One of the greatest things about writing for the Fool -- besides the nifty jester cap they send you when you stop misspelling P/E and finally learn where to put the dashes in the phrase enterprise value-to-free cash flow -- is the opportunity to learn more about companies that are already so familiar, you doubt you could find out anything new. Take Sharper Image
If you have ever gotten mail, dug into the back-of-seat "literature" on an airplane, or, say, lived through the '80s, you might already consider yourself an expert on the Sharper Image. Founded in the late '70s, it came to prominence during the subsequent decade's techno-consumerism. It became famous for its slick stores, frequent catalogs, and sometimes nifty, sometimes baffling product selection. A really cool CD player might be listed next to an overhyped leather jacket, like the "Best Jacket Ever" parodied on the Simpsons' version of the retailer, the Wicked Excess. (Before you Sharper Image fans start complaining about my citation of satire, note that the online store currently invites us to "show our support for the Rebel Forces" by buying a Star Wars jacket.)
Founder Richard Thalheimer looms large and stays in charge. He is currently the CEO and chairman, a not-uncommon double-duty that can spell trouble for shareholders at some companies. More on this below.
By the numbers
As I pointed out last week in a rather cursory flip through the quarterlies, the company has been doing an impressive job of pulling money in the front door and dribbling out a growing portion as shareholders' earnings. I even suggested that it looked like a bargain. Unlike its gifty, gadgety gadfly Brookstone
For this year's first quarter, revenues were up 34% to $156.4 million. Same-store sales, which gauge how well a company is improving its revenue without having to lay out for expensive, new storefronts, were up a healthy 8%. But the biggest improvements were the 40% rise in catalog sales, and nearly 60% climb in Internet sales.
Perhaps the best part of this story is that the company has been able to squeeze these increasing sales into even larger earnings growth by keeping firm control on costs. That helps explain last quarter's 160% growth in earnings.
So then, how do we account for the rather striking drop in the firm's stock price over the past couple of months? Don't get me wrong. I'm not suggesting that there's always a good reason for the Street's assessment of a company, but I'd like to at least look for the apparent excuse for any major downhill slide. In this case, the answer comes after a bit of searching, blowing in quietly, like the fresh wind after a summer thunderstorm.
Ionic breeze or impressive sleaze?
The robotic, massaging lounge chair may still capture our imagination, but it's the air purifier that's catching our bucks. The Sharper Image sells many other gadgets -- including my favorite, the $60 manscaper, the Turbo-Groomer 5.0 -- but its Ionic Breeze silent air purifiers are by far the biggest movers. This quiet-running, fan-less purifier runs room air through electrically charged plates, which capture airborne particles and release a bit o' ozone. That explains the flowery line up there about thunderstorm-fresh air. The firm doesn't seem to release sales figures for individual items -- warning sign No. 1, says I -- but analysts estimate that up to one-half of sales come by way of this single product line.
"What's so bad about that?" you may be shouting at your screen. "Coca-Cola
True, there can be beauty in a company that does one thing, and does it right, but unfortunately for Sharper Image shareholders, there are plenty of people who think that the air purifier doesn't quite get things right.
You might think that an industry-leading air purifier would be a slam dunk in our disinfectant-worshipping, Howard Hughes-ish nation, where citizens have learned to dread dirt and germs more than Hasselhoff's next album, but the heat is on. First of all, there are plenty of people who, to be blunt, think the thing is a complete scam. A bit of news-group searching brings up a lot of criticism on the Ionic Breeze line. To be fair, though, it has many fans, too. (Heh, fans, get it? It's not fan-less after all, eh? Right. Back to business.)
Much of its popularity rests on the clever, trademarked "seeing is believing" design, which is based on the same sick fascination we have with personal crud that also popularized the Biore Strip. When you open the thing up for a good scrub, it will indeed have collected plenty of appalling filth, but as one online wag put it, "so does my TV screen."
Most damning are the Consumer Reports tests that ranked the purifiers very poor. The first one prompted Sharper Image to request a change in testing methodology. When the magazine did so the following year and still gave the system abysmal marks, Sharper Image, apparently unacquainted with our nation's First Amendment, sued -- warning sign No.2, for me.
Finally, success brings competition. Search on "ionic breeze" even here at the Fool, and you'll be pelted with advertisements from dozens of competing products. Shopping mall archrival Brookstone has unveiled its own line of ion purifiers, and there's an even cheaper knockoff available at Home Depot
Back to the books
I'm not convinced that the competition or the negative press can kill the Ionic Breeze. People have predicted its demise for years, and it keeps selling. Its effect on the firm's accounting ledgers is impressive.
The company has no long-term debt and carries $75 million in cash. Inventories rose slightly less than sales the last quarter, indicating decent merchandise controls, but accounts receivable shot up 50%. At the same time, from this Fool's seat, there are other reasons to stay away from Sharper Image stock.
Free cash flow is one. A brief check of the numbers reveals that, despite five years of huge sales increases and solid earnings, the firm has turned in positive free cash flow only twice. What's the big deal? Well, as we members of the cult of free cash flow like to point out, earnings are an opinion, while cash is the real payback for your investment. (I stole that one from Bill Mann. I'm not sure where he stole it.) It's OK to put up with a lack of free cash flow if you expect it down the road, but Sharper Image has been rolling on the asphalt long enough that we should expect a nice green payback.
For me, the final strike is that the firm looks a little too much like a Thalheimer family piggy bank. Insider sales reports are heavily weighted with the Thalheimer moniker, including half a dozen trusts, plus big sales by a director, Alan Thalheimer, who is the father of the founder, CEO, and Chairman Richard.
So far this year, Thalheimer the younger has sold at least $7.6 million in stock. He also gets paid $2.5 million a year before stock options. That's equal to roughly 10% of the firm's net income last year. I don't begrudge the founder his success, and he still owns about 20% of the corporation. But, on the other hand, the possible demise of the Ionic Breeze is a significant hazard, and the thousands of tiny, part owners of the company deserve some compensation for wagering their own capital on an investment in Sharper Image. As a richly rewarded CEO and chairman of the board, Mr. Thalheimer's risk looks limited. Until there's some regular, unencumbered cash flow at the end of the tunnel, shareholders are shouldering too much of the burden of uncertainty. Sharper Image may turn out to be a bargain after all, but it's not the right bargain for me.
- Interested in learning the basics of free cash flow?
- Glutton for punishment? Get out your calculator and work with FCF.
- See how Tom Gardner and Rex Moore go hunting for Hidden Gems through measuring meaningful free cash flow.