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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------



| |  | For the fiscal year ended January 31, 2006
| |  | ------------------------------------------

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



| |  | For the transition period from              to
| |  | ----------------------------------------------

Commission File Number 0-15827



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SHARPER IMAGE CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                    
|-------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                       |  | 94-2493558                         
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. EmployerIdentification No.)
|                                                               | 
|350 The Embarcadero, 6thFloor, San Francisco,
California       |  | 94105                              
|(Address of principal executive offices)                       |  | (Zip Code)                         

Registrants telephone number including area code: (415) 445-6000

Securities registered pursuant to Section 12(b) of the Act:



|                             |  |                                       
|---------------------------- |  | --------------------------------------
|Common Stock, par value $.01 |  | NASDAQ                                
|(Title of Class)             |  | (Name of exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None



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Indicate by check
mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ̈No  x

Indicate by check mark if the
Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ̈No  x

Indicate by check mark whether the
Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈

Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. ̈

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                      |  |                       
|------------------------ |  | -------------------- |  | ----------------------
|Large accelerated filer ̈ |  | Accelerated filer  x |  | Non-accelerated filer ̈

Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).    Yes ̈No  x

The aggregate market value of the voting common stock held by non-affiliates of the
Registrant based on the reported last sale price for the common stock on the NASDAQ National Market on July 31, 2005, was $176,980,568

As of April 28, 2006, 14,953,720 shares of the Registrants common stock were outstanding.



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DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrants Proxy Statement for the 2006 Annual Meeting of Stockholders are incorporated by reference in Part III
hereof.

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K and the documents incorporated herein by reference of Sharper Image Corporation (referred to as the Company, The Sharper Image, Sharper Image,
it, we, our, ours and us) contain forward-looking statements within the meaning of federal securities laws that have been made pursuant to the provisions of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations, estimates and projections about the Companys industry, managements beliefs and certain assumptions made by the Companys management.
Words such as anticipates, expects, intends, plans, believes, seeks, estimates, or variations of such words and similar expressions, are intended to identify such
forward-looking statements. These statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed
or forecasted in any such forward-looking statements. Such risks and uncertainties include those set forth herein under Risk Factors as well as those noted in the documents incorporated herein by reference. Unless required by law, the
Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. However, readers should carefully review the statements set forth in other reports or documents
the Company files from time to time with the Securities and Exchange Commission, particularly the Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K.



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SHARPER IMAGE CORPORATION

ANNUAL REPORT ON FORM 10-K

FISCAL YEAR ENDED JANUARY 31, 2006



|           |  |                                                                                                                |  |         
|---------- |  | -------------------------------------------------------------------------------------------------------------- |  | --------
|           |  |                                                                                                                |  | Page No.
|           |  | PART I                                                                                                         |  |         
|           |  |                                                                                                               
|Item 1     |  | Business                                                                                                       |  | 1       
|Item 1A    |  | Risk Factors                                                                                                   |  | 12      
|Item 1B    |  | Unresolved Staff Comments                                                                                      |  | 20      
|Item 2     |  | Properties                                                                                                     |  | 20      
|Item 3     |  | Legal Proceedings                                                                                              |  | 21      
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                                            |  | 21      
|           |  |                                                                                                               
|           |  | PART II                                                                                                        |  |         
|           |  |                                                                                                               
|Item 5     |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Repurchases of Equity Securities |  | 22      
|Item 6     |  | Selected Financial Data                                                                                        |  | 23      
|Item 7     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                          |  | 24      
|Item 7A    |  | Quantitative and Qualitative Disclosures about Market Risk                                                     |  | 35      
|Item 8     |  | Financial Statements and Supplementary Data                                                                    |  | 35      
|Item 9     |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                           |  | 55      
|Item 9A    |  | Controls and Procedures                                                                                        |  | 55      
|Item 9B    |  | Other Information                                                                                              |  | 58      
|           |  |                                                                                                               
|           |  | PART III                                                                                                       |  |         
|           |  |                                                                                                               
|Item 10    |  | Directors and Executive Officers of the Registrant                                                             |  | 59      
|Item 11    |  | Executive Compensation                                                                                         |  | 59      
|Item 12    |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                 |  | 59      
|Item 13    |  | Certain Relationships and Related Transactions                                                                 |  | 59      
|Item 14    |  | Principal Accountant Fees and Services                                                                         |  | 59      
|           |  |                                                                                                               
|           |  | PART IV                                                                                                        |  |         
|           |  |                                                                                                               
|Item 15    |  | Exhibits and Financial Statement Schedules                                                                     |  | 60      
|Signatures |  | 61                                                                                                            



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ITEM 1. BUSINESS

THE SHARPER IMAGE

Sharper Image Corporation (referred to as the Company, The Sharper Image, Sharper Image and it) is a leading specialty retailer of innovative, high
quality products that are useful and entertaining and are designed to make life easier and more enjoyable. The Company offers a unique assortment of products in electronics, recreation and fitness, personal care, houseware, travel, toy, gifts and
other categories. The Sharper Image merchandising philosophy focuses principally on new and creative proprietary Sharper Image Design products and exclusive Sharper Image branded products and, to a lesser extent, on third party branded products. The
Company designs and develops its Sharper Image Design products, while Sharper Image branded products are generally designed by the Company with third parties. The Company believes that its unique merchandising and creative marketing strategies have
made The Sharper Image one of the most widely recognized retail brand names in the United States.

The Sharper Image was
founded in 1977 by Richard J. Thalheimer, who currently serves as Chairman and Chief Executive Officer. The Company mailed its first catalog in 1979, began the expansion into store operations in 1981 and commenced online operations in 1994. The
Sharper Image markets and sells merchandise primarily through three integrated sales channels: The Sharper Image stores, The Sharper Image catalog, which includes revenue from all direct marketing activities and television infomercials, and the
Internet. The Company believes that this multichannel approach provides significant marketing, advertising, sales and operational synergies and provides its customers with enhanced shopping flexibility and superior customer service. Financial
information related to each of these sales channels is disclosed in Note J to the financial statements. In addition to the Companys primary business, the Company leverages its name and reputation through its Corporate Incentives and Rewards
program and wholesale sales of Sharper Image brand products.

THE SHARPER IMAGE STORES

The Company has two store formats: The Sharper Image store and outlet stores. As of January 31, 2006, The Sharper Image operated 186
The Sharper Image stores and four outlet stores for a total of 190 stores in 37 states and the District of Columbia. Store sales generated the highest proportion of Company sales, representing 60.9% of total revenues for the year ended
January 31, 2006 (fiscal 2005) and 57.2% for the year ended January 31, 2005 (fiscal 2004). The Sharper Image stores present an interactive and entertaining selling environment that emphasizes the features and
functionality of the Companys innovative, fun and useful products and allows the customer to interact with and experience the product while shopping. The Companys average store sales per square foot are consistently above industry
averages, and during fiscal 2005 and 2004, its stores generated average sales of $505 and $618, respectively, per square foot. For stores opened for more than one year, the average sales per square foot in fiscal 2005 and fiscal 2004 were $522 and
$665, respectively. During fiscal 2005, The Sharper Image opened 20 new stores and closed five stores. The Company plans to increase its number of stores by approximately six to eight new stores during fiscal 2006.

Until the fourth quarter of fiscal 2005, each store was generally staffed with approximately 8 to 12 associates, including a manager, an
assistant manager, a senior sales associate, sales associates and other support staff. A number of the Companys high volume stores were staffed with 15 to 20 associates. The Companys store personnel were compensated primarily through
sales commissions through the fourth quarter of 2005. During the fourth quarter of 2005, the Company focused on reducing staff levels in each store to 7 to 10 associates per store. High volume stores were staffed with 12 to 18 associates per store.
Certain sales associate commission rates were reduced during the fourth quarter of 2005. Beginning in the first quarter of 2006, sales associate commissions were eliminated and replaced with base salary and sales incentive programs. Store management
is compensated with a base salary plus incentive pay for achieving certain sales levels and other operational criteria. The Companys store managers have an average tenure of over five years. In order to maintain a high customer service level,
the Companys sales associates undergo considerable training on the many new and often technically oriented products. The Companys stores are operated according to standardized



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procedures to maintain high levels of customer service, merchandise display and pricing, product demonstration, inventory maintenance, personnel training,
administration and security. The Sharper Image stores are designed by the Companys visual design and creative staff at its headquarters in San Francisco, California.

The Sharper Image stores typically have 2,500 to 4,000 square feet of selling space and approximately 1,200 to 2,000 square feet of storage and administrative space. The typical cost of leasehold
improvements before landlord contributions, but including fixtures and equipment, averages $500,000 to $700,000 per store. Initial inventory for a new The Sharper Image store generally costs approximately $200,000. Outlet stores typically consist of
between 2,100 to 3,200 square feet of selling space and are used to sell slow-moving, discontinued, reconditioned and regular merchandise.

Over the past several years, The Sharper Image has been updating the look and appeal of its new retail stores and remodeling selected existing stores. The updated format presents an open, fresh and inviting
environment designed to appeal to both men and women and to highlight the Companys Sharper Image Design and Sharper Image branded products and attractive product packaging. The average cost of converting an existing store to the new format
ranges from $500,000 to $650,000, subject to leasehold allowances, which is similar to the cost of a new store build out. The Company intends to continue to selectively remodel stores utilizing the new store format, which typically occurs at the
time of the stores lease renewal. The Company has 19 existing stores that it anticipates will be remodeled over the next two or three years to bring all of The Sharper Image stores into the current store format.

