Wednesday, August 08, 2007
Sharper Image & Richard Thalheimer: Clash of Egos
The competitive landscape for Sharper Image (SHRP-$7.16), the troubled San Francisco-based retailer of specialty technology products, recently intensified when founder and former CEO Richard J. Thalheimer launched his own E-commerce gadget site, richardsolo.com.
Although Sharper Image is a multi-channel specialty retailer, online operations are important to the Company’s profitability, generating about 16 percent of total sales in each of the prior two fiscal years (with 187 retail stores and catalog purchases contributing about 60 percent and 14 percent, respectively).
Case Study of Merchandising Failure
Historically, the sales of Air Purifiers constituted a significant portion of revenues and net income. Beginning in 2005, sales of the line of indoor air purification products declined significantly, due to competitive pressures and litigation claims made with respect to the performance and effectiveness of the Ionic Breeze branded product line. Contrary to the Company’s claims, independent third-parties, including Consumer Reports, found the air purifiers did not remove dust and smoke from the air and may, in fact, release high levels of ozone instead.
In fiscal 2006, 2005 and 2004, the air-purification line of products generated 23.4%, 27.7% and 40.0% of total revenues, respectively.
Returns and allowances for fiscal 2006 were $61.8 million or 10.8% of sales, as compared to $74.2 million or 10.2% for fiscal 2005.
Due to the foregoing dependency on air purification products, and product returns, the Company lost $(59.9) million, or $(4.00) per share, $(16.1) million, a share-net loss of $(1.01), respectively, in the fiscal year(s) ended January 31, 2007 and 2006, on declining annual sales of $525.3 million and $669.0 million, respectively.
All three sales channels showed attrition, too, year-over-year: the average revenue per transaction for stores, catalog, and Internet fell 30 percent to $98, 25 percent to $151, and 11 percent to $136, respectively.
Adding to the Company’s troubles, on September 6, 2006, the Board announced that it had launched an independent review of the company's historical stock-option practices and related accounting matters (dating back to 2003). And, on Sept. 18, the company said it would restate results for three fiscal years and two quarters due to options.
In late September 2006, with the share price down more than 76 percent from its February 6, 2004, closing high of $39.88, Thalheimer was ousted as CEO.
Clash of Egos
Sharper Image entered into a Separation Agreement with Mr. Thalheimer in December 2006, payable April 1, 2007. Pursuant to the terms of the Settlement Agreement, Thalheimer received the following amounts: (i) severance in the amount of $2.04 million, which included severance, interest, and ‘paid time-off’; (ii) continued health coverage for himself and his dependents until his death (or in the case of his dependents, until the later of Mr. Thalheimer’s death or September 30, 2016), estimated at $110,874; (iii) payment of a nonqualified retirement benefit of $3,900,000; (iv) an office allowance of $300,000 “to assist him in renting office space and in securing secretarial assistance for three years”; (v) reimbursement of attorney fees and expenses incurred by him in connection with the negotiation of the Settlement Agreement, up to $80,000.
Ironically, too, Thalheimer retained his 50% discount on all goods sold by Sharper Image, up to $50,000 per year (lifetime benefit). Perchance he could resell the Sharper Image purchases on his new web site at a profitable mark-up?
The Board shaved $3.0 million from his severance payment to offset “certain amounts Mr. Thalheimer previously received upon the exercise of options to purchase common stock of the Company that had been granted to him at exercise prices that were below the fair market value.” The 10Q Detective notes, however, that Thalheimer made $4.56 million by exercising a total of 183,500 stock options during Sharper Image's fiscal 2004 and 2005, according to company disclosures for those years.
Thalheimer further distanced himself from Sharper Image when he sold almost all of his company stock to key investors, including the Knightspoint Group and Sun Capital Partners Inc., for an aggregate purchase price of about $25 million, or $9.25 per share, leaving him with a reported 1 percent stake (down from 19.7% on May 8).
What's New is Old
Sharper Image is looking to turn the Company around by clearing inventory to make way for new-to-market branded products, high-quality private label products, and improved proprietary products, particularly in its air-purification product line.
