus without. And, as we get a better lead on what proprietary credit as a penetration percent to our total sales will be, it will really impact a lot of the advertising decisions that we make for next year. So, we’re watching it very closely, we’re reading it day-by-day and we’re going to get ready to lock and load our budget for next year as we come out of the holiday season and towards the end of January.

Evren Dogan Kopelman – JP Morgan

Great. Good luck with the rest of holiday.

Steven Lightman

Thank you.

Operator

Your next question comes from the line of [Lance Edis] of Mortar Rock Capital.

[Lance Edis] – Mortar Rock Capital Management

Actually, my question, I believe my question has already been answered so you can skip me, I guess, for now.

Tersh Barber

Okay, next question please operator.

Operator

Your next question comes from the line of Pamela Wilson of WL Ross

Pamela K. Wilson – WL Ross & Co LLC

[Inaudible] the litigation risk in, it looks like in May or June you have a potential trial and what’s the likely outcomes are and whether or not that might settle prior to going to trial.

Steven Lightman

I didn’t hear the first part of the question, you clicked out. Can you repeat the first part please.

Pamela K. Wilson – WL Ross & Co LLC

Yeah. I was interested in what the sort of risk is to the company of the litigation over the, you know, air purifiers?

Steven Lightman

Well, we announced in October that the judge in Florida denied the settlement of the nationwide class action lawsuit. We were disappointed as the proposed settlement was the result of substantial negotiations with the plaintiffs and we believe we provided fair terms for all the parties. We still stand behind the Ionic Breeze and we believe we have a strong case to take to court. We believe that scientific testing has demonstrated that it is a safe and effective product and improves air quality. And, in addition, the company’s testings that we for years of positive feedback of our customers pointing out how satisfied they are with the product. Having said that, litigation does cost money and it can be non productive. We’re willing to take it to court if necessary. In the meantime, our legal team is going to continue to see if we can reach some sort of resolution.

Pamela K. Wilson – WL Ross & Co LLC

Okay. And, has the sales decline on the air purifiers has that stopped declining? Or, are we still looking at, you know, a decline in that area?

Steven Lightman

I think, as we’ve reported in the Q, the decline in air purification and massage chairs has been consistent throughout the entire year. We are developing new strategies as we go into next fiscal year for introducing new products and new assortments and new versions of what we have and, we’re going to have to wait and see until that plan is fully implemented what the impact will be. I think we’ve stated before that the market share that the Sharper Image use to enjoy in air purification, the competitive marketplace has changed significantly and it would be very difficult for us to think we could get back to the levels we had at one point in time.

Pamela K. Wilson – WL Ross & Co LLC

Thank you.

Operator

Your next question comes from the line of Scott Tilghman of Hudson Square Research.

Scott Tilghman – Hudson Square Research

Good morning. A couple of questions. First of all, when the store base, one, are you seeing any geographic weakness or is the performance of the store base fairly consistent throughout the various regions?

Steven Lightman

I think we’re not really seeing a geographical differentiation between store performance. What you do see is one day stores in this area do great, on another day stores in this area do great. So, there is no definitive trend line that says all of our stores should be located in this part of the country or that part of the country. I think we’ve seen weather trends as other retailers have. I think we’ve experienced some ups and downs because of those things but, it’s not as easy as saying, “Gee, everything should be in the northeast quadrant of the United States.” Or, “Everything should be on the west coast.” Because, we have great performing stores all throughout the country.

Scott Tilghman – Hudson Square Research

Is it fairly, are the stores fairly normally distributed from an operating standpoint? Or, are there some additional closures possible in the next few quarters?

Steven Lightman

I think we’re waiting to get through the holiday season to see how all the stores perform on a 12 month rolling basis and then, we’re going to sit down and make those decisions. There’s always pluses and minuses that you go through in the course of the year with stores and as leases come up and whether improvements need to be made. So, will things be moving around as we go into next fiscal year? Probably but, at this point in time until the holiday season ends, it would be very difficult to give you any kind of indication of what it may look like.

Scott Tilghman – Hudson Square Research

Fair enough. The other topic I wanted to touch on is product sourcing which, you know, has long been a strength of the company and in the past couple of years it’s been sort of a challenge. What, if any changes are you making in that area?

Steven Lightman

Well, we’ve done two things that I think are very significant, maybe three things. First, we’ve really sured up our merchandising department. We brought Drew Reich in as our new EVP of merchandising. Drew comes to us with tons of experience, 23 years of experience. We’ve changed our methodology of sourcing merchandise. We have created the licensing department and we’ve shut down our product development department and what we’ve said to ourselves and what we’ve been implementing since the beginning of the year is, develop relationships with these licensees who are really experts in the field of manufacturing product and bringing new product to market. It’s what they do for a living and, be able to execute a period of exclusivity with our licensees so that for the first 90 days, for example, of a new licensee all of the Sharper Image product that they want to bring to market can only be at the Sharper Image. So, we have new exciting innovative product that we can say, “Only at the Sharper Image.” And, that has really helped us in terms of enhancing our assortment and finding new products.