THE SHARPER IMAGE CATALOG AND DIRECT MARKETING

The Sharper Image direct marketing operations, including revenues generated directly from the Companys award-winning, full-color monthly catalog, single product mailers, print ads and infomercials, generated
13.1% of the Companys total revenues in fiscal 2005 and 17.2% in fiscal 2004. The Sharper Image catalog is a full-color catalog that is mailed to an average of five to six million individuals each month, with an increase to six to eight
million individuals during the Fathers Day and graduation months and an increase to seven to 18 million individuals during the fourth quarter holiday season. The Sharper Image catalog has been recognized for creative excellence by leading
catalog industry trade groups. The catalog remains the primary advertising vehicle for the Companys retail stores and Internet business. During fiscal 2005 and 2004, the Company mailed approximately 98 million The Sharper Image catalogs
per year to over 21 million and 19 million households, respectively. For fiscal 2006, catalog circulation is currently expected to decrease by approximately 30%. The Company continually evaluates its advertising strategy and catalog
circulation may fluctuate from current plans.

The Sharper Image catalog design uses dramatic visuals and problem-solving
and benefit-oriented product descriptions. The catalog design features the most important products prominently. The number of items featured each month ranges between 200 and 250 products during the first three quarters of the year, increasing to
more than 300 products during the holiday shopping season in the fourth quarter. The Sharper Image catalog is designed and produced by the Companys small in-house staff of writers and production artists, supplemented by outside freelancers.
This enables the Company to maintain quality control and shorten the lead time needed to produce the catalog. During fiscal 2005, The Sharper Image catalog contained between 88 and 96 pages for non-peak months and between 100 and 124 pages for
Fathers Day, graduation and the peak holiday shopping season. For fiscal 2006, the number of pages of each catalog mailing in non-peak months is currently expected to be in the range of 52 to 76 pages.

The Sharper Image has developed a proprietary customer database of more than 21 million names, which it utilizes regularly. The
Company collects customer names through its catalog and Internet order processing, as well as electronic point-of-sale registers in the retail stores. The names and associated sales information are merged daily into the Companys master
customer file. This daily merge process provides a constant source of current information to help assess the effectiveness of the catalog as a form of retail advertising, to identify new customers that can be added to the Companys in-house
mailing list without using customer lists obtained from other catalogers and to identify the Companys top purchasers. To further enhance the effectiveness of the



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Companys catalog mailings to individuals in the customer database, the Companys in-house staff utilizes statistical evaluation and selection
techniques to determine which customer segments are likely to contribute the greatest revenue per mailing. The Company has established a data bank of top purchasers who receive preferred services, including invitations for special sales events,
special offers and enhanced customer service.

During fiscal 2004 and 2003, the Company expanded its infomercial presence
by highlighting several popular Sharper Image Design and private label products on cable and national broadcast stations. During fiscal 2005, as part of its cost cutting program, the Company decreased infomercial spending by 28.9% and currently
anticipates decreasing infomercial spending by approximately 25% in fiscal 2006. The Company believes that appropriate infomercial marketing, combined with its Internet and print advertising, broadens the existing customer base and will also
increase customer traffic and sales in retail store locations. Although the Company primarily uses infomercials to sell its air purification line of products, it also tests the popularity of additional products through this medium and will continue
to do so in fiscal 2006.

During fiscal 2005, the Company decreased the circulation of single product mailers, which
highlight Sharper Image Design proprietary and Sharper Image branded products, by 35.2% as compared to a decrease of 7.8% in fiscal 2004. The decrease was due primarily to an effort to control advertising expense, slower sales of the Companys
air purification line of products that are often featured in these mailers and decreased return on investment from these mailings. Although the Company has scaled back the use of single product mailers, it continues to believe that appropriate
investment in this type of advertising increases brand awareness and broadens the existing customer base. Single product mailers will continue to be used to test the popularity of products to a broad group of prospective customers. For fiscal 2006,
the circulation of single product mailers is currently expected to decrease by approximately 40%.

INTERNET OPERATIONS

The Sharper Image was an early entrant into Internet retailing. The Company has participated in online shopping since 1994 and has
maintained its own Website at www.sharperimage.com since 1995. Revenues from the Companys Internet operations, including auction sales, decreased to $107.2 million in fiscal 2005 from $116.3 million in fiscal 2004. The Companys Internet
operations generated 16.0% and 15.3% of total revenues in fiscal 2005 and 2004, respectively. During fiscal 2005, transactions from the Companys Internet operations, including auction sales, decreased 8.6% and average revenue per transaction
decreased 0.5%. The Companys Internet operations benefit from The Sharper Image brand name, its technology-oriented customer base, The Sharper Image catalogs and unique product offerings, as well as its multimedia approach to advertising. The
Company believes that its Sharper Image Design and Sharper Image branded products are particularly well positioned to be marketed and sold over the Internet and that the Companys Internet operations have enabled it to expand and diversify the
Companys existing customer base. Shoppers on the Companys Website have the convenience of exchanging or returning products purchased through the Internet at the Companys retail store locations. The Company sends out periodic email
marketing campaigns to its list of Internet shoppers. These emails include sneak previews of newly released products and special offers that are intended to drive sales in all selling channels. The Company currently also offers international
Websites where Internet shoppers are able to get local delivery of Sharper Image Design and Sharper Image branded products, which in some cases have been specifically adapted for use throughout Europe.

The Sharper Images goal is to make www.sharperimage.com a Website that provides the Companys Internet customers with an
interactive experience similar to The Sharper Image stores. In fiscal 2005, the Company added PayPal as a payment option for purchases on both the Companys eBay auctions and at www.sharperimage.com. Other improved functionalities include a new
within-site search system enhancing the ease with which customers can find products on our site and a new accessories page that allows shoppers to easily purchase both accessories and related products at checkout. The Companys home page also
includes a new marketing area at the bottom of the page designed to highlight online promotions, larger images and multiple product videos. The Company also updated its order tracking and order inquiry areas online to make it easier for customers to
keep track of their Sharper Image orders.



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The Company also has an established Internet auction site on eBay. During 2005, the
Company migrated its own auction business to eBay. The Companys products are prominently featured on eBays auction site, as well as on the Companys eBay store. Most products purchased through auction have the same warranty that
accompanies full-price products and customers also enjoy a 30-day return privilege. Auctions on eBay provide the Company an opportunity to effectively manage its closeout, reconditioned and overstocked inventory while maintaining gross margin goals.

The Company plans to continue to allocate resources and take additional steps to pursue continued growth of its Internet
operations. These steps include technological improvements, dramatic visual presentations, and establishment of strategic Internet marketing arrangements. The Company has established relationships with Google, eBay, MSN Shopping, Linkshare, Amazon,
Yahoo! Shopping, AOL and Catalog City.

OTHER OPERATIONS

In addition to the Companys store, catalog and Internet operations, the Company also has a business-to-business operation, which includes wholesale operations and its Sharper Image
Corporate Incentives and Rewards program. It also derives revenues from its customer list-rental program.

The business
development department is the primary group responsible for wholesale marketing to other retailers, including fine department and specialty stores in the United States, as well as retailers in other countries. The Company has wholesale marketing
arrangements with established retail chains such as Linens n Things; Bed, Bath and Beyond; and Federated Department Stores. This groups sales decreased by 17.9% to $48.0 million in fiscal 2005, as compared to $58.4 million in fiscal
2004.

Under the Sharper Image Corporate Incentives and Reward program, the Company sells product, reward cards, incentive
and merchandise certificates to major corporations and not-for-profit entities, who in turn distribute them under their programs to increase their sales or to motivate and reward their high-achieving employees and best customers. The Sharper Image
stores, catalog and Website are the primary means of offering, delivering and redeeming the incentives and gifts. The Company records revenues and expenses for its Sharper Image Reward Program through its retail stores, catalog and direct marketing,
and Internet operations.

MERCHANDISING, SOURCING AND DEVELOPMENT

Merchandising

The Sharper Image is known for its varied product mix and a
merchandising philosophy focusing on innovative, well-designed, high-quality products that are either developed by The Sharper Image, exclusive to The Sharper Image or in limited distribution. The Companys merchandising strategy emphasizes
products that are innovative and new-to-market. In recent years the Company has focused significant resources on the development and marketing of its Sharper Image Design and Sharper Image branded products. Sharper Image Design and Sharper Image
branded products typically generate higher gross margins than other products, minimize direct price comparisons and, the Company believes, strengthen The Sharper Image brand as well as broaden its customer reach. The decrease in the percentage of
the Companys total revenues attributable to Sharper Image Design and Sharper Image branded products to approximately 67% in fiscal 2005 from 74% in fiscal 2004 is due primarily to the decrease in sales of the Companys air purification
line of products starting in the first quarter of fiscal 2005 and a decrease in sales of Sharper Image branded massage chairs starting in the second half of fiscal 2005. The Company intends to aggressively develop and introduce new products in the
Sharper Image Design and Sharper Image branded product categories.

The Company offers products, most of which are in the
$20 to $500 price range, to appeal to a wide customer base. The Company chooses each product separately and focuses its marketing efforts on each items unique attributes, features and benefits. This approach distinguishes the Company from
other retailers who are oriented more to category or product classification. In product lines where the Company competes directly with



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other retailers, the Company generally chooses to sell the best available version of the product with the most advanced features. The Company adjusts its
merchandise mix to reflect market trends and customer buying habits. New products are selected or developed and brought into the Companys merchandise mix based on criteria such as anticipated popularity, gross margin, uniqueness, value,
competitive alternatives, exclusivity, quality and vendor performance. As a result of such shifting emphasis among individual items, and depending on the customers demand and the level of marketing and advertising programs, the mix of sales by
category changes from time to time and the sales volume of individual or related products can be significant to any particular reporting periods total sales. The effect of changes from year to year in the mix of sales by category can be to
increase or decrease the merchandise gross margin rates since margins vary according to category of merchandise.

