Gadget maker Sharper Image (NASDAQ:SHRP) reports fiscal Q1 2006 earnings tomorrow, and investors are nervous. According to the company's analysts, Sharper Image will report sharply lower profits.

What analysts say:

  • Buy, sell, or waffle? Eight analysts follow Sharper Image. Only one rates the stock a buy, four call it a hold, and three a sell.
  • Revenues. On average, they're predicting a 27% plunge in sales tomorrow, to $106.3 million.
  • Earnings. And more than twice last year's loss, at $0.76 per share.

What management says:
Last week, Sharper Image released its sales numbers for the month of May and for the first four months of the fiscal year. While the numbers were bleak, the good news is that they suggest things will be no worse than the analysts have already predicted. Total company sales were down 26% year over year for February through May, and down 27% in May itself. Although the company did not specify its sales numbers for the first quarter in particular, those results suggest that the predicted 27% plunge might even overstate the bad news by a few basis points.

In the fiscal 2005 earnings report released in April, CEO Richard Thalheimer described a series of steps aimed at stemming the tide of red ink at Sharper Image. The company has slashed overhead costs, advertising, and capital expenditures on the costs side, while introducing new products to replace the diminished revenues generated by the company's Ionic Breeze air purifiers and massage-chair lines.

What management does:
Sales from those two product lines have been in freefall for months now, down 15% in the last six months, while the cost of goods sold has barely budged. As a result, Sharper Image's gross margins have deteriorated steadily over the past several quarters. Even the firm's 19% reduction in operating costs over the last six months hasn't been enough to prevent the firm's bottom-line numbers from falling into the red.

Margins %

10/04

1/05

4/05

7/05

10/05

1/06

Gross

47.1

45.7

44.0

42.1

40.5

36.9

Op.

4.4

3.4

2.0

0.5

(1.2)

(4.0)

Net

2.6

1.9

1.1

0.2

(0.8)

(2.3)
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Thalheimer recently emphasized his firm's strong financial position as evidence that it can weather the current Ionic storm, citing Sharper Image's $53 million in cash and its debt-free balance sheet. His promise to continue reducing inventories in 2006, if proven tomorrow, could strengthen the balance sheet further by converting goods to cash. Meanwhile, collections remain strong. Even as sales declined 15% over the last six months, Sharper Image slashed its accounts receivable by 42%.

Thanks to steps like these, even though the company was unprofitable on a GAAP basis in the second half of 2005, it still managed to generate cash profits of nearly $8 million. With capital expenditures expected to fall further in tomorrow's news, I suspect we'll see that Sharper Image remained free cash flow-positive once again.

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Fool contributor Rich Smith does not own shares of any company named above.