For example, the retailer just licensed its brand to a company that makes luggage; announced it has a deal with Las Vegas-based Zero Gravity Corp to start selling flights with periods of weightlessness on a NASA airplane for $3,500 per person; and, partnered with Donald Trump to offer its customers a line of Trump-signature Steaks Classic Collection, featuring USDA Prime Certified Angus Beef Brand steaks.
Your eyes are yours to close
Never let go Sleep is wrong
When I grow up I'm never gonna sleep
When I grow up I'm never gonna cry
When I go out I'm never coming home
When I grow up I'm never gonna die ~~ Artist, Sleepytime Gorilla Museum – (Sleep Is Wrong Lyrics)
In a recent interview with BusinessWeek (August 13, 2007), Thalheimer said, “there's a lot of humble pie in being asked to leave." But when it came to his new venture, the motivation was simply: "my favorite quest in life is to find that one product and market it hard. I just love it."
Unfortunately, Thalheimer will continue to be the irritant in Sharper Image’s air purification filters—a distraction the new merchandising team does not need. In our view, despite his statements to the contrary, Thalheimer’s ego will not let him—to paraphrase the Welsh poet, Dylan Thomas: “ go gentle into that good night.”
Thalheimer says that his new work “isn’t a dig at Sharper Image,” but there are definite commonalities between the Internet operations. To wit: The graphics on both sites feature the company name encased in white lettering within a black-colored header. In addition, Thalheimer’s site sells similar goods: air purifiers, interesting gadgets (such as InfoScan Pens and Night Vision goggles), and Archos video units. In our view, however, the presentation on Thalheimer’s site is “cheesier” and the product-designs/offerings seem inferior.
Notice the name of Thalheimer’s website, too: Richard Solo—a not too subtle reference to Thalheimer making all of the merchandising decisions.
Curiously, the Company never had Thalheimer sign a non-compete agreement. Ergo, each customer that Sharper Image fails to attract to its Internet operations—and a sale that might instead find its way to richardsolo.com—will adversely affect the Company’s business and future operating results.
Sharper Image did, however, include a Confidential Information clause in Thalheimer’s Settlement Agreement: I agree that in the course of my employment with the Company I have had access to confidential and proprietary information relating to the Company, its subsidiaries, and affiliates, and their respective businesses, clients, finances, operations, strategic or other plans, employees, trade practices, trade secrets, know how, or other matters that are not publicly known outside the Company and that are integral to the operations and success of the Company (Confidential Information), and that such Confidential Information has been disclosed to me in confidence and only for the use of the Company. I agree that (a) I will keep such Confidential Information confidential at all times, (b) I will not make use of such Confidential Information on my own behalf, or on behalf of any third party….
Does not merchandising decisions, which are integral to the future profitability and success of Sharper Image, constitute Confidential Information? As such, if the website richardsolo.com becomes too successful, Sharper Image’s attorneys may just come knocking on Thalheimer’s door looking for a payment of their own.
The 10Q Detective doubts, however, that in its current format, with little advertising too support his new brand, richardsolo.com poses much of a competitive threat to Sharper Image.
According to Alexa.com, the recent three-month traffic rankings for the websites of Sharper Image and richardsolo.com were 17,225 and 1,021,529, respectively. In terms of reach (page views and users), Sharper Image is currently winning this clash of egos – it’s called branding!
Investment Thesis: Avoid
Even with Thalheimer out of the way, the gadget retailer is still in shambles. For the quarter ended April 30, the loss was $(16.8) million, or $(1.12) per share, up from $(12.7) million or 85 cents per share, in the same period a year ago.
Revenue fell to $67.6 million from $106.8 million in the prior year, due primarily to a decrease in the sales of proprietary designed and Sharper Image branded products, in particular the air purification product line and massage chairs.
Sharper Image’s business is highly seasonal, reflecting the general pattern of peak sales and earnings for the retail industry during the holiday shopping season. In recent past years, a substantial portion of total revenues (about 39%) and all or most of net earnings, if any, has occurred in the fourth fiscal quarter ending January 31.
The share price has fallen an additional 23 percent since Thalheimer sold his holdings back in May.
Until new management can demonstrate their merchandising acumen in judging customers’ purchasing habits, however, we would avoid making investment purchases in the stock of Sharper Image.
Editor David J. Phillips does not hold a financial interest in Sharper Image. The 10Q Detective has a Full Disclosure Policy.