Sharper
Image Design products are produced for the Company on a contract basis, substantially all by manufacturers in Asia, primarily China. The Company provides all product specifications to the contract manufacturers. Development lead-time is generally in
the range of 12 to 18 months, although certain product introductions may require a shorter or longer lead-time.

The
Sharper Image regularly generates information on merchandise orders and inventory that is reviewed by the Companys product managers, its senior merchandising staff and top management. The Company averages new offerings of approximately 100 to
200 products during the fourth quarter peak selling season. The Sharper Image carefully considers which products will or will not be offered in future months based upon numerous factors including revenues generated, gross margins, the cost of
catalog and store space devoted to each product, product availability and quality.

Product Sourcing

The process of finding new products involves the Companys product managers who review voluminous product literature, travel
extensively throughout the United States and Asia to attend trade shows and exhibitions and meet with distributors and manufacturers. The Company enjoys relationships with many major manufacturers who use The Sharper Image regularly to introduce
their newest products in the United States.

The Sharper Image purchases merchandise from numerous foreign and domestic
manufacturers and importers. The Company had a single supplier that provided approximately 19% of the Companys net merchandise purchases in fiscal 2005 and 28% in fiscal 2004. In fiscal 2005 and 2004, substantially all of the products offered
by the Company were manufactured in Asia, primarily China.

Product Development

The Companys Sharper Image Design group has more than 10 years of experience in designing and developing new products. Product ideas
are generated internally or by adapting ideas and technologies presented to the Company. Outside inventors and patent holders often approach The Sharper Image to help turn an idea into a successful consumer product. The design and packaging of the
Companys proprietary Sharper Image Design products is created internally; manufacturing is contracted to outsidersprincipally with factories in China.

The product development team is an integral part of the merchandising team to ensure coordination of the product assortment. The teams meet regularly to assess product opportunities, review
pricing, evaluate consumer feedback, address product quality, evaluate marketplace trends and update current sales. The goal of both the product developers and the merchandising team is to offer consumers a distinctive selection of unique and
innovative products that, in many instances, are exclusive to The Sharper Image.

As the product development process has
evolved over the past decade, the pace of introduction of new products has accelerated. In fiscal 2005, Sharper Image Design introduced 14 consumer electronics items in our ZipConnect programCD stereos and speaker systems designed to complement the iPod and MP3
music



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players. Additionally, 11 other successful Sharper Image Design products were launched in fiscal 2005 across diverse product categories. These included the
Soap Genie automatic soap dispenser; a security
camcorder hidden in a clock; an ultrasonic rodent deterrent; a watch winder; plus improved deluxe versions of our popular automatic eyeglass cleaner and ultrasonic jewelry cleaner. The total of 25 major new products introduced in the
past year was approximately double the output in each of the prior two years.

In addition to Sharper Image Design
products, many more products bear the Sharper Image brand; these are developed by the merchandising teams product managers, working with third-party manufacturers. Their goal is to distinguish the Company from competitors by
negotiating exclusive distribution or exclusive features for many of these third-party products across our entire range of merchandiseelectronics, housewares, personal care, toys, recreation, fitness, travel and gifts. In fiscal 2005, the
Company enjoyed particular strength in the areas of robotic and radio-controlled toys, viscoelastic foam products with antibacterial properties and executive golf gifts.

CUSTOMER SERVICE

The Sharper Image is committed to providing its customers with
courteous, knowledgeable and prompt service. The Companys customer service and catalog sales groups at the corporate headquarters in San Francisco and at distribution centers in Little Rock, Arkansas, and Richmond, Virginia, provide personal
attention to customers who call toll free or send emails to request a catalog subscription, place an order or inquire about a product. The Companys customer service group is also responsible for resolving customer problems promptly and to the
customers satisfaction. The Company also contracts with third party call centers for additional sales and customer service representative coverage. These third party call centers are subject to the same high-level expectations of customer
service as the Companys internal staff.

ORDER FULFILLMENT AND DISTRIBUTION

The Sharper Image owns an approximately 103,000 square foot fulfillment and distribution facility in Little Rock, Arkansas. The Sharper
Image currently has leased facilities in Little Rock, Arkansas; Ontario, California; and Richmond, Virginia; totaling approximately 486,000 square feet for catalog, direct response, Internet orders, store fulfillment needs, returns processing and
storage. The Companys merchandise is generally delivered to its catalog and Internet customers and to The Sharper Image stores directly from its distribution facilities. Some products are shipped directly from the vendor to the customer or to
the Companys stores. The shipment of products directly from vendors to the stores and customers reduces the level of inventory required to be carried at the distribution center, freight costs and the lead-time required to receive the products.
Each catalog order is received via remote terminal at the distribution facility after the order has been approved for shipment. The Companys goal is to ship the majority of catalog and Internet orders within 24-48 hours after the order is
received.

Maintaining sufficient inventory levels is critical to The Sharper Images business. The Companys
stores are equipped with electronic point-of-sale registers that communicate daily with the main computer system at corporate headquarters, transmitting sales, inventory and customer data, as well as receiving data from headquarters. The sales,
inventory and customer data enable sales and corporate personnel to monitor sales by item on a daily basis, provide the information utilized by the automatic replenishment system (ARS) and merchandising personnel for inventory allocations, provide
management with current inventory and merchandise information, and enable the Companys in-house mailing list to be updated regularly with customer names and activity. The Companys main inventory focus in the fourth quarter of fiscal 2005
was to decrease year over year inventory levels given the decline in sales in fiscal 2005 and anticipated declining sales in fiscal 2006.

ADVERTISING

While the catalog remains The Sharper Images primary advertising vehicle, the Company also broadens its customer
base through multimedia advertising, including infomercials, newspapers, magazines, email marketing



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programs, Internet advertising and marketing programs, and business-to-business trade publications. During fiscal 2005, the Company decreased its advertising
in each of these mediums as it sought to balance new product exposure with declining sales trends, resulting in lower advertising returns. The Company runs primarily direct response advertising which requires a minimum level of sales return to
advertising cost to justify or to increase expenditures. Brand advertising is minimal. The Company continually reevaluates its advertising strategies and spending levels to improve the effectiveness of its advertising programs. The
Companys current plan for fiscal 2006 is to decrease total advertising by approximately 30% across all advertising mediums, except for Internet advertising, which is planned to be at or higher than fiscal 2005 levels.

INFORMATION TECHNOLOGY

The Sharper
Image maintains an integrated management information system for merchandising, point-of-sale, order fulfillment, distribution and financial reporting. The Company believes its system increases productivity by providing extensive merchandise
information and inventory control. The Company continually evaluates and enhances its computer systems and information technology in order to provide additional and improved management and financial information. The Company has backup systems for
its mainframe and servers located at its distribution center in Little Rock, Arkansas.

ASSOCIATES

The Sharper Image places great importance on recruiting, training and providing the proper incentives for quality personnel. The Sharper
Image seeks to hire and retain qualified sales and customer service representatives in its store, catalog and Internet operations and to thoroughly train them. Each new store manager undergoes an intense program during which the manager is trained
in many aspects of the Companys business. Sales personnel are trained during the first two weeks of employment, or during the weeks before a new store opens, and updated periodically with ongoing sales training sessions. Training for sales
personnel focuses primarily on acquiring a working knowledge of the Companys products, developing selling skills and obtaining an understanding of The Sharper Images high customer service standards. Each sales associate is trained to
adhere to the Companys philosophy of taking ownership of every customer service issue that may arise. The Company also has developed ongoing programs conducted at each store that are designed to keep sales personnel updated on all
new product offerings.

As of January 31, 2006, The Sharper Image employed approximately 2,500 associates,
approximately 49% of whom were full time. The Company also hires a significant number of seasonal employees during its peak holiday selling season. The Company considers its associate relations to be good.

COMPETITION

The Sharper Image
operates in a highly competitive environment. The Company competes principally with a diverse mix of department stores, sporting goods stores, discount stores, specialty retailers and other catalog and Internet retailers that offer products similar
to or the same as some of those the Company offers. Many of the Companys competitors are larger companies with greater financial resources, a wider selection of merchandise and greater inventory availability. Larger retailers, such as
department stores, offer a wider range of products and offer the convenience of one-stop shopping. Specialty retailers, such as electronics stores, may offer only a certain category of product but often offer a wider range of selection within a
particular product category. Discount stores may offer analogous products at lower price points.

Since The Sharper Image
offers a more limited range of products compared to its competitors, its ability to anticipate the preferences of its customers, to effectively market and distinguish The Sharper Image brand is critical. Although the Company attempts to market
products not generally available elsewhere and has emphasized exclusive products in its merchandising strategy, some of the Companys products or similar products can also be found in other retail stores, other catalogs or through the Internet.
The Sharper Image offers



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competitive pricing when other retailers market certain products similar to the Companys products at lower prices. In addition, a number of other
companies have attempted to imitate the presentation and method of operation of the Companys catalog and stores and its Sharper Image Design products. The Companys ability to distinguish its products from similar products offered by its
competitors is particularly important in order to maintain pricing and because of the ease with which customers can comparison shop on-line. A significant, but decreasing, portion of the Companys sales and net income are generated by its air
purification line of products. The Company believes the success of this product line has and may continue to encourage other companies to imitate these products. Another key product group is massage chairs, whereby competitors may compete with us by
offering lower retail prices on similar products with fewer features.

