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Sharper Image Needs...A Sharper Image


For six years, the Ionic Breeze Quadra air purifier was Sharper Image Corp.'s (SHRP) primo money machine, contributing an estimated 40% to 50% of the gadget retailer's sales. Now, the danger of relying too heavily on one hit product is becoming clear.

As rivals pile into the market, demand is slowing for the $350 Ionic Breeze, say analysts. That has left Sharper Image scrambling to come up with a hot new gadget to replace it, even as costs are rising and efforts to boost sales by diversifying into wholesale are slashing margins. The result: tumbling earnings and a host of unhappy shareholders. Since early August, when Sharper Image warned that earnings would come in lower than expected, the stock has fallen 29%, to $18.81.

Execs, who declined to comment for this story, have insisted they have the right product mix to get back on track. But analyst Gary Holdsworth of Wedbush Morgan Securities Inc., warns the stores lack a "must-have" gadget. "We'll see a lull until that happens," he says.

It's quite a reversal for the nation's premier purveyor of high-end gizmos. Founded in San Francisco 27 years ago, the company established itself in the '80s with fogless mirrors and waterproof shower radios. In the late '90s it cashed in on the Razor scooter fad. When that faded, Sharper Image was ready with the Ionic Breeze -- which helped double annual sales to $647.5 million between 1999 and 2003. But with troubles mounting, the company announced on Aug. 19 that same-store sales grew a meager 1% in the second quarter. And despite a 20% sales increase, net income fell 16%, to $676,000. For the year, W.R. Hambrecht & Co. estimates net income will rise just 4.9%, to $26.5 million -- a far cry from the 58% jump in earnings in 2003.

Sharper Image's biggest problem is that its purifier has run into a buzzsaw of competition. Direct rival Brookstone (BKST) is selling its new Pure-Ion UV air purifier for $300; Home Depot (HD) and RadioShack (RSH) are selling their own versions for $200. In an effort to goose sales, Sharper Image came up with an easier-to-clean model. But it costs $400.

CANNIBALIZING?

It doesn't help that Consumers Union gave the purifier poor reviews in 2002 and 2003. Sharper Image sued the research group last year, alleging product disparagement. In a July 30 court brief, Consumers Union says its reviews were "truthful and accurate" and that "Sharper Image presents no evidence to show that Consumers Union's conclusions are false or unfounded."

The troubles with the Ionic Breeze come at a time when Sharper Image is relying more on its lower-margin wholesale business. The retailer began putting its products in department stores and the likes of Bed Bath & Beyond (BBBY) and Circuit City in the mid-1990s. The aim was to get the Sharper Image name in front of more shoppers. Now wholesale sales are growing much faster than the rest of the company; in the second quarter, the wholesale unit accounted for 10.7% of sales, up from 3.8% the prior year. That's led some analysts to question whether Sharper Image is merely cannibalizing itself.

Sharper Image insists it has the products to turn things around. After the August earnings announcement, CEO Richard Thalheimer said sales of the $800 iJoy Turbo 2 massage chair and a line of Dyson brand vacuum cleaners remain strong. But those products, available elsewhere, aren't nearly as profitable as items such as the Ionic Breeze that are sold exclusively at Sharper Image.

To top it off, costs are rising. With TV airtime rates way up because of the avalanche of election-related advertising, the company is instead trying to boost catalog circulation by 8% to 10%. Sharper Image is betting that putting more money into the catalogs will be worth it. "The stores look great; the products look great," Thalheimer insisted in August. But if customers don't bite, he could be stuck with more than a few air purifiers after the holidays.

By Louise Lee in San Mateo, Calif.


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