Secondarily, we’ve been working with the [inaudible] vendors, the branded vendors and we’ve been working on deals with them where there’ll be a period of exclusivity to bring products to market. A couple that come to mind, Panasonic, their new razors, they bring them to the Sharper Image first, especially at the holiday season, that’s terrific for us to be able to expose new products for them. We’re working with Microsoft where I think in 27 or 28 of our stores right now you can go in and see a whole gaming station set up around the Xbox where they’ve created a special package of the Xbox with a couple of games in it that are only at the Sharper Image and we were able to put together a whole station with them. So, I think what we’re seeing is that there’s a lot of vendors out there that look to the Sharper Image to bring products to market because, as we’ve said before, we’re such an interactive shopping experience, we’re so hands on and our staff is so knowledgeable about the product, it enhances the vendors ability to get product to market quicker and have customers understand the product. So, I think, we’ve done a lot from a merchandizing standpoint to really sure up our product assortment and the quality of the products we offer.

Scott Tilghman – Hudson Square Research

Great. Thank you.

Operator

Your next question comes from the line of Randy Saluck with Mortar Rock Capital.

Randy Saluck – Mortar Rock Capital Management

Randy Saluck but, thank you. A quick question, given the company’s cash flow situation and the fact that the syndicate hasn’t been wrapped up yet, how much flexibility do you have in the syndicate is delayed and what are your backup plans?

Rebecca Roedell

I’ll speak to that. As I was saying before, of course, any person who’s going to be looking at cash flow is always going to run some sensitivity models and we’ve been working very closely with our banks as well as internally to make sure we’re prepared for those different types of situations. We’ve worked with Wells Fargo and we’ve worked on the syndication and we continue to stay in contact with them. They also know the different sensitivity outcomes and our different cash flow needs in the future. So, we’re working closely with them. We, at the same time, in addition to working with Wells Fargo are always exploring other options. We’ve showed before that we have a very supportive board and they know the numbers as well as we do and they know that if one of those other sensitivity models is an outcome then we’ll be able to be prepared for handling those and have the flexibility to deal with those cash flow needs.

Randy Saluck – Mortar Rock Capital Management

Will you share some of the alternatives with us to just give us some comforts because, you know, obviously, that’s a short term issue.

Rebecca Roedell

No, I’m not able to do that until I have agreements in hand and things are more sured up and then, once we get those options in Randy and we’re more comfortable to be able to share those details, we’ll do so.

Randy Saluck – Mortar Rock Capital Management

Okay. And, is mid January the time you’re hoping to put a wrap to things?

Rebecca Roedell

January, end of January beginning of February is really, you know, we have the cash coming in, debt being paid down with the holidays sales. That’s allows us to have the flexibility to be able to explore our different options and work with our banking group and make sure we’re prepared. But, again, I mentioned before, sooner is better just so we can focus on the strategies of the company rather than the financing of the company.

Randy Saluck – Mortar Rock Capital Management

Gotcha. Thank you very much.

Rebecca Roedell

You’re welcome Randy.

Operator

Your next question comes from the line of [Kurt Wortman of Rev Cap Partners].

[Kurt Wortman – Rev Cap Partners]

Two quick questions. One, it looks like the merchandise inventories are down about $20 million year-over-year. Do you have sufficient merchandise in the stores to drive the holiday sales? And then secondly, could you update us at all where liquidity is today?

Rebecca Roedell

I think you’re the first question, inventory levels.

Steven Lightman

Let me, I’ll talk to the inventory level part and then I’ll turn it over to Becky. Our inventory levels are down year-over-year for a couple of reasons. Last year in our inventory we had a lot of inventory we’d rather not have owned. And, as you know, from the July sale that we had this year where we really cleared all that inventory out of our distribution centers and our stores we were able to reduce our overall inventory level and still keep the stores full of the merchandise that we want to have and that we want to be selling. So, I think we’ve done a very good job cleaning up our inventory this year. In terms of what that meant from a liquidity standpoint, I would turn that over to Becky to explain.

Rebecca Roedell

Sure, you asked what the debt levels are today. They’re pretty consistent with what we reported at the end of October and a lot of it is really just taking the ending debt in October and just managing to what our cash flow needs are related to inventory product buys and receiving the terms and working with our banks and issuing any LPs that we might need to. But, they’re pretty similar to those levels that you’ve read already.

[Kurt Wortman – Rev Cap Partners]

And, liquidity is pretty consistent with where it was end of October?

Rebecca Roedell

That is correct and continues, I shared before in the past, as our inventory increases our liquidity also increases and as our sales for holiday come in, of course, it’s going against our debt. So, the math is pretty simple to see what happens in December and January.

[Kurt Wortman – Rev Cap Partners]

Okay. Thanks guys.

Rebecca Roedell

You’re welcome.

Operator

Again, if you’d like to ask a question, simply press star then the number one on your telephone keypad. We’ll pause just for a moment to compile the Q&A roster.

Tersh Barber

Okay. Well, it looks like there are no more questions so I’ll turn the call over to Steve.

Steven Lightman

Well, I want to thank you all for joining us this morning. Those of you on the west coast, I know it’s very early. Those of you on the east coast, a little more reasonable. We really look forward to updating you and informing you of how our holiday season is and year end on our next call and I think you all for your time today.

Operator

This concludes today’s conference call. You may now disconnect.

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