The Sharper Image competes principally on the basis
of product exclusivity, selection, brand recognition, quality and price of its products, merchandise presentation in its catalog, its stores and on the Internet and television, its customer list and the quality of its customer service. The Company
has continued with its commitment to providing resources for its internal product development group to create and produce Sharper Image Design products, and to its merchandising team to support a program to increase the number of Sharper Image brand
products exclusively available from the Company. The Company believes that these Sharper Image Design and Sharper Image brand products provide it with a competitive advantage in its merchandise offerings.

INTELLECTUAL PROPERTY

The Sharper
Image believes its registered service mark and trademark The Sharper Image and the brand name recognition that it has developed are of significant value. The Company actively protects its brand name and other intellectual property rights
to ensure that the quality of its brand and the value of its proprietary rights are maintained. The Company seeks patents to establish and protect its proprietary rights relating to the technologies and products it is currently developing, that it
may develop, or that its competitors may develop. The Company has taken and will continue, in the future, to take all steps necessary to broaden and enhance its patent protection by obtaining both utility and design patent protection directed to its
proprietary products. As of January 31, 2006, The Sharper Image held 71 U.S. utility patents and more than 120 U.S. design patents.

The Sharper Image has at least 13 U.S. utility patents and several U.S. design patents that protect its air purification line of products. The earliest expiration date of any of these utility patents is 2018. The
Company also has multiple foreign and domestic pending patent applications directed to its air purification line of products. Although the Company believes its existing patents, as well as its ongoing patent prosecution efforts, will continue to
provide protection for its air purification products, this product line could face additional competition.

The Sharper
Image owns or has rights to various copyrights, trademarks and trade names used in its business. These include The Sharper Image®, Sharper Image Design®, ZipConnect, Sound Soother®, Ionic Breeze®, The
Breeze®, Quadra®, Ionic Hair Wand® 2.0, Personal Cooling System, Quiet Power Motorized Tie Rack, Shower Companion® and Turbo-Groomer®.

SEASONALITY

The Sharper Image business is highly seasonal, with sales peaking during the fourth quarter holiday shopping season. A substantial portion
of the Companys total revenues, and all or most of its net earnings, if any, occur in the fourth fiscal quarter ending January 31. The Company generally experiences lower revenues during the other fiscal quarters, and as is typical in the
retail industry, has incurred and may continue to incur losses in these quarters. In addition, as with many retailers, the Company makes merchandising and inventory decisions for the holiday season well in advance of the holiday selling season. The
fourth quarter accounted for approximately 40% of total revenues in fiscal 2005 and 2004. In addition, the Companys fourth quarter accounted for substantially all of the Companys net earnings in fiscal 2004 and was the only quarter in
which the company had an operating profit in 2005.



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EXECUTIVE OFFICERS OF THE REGISTRANT

Company executive officers, their respective ages and positions as of April 1, 2006, and a description of their business experience are set forth below. There are no family relationships
among any of the executive officers named below.

Richard Thalheimer,age 58

Mr. Thalheimer is the Companys Founder and has served as the Companys Chief Executive Officer and a Director since 1978
and as Chairman of the Board of Directors since 1985. Mr. Thalheimer also served as the Companys President from 1977 through July 1993.

Tracy Wan,age 46

Ms. Wan has served as President and Chief Operating Officer
since April 1999 and as a member of the Companys Board of Directors since October 2004. Prior to that she served as Executive Vice President and Chief Financial Officer from August 1998 through April 1999; Senior Vice President and Chief
Financial Officer from February 1995 through August 1998; as Vice President and Chief Financial Officer from September 1994 through February 1995; as Vice President and Controller from November 1991 through September 1994; and as Controller from
July 1989 through November 1991.

Jeffrey Forgan,age 48

Mr. Forgan has been our Executive Vice President and Chief Financial Officer since August 2005. Mr. Forgan previously served as
our Executive Vice President and Chief Financial Officer from May 2002 to December 2004 and Senior Vice President and Chief Financial Officer from April 1999 through May 2002. Mr. Forgan voluntarily resigned from the Company in December 2004 to
attend to certain family matters. Prior to April 1999, Mr. Forgan served as Vice President, Corporate Finance with Foundation Health Systems from 1995 to 1998, and was with Deloitte & Touche LLP from 1980 to 1995, serving as an audit
partner during 1995. Mr. Forgan is a certified public accountant.

Craig Trabeaux,age 49

Mr. Trabeaux has served as Executive Vice President, Retail Operations and Real Estate since February 2005. Prior to that he served
as Senior Vice President, Retail Operations from September 2000 to February 2005; as Vice President, Stores from September 1999 through September 2000; as Regional Manager from February 1998 through September 1999; as Senior District Manager from
October 1995 through January 1998; as District Manager from February 1989 through September 1995; and as Store Manager July 1987 through January 1989.

Greg Alexander,age 44

Mr. Alexander has served as Executive Vice President,
Chief Information Officer since February 2006. Prior to that, Mr. Alexander served as Senior Vice President, Information Technology from March 1999 through February 2006, as Vice President, Information Technology from February 1995 through
March 1999 and as Director, Information Technology from July 1991 through February 1995.

William Feroe,age 49

Mr. Feroe has served as Executive Vice President, Merchandising since February 2005. Prior to that he served as Senior
Vice President, Merchandising from July 2002 to February 2005; as Vice President, Planning and Allocation from September 1999 through July 2002; as Director of Planning and Allocation from September 1998 through September 1999; and as Manager,
Allocation and Distribution from November 1997 to September 1999.



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Anthony Farrell,age 56

Mr. Farrell has served as Senior Vice President, Creative Services since July 1998. Prior to joining The Sharper Image,
Mr. Farrell served as a consultant to The Sharper Image from April 1998 through July 1998. Mr. Farrell was Senior Vice President, Merchandising with SelfCare Catalog from March 1991 through December 1997.



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AVAILABLE INFORMATION

The Internet address of The Sharper Image is www.sharperimage.com. The Company makes available on its Website its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Information on the Companys Website is not incorporated into this annual report.



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ITEM 1A. RISK FACTORS

If we fail to continuously offer new merchandise that our customers find attractive, the demand
for our products may be limited.

In order to meet our strategic goals we must successfully offer our customers
new, innovative and high-quality products on a continuous basis. Our product offerings must be affordable, useful to the customer, well-made, distinctive in design and not widely available from other retailers. We cannot predict with certainty that
we will successfully offer products that meet these requirements in the future. Some products or a group of related products usually produce sales volumes that are significant to our total sales volume in a particular period.

If other retailers, especially department stores or discount retailers, offer the same products or products similar to those we sell, or
if our products become less popular with our customers, our sales may decline or we may decide to offer our products at lower prices. If customers buy fewer of our products or if we have to reduce our prices, our revenues and earnings will decline.
Our products must appeal to a broad range of consumers whose preferences we cannot predict with certainty and may change between sales seasons.

If
we do not maintain sufficient inventory levels, if we are unable to deliver our products to our customers in sufficient quantities, or if our inventory levels are too high, our operating results will be adversely affected.

We must be able to deliver our merchandise in sufficient quantities to meet the demands of our customers and deliver this merchandise to
customers in a timely manner. We must be able to maintain sufficient inventory levels, particularly during the peak holiday selling season. If we fail to achieve these goals we may be unable to meet customer demand and our future results will be
adversely affected if we are not successful in achieving these goals. If our inventory levels are too high we may recognize lower gross margins in order to sell through this inventory. Our success depends on our ability to anticipate and respond to
changing product trends and consumer demands in a timely manner.

A significant portion of our sales during any given period of time may be generated
by a particular product or line of products and if sales of those products or line of products decrease, our results of operations may be adversely affected.

During fiscal 2005 and fiscal 2004 the sales of our air purification line of products constituted a significant portion of our total revenues and net income. Although not as significant, the
sales from our home and portable stereo system and massage product lines constituted a substantial portion of our total revenues and net income for both fiscal 2005 and 2004. The decrease in revenues for fiscal 2005 as compared to fiscal 2004 was
due primarily to a decrease in the sale of our air purification and massage chair line of products.

Our future success
will be substantially dependent on the continued sales of existing core as well as new products, while at the same time achieving and improving on current gross margin rates. We cannot predict whether we will be able to increase sales of existing
core products or successfully introduce new products, increase our revenue level or achieve higher gross margin rates in future periods. Failure to do so may adversely affect our results of operation.

Poor economic conditions may reduce consumer spending on discretionary retail products such as the ones we offer.

Consumer spending patterns, particularly discretionary spending for products such as ours, are affected by, among other things, prevailing
economic conditions, stock market volatility, increasing gas prices, war and threats of war, acts of terrorism, wage rates, interest rates, inflation, taxation, consumer confidence and consumer perception of economic conditions. General economic,
political and market conditions, such as recessions, may adversely affect our business results and the market price of our common stock. We may not be able to accurately anticipate the magnitude of the impact of these conditions on future quarterly
results.



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Our success depends in part on our ability to internally design and develop our Sharper Image Design products.

We have invested significant resources in and are significantly dependent on the success of Sharper Image Design
products. These products have typically generated higher gross margins than other products and our merchandising strategy emphasizes these products. Some of these products or a group of related products, which are affected by customers demands
and the level of our marketing and advertising efforts, can produce sales volumes that are significant to our total sales volume in a particular period. In order to be successful, we must continue to design and develop products that meet the demands
of our customers, as well as create customer demand for these products. Our goal is to increase the percentage of total revenues attributable to Sharper Image Design and Sharper Image branded products, although we expect this percentage may decline
from time to time and cannot assure you we will otherwise achieve our goal. If we are unable to successfully design and develop these products, our operating results may be adversely affected.

We rely on foreign sources of production and our business would be adversely affected if our suppliers are not able to meet our demand and alternative sources are
not available.

We must ensure that the products we design and develop are manufactured cost-effectively. We rely
solely on a select group of contract manufacturers, most of whom are located in Asia (primarily China), to produce these products in sufficient quantities to meet customer demand and to obtain and deliver these products to our customers in a timely
manner. These arrangements are subject to the risks of relying on products manufactured outside the United States, including political unrest and trade restrictions, local business practices and political issues, including issues relating to
compliance with domestic or international labor standards, currency fluctuations, work stoppages, economic uncertainties, including inflation and government regulations, availability of raw materials and other uncertainties. If we are unable to
successfully obtain and timely deliver sufficient quantities of these products, our operating results may be adversely affected. In July 2005, China permitted the exchange rate of its currency, the Chinese Yuan (CNY), to float against
the U.S. Dollar (USD). Although substantially all of our supply contracts in China are denominated in USD, our suppliers could attempt to renegotiate these contracts and increase costs to us if the CNY/USD exchange rate were to
change materially.

We had a single supplier located in Asia for a number of our products that provided approximately 19%
of the net merchandise purchases in fiscal 2005. If we were unable to obtain products from this supplier on a timely basis or on commercially reasonable terms, our operating results may be adversely affected.

Some of our smaller vendors have limited resources, limited production capacities and limited operating histories. We have no long-term
purchase contracts or other contracts that provide continued supply, pricing or access to new products and any vendor or distributor could discontinue selling to us at any time. We compete with many other companies for production facilities and
import quota capacity. We cannot assure you that we will be able to acquire the products we desire in sufficient quantities or on terms that are acceptable to us in the future. In addition, we cannot assure you that our vendors will make and deliver
high quality products in a cost-effective, timely manner. We also may be unable to develop relationships with new vendors.

We depend on our
vendors ability to timely deliver sufficient quantities of products and our business can be harmed by work stoppages or other interruptions to delivery of products.

All products we purchase from our vendors in Asia must be shipped to our distribution centers by freight carriers and we cannot assure you
that we will be able to obtain sufficient freight capacity on a timely basis and at favorable rates. Our inability to acquire suitable products in a cost-effective, timely manner or the loss of one or more key vendors or freight carriers could have
a negative effect on our business.

Many of our shipments that come from Asia move through the West Coast ports that have
been negatively impacted in recent years by labor slowdowns. During the second half of fiscal 2004, a slowdown caused our airfreight costs to increase as we used alternative delivery methods to mitigate some of the impacts of the



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slowdown. The increased usage of air freight transportation had a negative impact on our gross margins and expenses. Future slowdowns at the ports would
cause supply chain issues for us and might adversely affect our operating results.

Our ability to protect our proprietary technology, which is vital
to our business, particularly our air purification products, is uncertain and our inability to protect these rights could impair our competitive advantage and cause us to incur substantial expense to enforce our rights.

We believe our registered house marks The Sharper Image, sharperimage.com, Sharper Image Design and
Sharper Image as well as the trademark fame that we have established are of significant value. We actively pursue and protect, domestically and internationally, our corporate trademarks, patents, copyrights and trade secrets to ensure
that the quality of our brand and the value of our proprietary rights are maintained. We protect our proprietary marketing strategies, illustrative catalogs and product packaging through numerous copyright registrations. We also seek patents to
establish and protect our proprietary rights relating to the technologies and products we have developed, are in the process of developing, or that we may develop in the future. As of January 31, 2006, we held 71 U.S. utility patents and more
than 120 U.S. design patents.

We cannot assure you that a third party will not infringe upon or design around any patent
issued or licensed to us, including the patents related to our air purification line of products, or that these patents will otherwise be commercially viable. Litigation to establish the validity of patents, to defend against patent infringement
claims of others and to assert patent infringement claims against others can be expensive and time-consuming even if the outcome is favorable to us. If the outcome is unfavorable to us, we may be required to pay damages, pay ongoing fees if we
continue to sell the product, stop production and sales of infringing products or be subject to increased competition from similar products. We have taken and may, in the future, take steps to enhance our patent protection, but we cannot assure you
that these steps will be successful or that our patent protection will be adequate.

We also rely upon trade secrets,
know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position. We attempt to protect our proprietary technology in large part by confidentiality agreements with our employees, consultants
and other contractors. We cannot assure you, however, that these agreements will not be breached, that we will have adequate remedies for any breach or that competitors will not know of or independently discover our trade secrets.

Our quarterly operating results and comparable store sales are subject to significant fluctuations and seasonality.

Our business is seasonal, reflecting the general pattern of peak sales and earnings for the retail industry during the fourth quarter
holiday shopping season. Typically, a substantial portion of our total revenues and all or most of our net earnings occur during our fourth quarter ending on January 31. The fourth quarter accounted for approximately 40% of total revenues in
both fiscal 2005 and 2004. In addition, the fourth quarter accounted for substantially all of our net earnings in fiscal 2004 and was the only the quarter in which we had an operating profit in fiscal 2005. In anticipation of increased sales
activity during the fourth quarter, we incur significant additional expenses, including significantly higher inventory costs and the costs of hiring a substantial number of temporary employees to supplement our regular staff. If for any reason our
sales were to be substantially below those normally expected during the fourth quarter, our annual operating results would be adversely affected. Due to this seasonality, our operating results for any one period may not be indicative of our
operating results for the full fiscal year.

We generally experience lower revenues and net operating results during our
first three quarters of the fiscal year and have historically experienced losses in these quarters. Our quarterly results of operations may fluctuate significantly as a result of a variety of factors including, among other things, the timing of new
store openings, net sales contributed by new stores, increases or decreases in comparable store sales, changes in our merchandise mix and net catalog sales.



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In addition, as with other retailers, we typically make merchandising and purchasing
decisions well in advance of the holiday shopping season. As a result, poor economic conditions or lower than projected customer demand for our products during the fourth quarter could result in lower revenues and net operating results.

Our comparable store sales also fluctuate significantly and can contribute to fluctuations in our quarterly operating results. Our
comparable store sales are affected by a variety of factors, including customer demand in different geographic regions, our ability to efficiently source and distribute products, changes in our product mix, competition, advertising and our wholesale
operations. Although we believe it is sound business strategy to take advantage of broadening our customer base and to leverage our brand and advertising through the increase in our wholesale business, the impact of selling our Sharper Image Design
and Sharper Image branded products through an increased number of other selected retailers may put pressure on our own comparable store sales increase percentage.

Our comparable store sales have fluctuated significantly in the past and we believe that such fluctuations may continue. For fiscal 2005, we experienced decreasing comparable store sales and
expect this to continue for at least a portion of fiscal year 2006. Our historic comparable net store sales changes from the prior fiscal year were as follows:



|            |  |                                |  
|----------- |  | ------------------------------ | -
|Fiscal year |  | Percentage increase (decrease) |  
|2000        |  | 29.0                           |  
|2001        |  | (16.0                          | )
|2002        |  | 13.6                           |  
|2003        |  | 15.3                           |  
|2004        |  | (1.1                           | )
|2005        |  | (16.0                          | )

Comparable store sales are not a measure that has been defined under generally
accepted accounting principles. We define comparable store sales as sales from stores where selling square feet did not change by more than 15% in the previous 12 months and which have been open for at least 12 months. Stores are generally included
in our annual comparable store sales calculation once they have 24 months of comparable sales. We cannot assure you that our comparable store sales results will increase in the future. Any reduction in or failure to increase our comparable store
sales results could impact our future operating performance and cause the price of our common stock to decrease.

We are dependent on the success of
our advertising and direct marketing efforts and our profitability will be adversely affected by increased costs associated with these efforts.

Our revenues depend in part on our ability to effectively market and advertise our products through The Sharper Image catalog and direct marketing operations. Increases in advertising, paper or postage costs may limit
our ability to advertise without reducing our profitability. We are also utilizing and constantly testing other advertising media, such as infomercials, radio, single product mailings and other print media. If we decrease our advertising efforts, as
we did in fiscal 2005, due to increased advertising costs, restrictions placed by regulatory agencies or for any other reason, our future operating results may be materially and adversely affected. Our advertising expenditures decreased by
approximately $36.1 million, or 24.1%, in fiscal 2005 from the prior fiscal year. If our advertising is ineffective and our increased advertising expenditures do not result in increased sales volumes, our sales and profits will be adversely
affected. We depend on the continued availability of infomercial time at reasonable prices. We expect to continue to spend on advertising and marketing at significant levels in fiscal 2006 but at lower levels than fiscal 2005. We may not be able to
continue to produce a sufficient level of sales to cover such expenditures, which would reduce our profitability or increase our net loss.



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Our wholesale sales present certain risks that could adversely affect our profitability.

We sell products through a multichannel strategy. While we believe that our wholesale sales offer growth opportunities and exposure to a
greater customer base, this growth could adversely impact our business. In general, depending on product mix, our sales to wholesale partners carry lower gross margins than sales made through our other channels. In addition, these sales could shift
sales from our higher margin sales channels, particularly our retail and catalog channels. Wholesale customers may also decide to decrease or eliminate their level of purchases.

Our business will be harmed if we are unable to successfully implement our growth strategy.

Our growth strategy primarily includes the following components:



| |  |  | increase Sharper Image Design and Sharper Image branded product offerings;
| | - |  | --------------------------------------------------------------------------



| |  |  | broaden our customer base;
| | - |  | --------------------------



| |  |  | open new stores; and
| | - |  | --------------------



| |  |  | broaden our sales and marketing channels.
| | - |  | -----------------------------------------

Any failure on our part to successfully implement any or all components of our growth strategy would likely have a material adverse effect on our financial condition, results of operations and cash flows. We believe
our past growth has been attributable in large part to our success in meeting the merchandise, timing and service demands of an expanding customer base with changing demographic characteristics, but there is no assurance that we will be able to
continue to have such success. Due to challenges in our business in fiscal 2005, our current plan is to moderate store growth in fiscal 2006 to six to eight new stores as compared to 20 in fiscal 2005, 28 in fiscal 2004 and 25 in fiscal 2003. The
decrease in the rate we plan to open new stores in fiscal 2006 compared to prior years will limit our ability to increase net store sales.

The
expansion of our store operations could result in increased expenses with no guarantee of increased profitability.

We plan to open approximately six to eight new stores in fiscal 2006. We may not be able to attain our target new store openings, and any of our new stores that we open may not be profitable, either of which could have an adverse impact on
our financial results. Our ability to expand by opening new stores will depend in part on the following factors:



| |  |  | the availability of attractive store locations;
| | - |  | -----------------------------------------------



| |  |  | our ability to negotiate favorable lease terms;
| | - |  | -----------------------------------------------



| |  |  | our ability to identify customer demand in different geographic areas;
| | - |  | ----------------------------------------------------------------------



| |  |  | the availability and cost of store fixtures;
| | - |  | --------------------------------------------



| |  |  | general economic conditions; and
| | - |  | --------------------------------



| |  |  | availability of sufficient funds for expansion.
| | - |  | -----------------------------------------------

Even though we continue to expand our store base, we have remained concentrated in limited geographic areas. This could increase our exposure to customer demand, weather, competition, distribution problems and poor
economic conditions in these regions. In addition, our catalog sales, Internet sales or existing store sales in a specific region may decrease as a result of new store openings.

Some of our expenses will increase with the opening of new stores. If store sales are inadequate to support these new costs, our
profitability will decrease. For example, inventory costs will increase as we increase inventory levels to supply additional stores. We may not be able to manage this increased inventory without



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decreasing our profitability. Our current credit facility has various loan covenants we must comply with in order to maintain the credit facility. We cannot
predict whether we will be successful in obtaining additional funds or new credit facilities on favorable terms or at all.

We rely on our catalog
operations which could have significant cost increases and could have unpredictable results.

Our success depends in
part on the success of our catalog operations. We believe that the success of our catalog operations depends on the following factors:



| |  |  | our ability to achieve adequate response rates to our mailings;
| | - |  | ---------------------------------------------------------------



| |  |  | our ability to continue to offer a merchandise mix that is attractive to our mail order customers;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | our ability to cost-effectively add new customers;
| | - |  | --------------------------------------------------



| |  |  | our ability to cost-effectively design, produce and deliver appealing catalogs; and
| | - |  | -----------------------------------------------------------------------------------



| |  |  | timely delivery of catalog mailings to our customers.
| | - |  | -----------------------------------------------------

Catalog production and mailings entail substantial paper, postage, merchandise acquisition and human resource costs, including costs associated with catalog development and increased inventories.
We incur nearly all of these costs prior to the mailing of each catalog. As a result, we are not able to adjust the costs incurred in connection with a particular mailing to reflect the actual performance of the catalog. Increases in costs of
mailing, paper or printing would increase costs and would adversely impact our earnings if we were unable to pass such increases directly on to our customers or offset such increases by raising prices or by implementing more efficient printing,
mailing, delivery and order fulfillment systems. If we were to experience a significant shortfall in anticipated revenue from a particular mailing, and thereby not recover the costs associated with that mailing, our future results would be adversely
affected. In addition, response rates to our mailings and, as a result, revenues generated by each mailing are affected by factors such as consumer preferences, economic conditions, the timing and mix of catalog mailings, the timely delivery by the
postal system of our catalog mailings and changes in our merchandise mix, several or all of which may be outside our control. Further, we have historically experienced fluctuations in the response rates to our catalog mailings. If we are unable to
accurately target the appropriate segment of the consumer catalog market or to achieve adequate response rates, we could experience lower sales, significant markdowns or write-offs of inventory and lower margins, which would adversely affect our
future results.

We have distribution and fulfillment operations located in Little Rock, Arkansas; Ontario, California; and Richmond, Virginia. Any
disruption of the operations in these centers could make it difficult to meet customer demand.

We conduct the
majority of our distribution operations and all of our catalog and Internet order processing fulfillment functions from our own facility in Little Rock, Arkansas; and leased facilities in Little Rock, Arkansas; Ontario, California; and Richmond,
Virginia. We also use contract fulfillment and warehouse facilities for additional seasonal requirements. Any disruption in the operations at any distribution center, particularly during the holiday shopping season, could result in late delivery of
products and make it difficult to meet customer demand for our products.

In addition, we rely upon third party carriers
for our product shipments, including shipments to and from all of our stores. As a result, we are subject to certain risks, including employee strikes and inclement weather, associated with such carriers ability to provide delivery services to
meet our shipping needs.

We are also dependent on temporary employees to adequately staff our distribution facilities,
particularly during busy periods such as the holiday shopping season. We cannot assure you that we will continue to receive adequate assistance from our temporary employees, or that we will continue to have access to sufficient sources of temporary
employees.



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We experience intense competition in the rapidly changing retail markets and if we are unable to compete
effectively, we may not be able to maintain profitability.

We operate in a highly competitive environment. We
principally compete with a variety of department stores, sporting goods stores, discount stores, specialty retailers and other catalogs that offer products similar to or the same as our products. We may increasingly compete with major Internet
retailers. Many of our competitors are larger companies with greater financial resources, a wider selection of merchandise and greater inventory availability and offer the convenience of one-stop shopping. Specialty retailers, such as electronics
stores, may offer only a certain category of product but often offer a wider range of selection within a particular category of product. Discount stores may offer analogous products at lower price points. We offer a more limited range of products
compared to our competitors, and if we are unable to anticipate the preferences of our customers and effectively market and distinguish The Sharper Image brand, or if we experience increased competition, our business and operating results could be
adversely affected.

The U.S. retail industry, the specialty retail industry in particular, and the e-commerce sector are
dynamic in nature and have undergone significant changes over the past several years. Our ability to anticipate and successfully respond to continuing challenges is critical to our long-term growth and we cannot assure you that we will anticipate
and successfully respond to changes in the retail industry and e-commerce sectors.

We maintain a liberal merchandise return policy, which allows
customers to return most merchandise, and as a result, excessive merchandise returns could harm our business.

We
make allowances for returns of store, catalog and Internet sales in our financial statements based on historical return rates. We cannot assure you that actual merchandise returns will not exceed our allowances. In addition, because our allowances
are based on historical return rates, we cannot assure you that the introduction of new merchandise in our stores or catalogs, the opening of new stores, the introduction of new catalogs, increased sales over the Internet, changes in our merchandise
mix or other factors will not cause actual returns to exceed return allowances. Any significant increase in merchandise returns that exceed our allowances could have a material adverse effect on our future results.

We may be subject to risks associated with our products, including product liability or patent and trademark infringement claims.

Our current and future products may contain defects, which could subject us to product liability claims, higher return rates and product
recalls. Although we maintain limited product liability insurance, if any successful product liability claim or product recall is not covered by or exceeds our insurance coverage, our business, results of operations and financial condition would be
harmed. Additionally, third parties may assert claims against us alleging infringement, misappropriation or other violations of patent, trademark or other proprietary rights, whether or not such claims have merit. Such claims can be time consuming
and expensive to defend and could require us to cease using and selling the allegedly infringing products, which may have a significant impact on total company sales volume, and could cause us to incur significant litigation costs and expenses.

If we lose our key personnel, we may not be able to successfully develop and merchandise our products.

Our success depends to a significant extent upon the abilities of our senior management, particularly Richard Thalheimer, our Founder,
Chairman and Chief Executive Officer. The loss of the services of any of the members of our senior management or of certain other key employees could have a significant adverse effect on our business, financial condition and operating results. We
maintain key man life insurance on Mr. Thalheimer in the amount of $15 million. The terms of Mr. Thalheimers employment are governed by an employment agreement. Our future performance will depend upon our ability to attract and
retain qualified management, merchandising and sales personnel. There can be no assurance that the members of our existing management team will be able to manage our company or our growth or that we will be able to attract and hire additional
qualified personnel as needed in the future.



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A single shareholder exerts considerable influence over our business affairs and may make business decisions which
may not be in your best interest.

As of January 31, 2006, Richard Thalheimer, our Founder, Chairman and Chief
Executive Officer, beneficially owned approximately 22% of our common stock. As a result, Mr. Thalheimer will continue to exert substantial influence over the election of directors and over our corporate actions.

Our common stock price is volatile.

Our common stock is quoted on the NASDAQ National Market, which has experienced and is likely to experience in the future significant price and volume fluctuations, which could reduce the market price of our common stock without regard to
our operating performance. From February 1, 2005, to January 31, 2006, the price per share of our common stock has ranged from a high of $17.20 to a low of $8.86. We believe that among other factors, any of the following factors could
cause the price of our common stock to fluctuate substantially:



| |  |  | monthly fluctuations in our comparable store sales;
| | - |  | ---------------------------------------------------



| |  |  | announcements by activist shareholders;
| | - |  | ---------------------------------------



| |  |  | announcements by other retailers;
| | - |  | ---------------------------------



| |  |  | the trading volume of our common stock in the public market;
| | - |  | ------------------------------------------------------------



| |  |  | general economic conditions;
| | - |  | ----------------------------



| |  |  | financial market conditions;
| | - |  | ----------------------------



| |  |  | acts of terrorism; and
| | - |  | ----------------------



| |  |  | war and threats of war.
| | - |  | -----------------------

Our charter
documents, Delaware law, stockholders rights plan and other agreements may make a takeover of us more difficult.

We
are a Delaware corporation. The Delaware General Corporation Law contains certain provisions that may make a change in control of our company more difficult or prevent the removal of incumbent directors. In addition, our Certificate of Incorporation
and Bylaws and our stockholders rights plan and other agreements contain provisions that may have the same effect. These provisions may have a negative impact on the price of our common stock, may discourage third-party bidders from making a bid for
our company or may reduce any premiums paid to stockholders for their common stock.

We face risks arising from the outcome of various litigation
matters.

We are and have been in the past involved in various litigation matters, including those arising in the
ordinary course of business. While we do not believe that any of these litigation matters alone or in the aggregate will have a material adverse effect on our financial position, an adverse outcome in one or more of these matters could be material
to our results of operations for any one period. Further, litigation can consume substantial financial and management resources and no assurance can be given that any adverse outcome would not be material to our financial position.

Our business could be negatively impacted by natural disasters and their effects.

Our sales could be negatively impacted by natural disasters. Loss of sales from affected store locations, as well as potential catalog and Internet sales from the affected region can have a
negative impact on our overall sales. In addition to the loss of sales, we could also incur substantial property damage and inventory loss at the affected locations.



19



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##### Table of Contents

As a well known company we are susceptible to unsolicited attention in the print and
electronic media.

The Sharper Image name is well known and, as a result, appears often in print and electronic
media. Because of the right to free speech, we may not have any ability to prevent or respond to the content of these publications, even if we strongly disagree with the content and/or conclusions. Even if we are vigorous in expressing our
disagreement, negative press has the potential to adversely impact our business.

We are reliant on third party credit processors for a portion of
our business.

We rely on third party credit card processors and other payment vendors to process the payment of
many of our customers purchases, some of which may be affected by fraudulent conduct beyond our control. Under certain circumstances which cannot be specifically predicted and whose outcomes may be influenced by considerations beyond our
control, we may disagree with these processors as to which party is responsible for fraudulent transactions. Depending on the outcome of these disagreements, operating results may be adversely affected.

We have received notice from an investment group that it intends to replace members of our Board of Directors.

We received a notice from Knightspoint Partners II, L.P. in March 2006 indicating that it intends to nominate seven individuals to our
board of directors and present a number of proposals at our 2006 annual meeting of stockholders. In April 2006, a Schedule 13D was filed by Firebrand Partners II, LLC and other persons named therein indicating that they may nominate a slate of
directors to our board but no candidates were named. The candidates and proposals in the Knightspoint filing are currently being evaluated by our nominating committee and board of directors. If we were to oppose the Knightspoint nominees or
proposals as not in the best interest of the Company or our stockholders, management would be required to expend substantial time and energy, which may divert managements attention from our operations. In connection with these matters,
and regardless of whether we oppose the Knightspoint nominees and proposals, we will incur significant additional costs, including legal and financial advisory fees, that will negatively impact our operating results. At this time, management
cannot estimate the impact that such proposals will have on our operating results. We may also experience management and employee distraction and may have difficulty attracting and retaining employees as a result of the uncertainty created by
these matters.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

The Company occupies approximately 80,000 square feet of office space for
its corporate headquarters in San Francisco, California, under a lease that will expire in January 2016. The Company also leases approximately 6,800 square feet for its product development offices in Northern California.

As of January 31, 2006, the Company operated 190 The Sharper Image stores under leases covering a total of approximately 837,000
square feet. Remaining initial lease terms range from under one to 12 years. Some of the Companys leases for its stores contain renewal options that range from two to five years.

The Company owns and operates a 103,000 square foot distribution facility located in Little Rock, Arkansas. Distribution and warehouse
functions also are conducted through a 269,000 square foot leased facility in Ontario, California, a 104,000 square foot leased facility in Little Rock, Arkansas, a 113,000 square foot leased facility in Richmond, Virginia, and other seasonally
occupied space rented by the Company in close proximity thereto. Remaining initial lease terms for the Companys distribution facilities range from four to five years, with renewal options that range from three to five years.



20



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##### Table of Contents

ITEM 3. LEGAL PROCEEDINGS

The Company aggressively pursues claims against companies with
products that infringe its intellectual property. In addition, from time to time, the Company is involved in various disputes and legal proceedings that arise in the ordinary course of business. These include disputes and lawsuits related to
intellectual property, product liability and employee relations matters. Except as noted below, the Company does not believe that the resolution of these matters will have a material adverse effect on the Companys financial position or results
of operations.

The Company currently is a defendant in five purported class actions alleging inaccurate advertising claims
on behalf of the Ionic Breeze Quadra, including its failure to perform as claimed. Sharper Image strongly rejects these allegations. The actions are filed on behalf of purchasers of the Ionic Breeze Quadra in the State Courts of California (San
Francisco) and Florida (Jacksonville), as well as the U.S. District Courts of Maryland and Florida (Miami). Only the San Francisco action has been certified for class representation, a ruling which is on appeal by the Company. The Florida
State Court action is stayed pending resolution of the ongoing San Francisco case. The Maryland and Florida federal cases are in the initial stages of procedure. The Company believes these lawsuits, which are virtually identical, are
without merit and has been and intends to continue resisting them vigorously. The Company does not believe that the ultimate resolution of these lawsuits will have a material adverse effect on the financial position of the Company, although an
adverse outcome in one or more of these lawsuits will have a material adverse effect on the results of operations for any one period. Further, litigation can consume substantial financial and management resources and no assurances can be given that
any adverse outcome would not be material to the financial position of the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a
vote of security holders of the Company during the fourth quarter of fiscal 2005.



21



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##### Table of Contents

PART II



|ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES OF EQUITY SECURITIES
|------- | --------------------------------------------------------------------------------------------------------------

The common stock of Sharper Image Corporation is traded on the NASDAQ National Market under the symbol SHRP. At April 28,
2006, the number of holders of record of the Companys common stock was 312. The following table sets forth for the periods indicated high and low last sale prices per share of the Companys common stock on the NASDAQ National Market, as
reported by NASDAQ.



|                                   |  |      |       |     |   |      
|---------------------------------- |  | ---- | ----- | --- | - | -----
|                                   |  | High |       | Low
|Fiscal Year Ended January 31, 2006 |  |      |       |     |   |      
|First Quarter                      |  | $    | 17.20 |     | $ | 13.39
|Second Quarter                     |  |      | 14.87 |     |   | 12.49
|Third Quarter                      |  |      | 14.23 |     |   | 9.86 
|Fourth Quarter                     |  |      | 11.50 |     |   | 8.86 
|                                   |  |     
|Fiscal Year Ended January 31, 2005 |  |      |       |     |   |      
|First Quarter                      |  | $    | 39.88 |     | $ | 30.56
|Second Quarter                     |  |      | 31.68 |     |   | 26.10
|Third Quarter                      |  |      | 26.67 |     |   | 16.90
|Fourth Quarter                     |  |      | 23.14 |     |   | 16.61

The Company has not paid cash dividends to holders of its common stock and does
not intend to pay cash dividends for the foreseeable future.

In October 2004, the Board of Directors authorized a stock
repurchase program to acquire up to one million shares of outstanding common stock in the open market. As of January 31, 2006, we had repurchased and retired a total of 810,000 shares under this program, including 710,000 shares repurchased and
retired during fiscal 2005 at a weighted average cost of $14.99 per share and a total cost of approximately $10.6 million.

The following table shows repurchases made during fiscal 2005. There were no repurchases of common stock of the Company made during the fourth quarter of fiscal 2005 by Sharper Image Corporation or any affiliated purchaser, as defined in
Rule 10b-18(a)(3) under the Exchange Act.



|                                     |  |                                    |  |                              |       |                                                               |         |                                                    |        
|------------------------------------ |  | ---------------------------------- |  | ---------------------------- | ----- | ------------------------------------------------------------- | ------- | -------------------------------------------------- | -------
|Period                               |  | Total Number of Shares Repurchased |  | Average Price Paid per
Share |       | Number of Shares Purchased as Part of Publicly Announced Plan |         | Maximum Number of Shares that May Yet Be Purchased
|February 1, 2005 to April 30, 2005   |  | 610,000                            |  | $                            | 15.21 |                                                               | 610,000 |                                                    | 290,000
|August 1, 2005 to September 30, 2005 |  | 100,000                            |  | $                            | 13.63 |                                                               | 100,000 |                                                    | 190,000



22



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##### Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

The Companys financial statements as of January 31,
2006 and 2005 and for each of the three fiscal years in the period ended January 31, 2006, audited by Deloitte & Touche LLP, the Companys independent registered public accounting firm, are included in Item 8, Financial
Statements and Supplementary Data of this Form 10-K. The following historical operating results data for the years ended January 31, 2006, 2005 and 2004 and balance sheet data as of January 31, 2006 and 2005 has been derived from the
financial statements of the Company included herein. The operating results data for the years ended January 31, 2003 and 2002 and balance sheet data as of January 31, 2004, 2003 and 2002 are derived from the financial statements of the
Company not included herein. The information set forth below should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes thereto of
the Company included elsewhere in this document.



|                                                                      |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|--------------------------------------------------------------------- | ------------------ | ----------------------------- | ---------- | ------------------ |  | - | ------------------ | --- |  | ------------------ | ---------- | --- | ------------------ | - | ---------- | - |  | - | ---------- | --
|Dollars are in thousands except
for earnings per share and statistics |                    | Fiscal Year Ended January 31, |           
|                                                                      | 2006 (Fiscal 2005) |                               |            | 2005 (Fiscal 2004) |  |   | 2004 (Fiscal 2003) |     |  | 2003 (Fiscal 2002) |            |     | 2002 (Fiscal 2001) |  
|Operating Results                                                     |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|Revenue                                                               |                    | $                             | 668,993    |                    |  | $ | 760,003            |     |  | $                  | 647,511    |     |                    | $ | 513,769    |   |  | $ | 389,105    |   
|Earnings (loss) before income taxes                                   |                    |                               | (27,373    | )                  |  |   | 24,830             |     |  |                    | 39,413     |     |                    |   | 25,738     |   |  |   | (275       | ) 
|Net earnings (loss)                                                   |                    |                               | (15,229    | )                  |  |   | 14,650             |     |  |                    | 23,119     |     |                    |   | 15,187     |   |  |   | (361       | ) 
|Earnings (loss) per common equivalent share                          |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|Basic                                                                 |                    | $                             | (1.01      | )(1)               |  | $ | 0.94               | (1) |  | $                  | 1.60       | (1) |                    | $ | 1.23       |   |  | $ | (0.03      | ) 
|Diluted                                                               |                    | $                             | (1.01      | )(1)               |  | $ | 0.90               | (1) |  | $                  | 1.51       | (1) |                    | $ | 1.15       |   |  | $ | (0.03      | ) 
|                                                                      |                    |                               |            |                    | 
|Balance Sheet Data                                                    |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|Working capital                                                       |                    | $                             | 97,850     |                    |  | $ | 133,388            |     |  | $                  | 128,761    |     |                    | $ | 67,830     |   |  | $ | 51,411     |   
|Total assets                                                          |                    |                               | 328,761    |                    |  |   | 376,100            |     |  |                    | 315,333    |     |                    |   | 215,724    |   |  |   | 163,592    |   
|Long-term notes payable                                               |                    |                               |           |                    |  |   |                   |     |  |                    |           |     |                    |   |           |   |  |   | 2,033      |   
|Stockholders equity                                                  |                    |                               | 180,433    |                    |  |   | 206,007            |     |  |                    | 185,254    |     |                    |   | 114,847    |   |  |   | 92,286     |   
|Current ratio                                                         |                    |                               | 1.87       |                    |  |   | 1.98               |     |  |                    | 2.18       |     |                    |   | 1.75       |   |  |   | 1.83       |   
|                                                                      |                    |                               |            |                    | 
|Statistics                                                            |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|Number of stores at year end                                          |                    |                               | 190        |                    |  |   | 175                |     |  |                    | 149        |     |                    |   | 127        |   |  |   | 109        |   
|Comparable store sales increase (decrease)                            |                    |                               | (16.0      | )%                 |  |   | (1.1               | )%  |  |                    | 15.3       | %   |                    |   | 13.6       | % |  |   | (16.0      | )%
|Annualized net sales per sq ft                                        |                    | $                             | 505        |                    |  | $ | 618                |     |  | $                  | 676        |     |                    | $ | 627        |   |  | $ | 578        |   
|Number of catalogs mailed                                             |                    |                               | 98,617,000 |                    |  |   | 97,755,000         |     |  |                    | 86,296,000 |     |                    |   | 77,772,000 |   |  |   | 70,135,000 |   
|Average revenue per transaction                                       |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|Stores                                                                |                    | $                             | 140        |                    |  | $ | 151                |     |  | $                  | 142        |     |                    | $ | 128        |   |  | $ | 118        |   
|Catalog                                                               |                    | $                             | 202        |                    |  | $ | 215                |     |  | $                  | 198        |     |                    | $ | 199        |   |  | $ | 174        |   
|Internet(2)                                                           |                    | $                             | 152        |                    |  | $ | 153                |     |  | $                  | 148        |     |                    | $ | 145        |   |  | $ | 127        |   
|Return on average stockholders equity                                |                    |                               | (7.9       | )%                 |  |   | 9.7                | %   |  |                    | 15.4       | %   |                    |   | 14.7       | % |  |   | 0.4        | % 
|Book value per share                                                  |                    | $                             | 11.98      |                    |  | $ | 13.18              |     |  | $                  | 12.82      |     |                    | $ | 9.32       |   |  | $ | 7.75       |   
|Weighted average number of shares outstanding                         |                    |                               |            |                    |  |   |                    |     |  |                    |            |     |                    |   |            |   |  |   |            |   
|Basic                                                                 |                    |                               | 15,066,843 |                    |  |   | 15,634,355         |     |  |                    | 14,446,128 |     |                    |   | 12,327,157 |   |  |   | 11,904,562 |   
|Diluted                                                               |                    |                               | 15,066,843 |                    |  |   | 16,290,060         |     |  |                    | 15,333,235 |     |                    |   | 13,182,050 |   |  |   | 11,904,562 |   

---

|(1) | The earnings per common equivalent share reflect the effect of the additional 2.1 million shares issued from the May 2003 stock offering.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes results from the Companys and eBays auction sites.
|--- | -------------------------------------------------------------



23



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##### Table of Contents

|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

The following discussion and analysis should be read together with the Companys financial statements and related notes thereto
included in Item 8 in this Annual Report on Form 10-K.

MANAGEMENT OVERVIEW

Sharper Image Corporation (referred to as The Sharper Image, Sharper Image, the Company,
we, us and our) is a leading specialty retailer of innovative, high quality products that are useful and entertaining and are designed to make life easier and more enjoyable. We market and sell our merchandise
primarily through three integrated sales channels: The Sharper Image stores, The Sharper Image catalog, which includes revenue from all direct marketing activities and infomercials, and the Internet. We also market to other businesses through our
corporate sales, where revenues are recorded in each of our three sales channels and our wholesale operations. Our fiscal years are ended January 31, 2006 (fiscal 2005 or 2005), January 31, 2005 (fiscal
2004 or 2004), and January 31, 2004 (fiscal 2003 or 2003).

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements are based on accounting principles generally accepted in the United States of America, many of
which require management to make significant estimates and assumptions (see Note A to the Financial Statements). We believe that the following are some of the more critical judgment areas in the application of our accounting policies that currently
affect our financial condition and results of operation.

Revenue recognition. We recognize revenue at
the point of sale at our retail stores and at the time of customer receipt for our catalog and direct marketing sales, including the Internet. We recognize revenue for sales to resellers or sales made on a wholesale basis when title passes to the
purchaser at the time the products are shipped. Estimated reductions to revenue for customer returns are recorded based on our historical return rates. Revenues are recorded net of sale discounts and other rebates and incentives offered to
customers. Deferred revenue represents merchandise certificates, gift cards and reward cards outstanding and unfilled cash orders at the end of the fiscal period. Delivery revenue is recognized at the time of customer receipt.

Merchandise inventories. We record inventory at lower of cost (first-in, first-out method) or market value. We
reduce the carrying value of our inventory for estimated obsolescence or unmarketable inventory by an amount equal to the excess of the cost of inventory over the estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those projected by management, additional reserves may be required.

Accounts receivable. Counterparties to our accounts receivable include credit card issuers, corporate marketing incentive customers, wholesale customers, installment plan customers, merchandise vendors, and landlords
from whom we expect to receive amounts due. An allowance for credit losses is recorded based on estimates of counterparties ability to pay. If the financial condition of these counterparts deteriorates, additional allowances may be required.

Impairment of long-lived assets. We review our long-lived assets for impairment when indicators of
impairment are present and the undiscounted cash flow estimated to be generated by those assets is less than the assets carrying amount. Our policy is to evaluate long-lived assets for impairment at a store level for retail operations and an
operating unit level for our other operations. Our retail stores typically take 18 months to achieve their full profit potential. If actual market conditions are less favorable than managements projections, future write-offs may be necessary.

Income taxes. Income taxes are accounted for using an asset and liability approach that requires the
recognition of deferred tax assets and liabilities for the expected future tax consequences of events then known to



24



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##### Table of Contents

management that have been recognized in our financial statements or tax returns. In estimating future tax consequences, all expected future events then known
to management are considered other than changes in the tax law or rates.

Results of Operations

The Company enjoyed excellent revenue growth in fiscal years 2003 and 2004. Throughout these two and prior profitable years, two large and
growing merchandise categoriesair purifiers (which are developed in-house) and massage chairs (from a third-party maker)accounted for a significant portion of our revenues. As described below, in 2005 aggregate net sales from these two
product lines declined approximately $126 million compared to 2004 and resulted in the first net loss the Company has experienced in the past three years. Net sales for our other product lines, however, increased in 2005 by approximately $35
million, largely driven by sales of new products and branded electronics.

The decrease in the sales of the Companys
air purifiers followed the release in April 2005 of news stories that included criticisms of the Companys Ionic Breeze silent air purifiers. These stories were widely distributed in the popular mass media, including television and newspapers.
The Company publicly protested that the criticisms were unwarranted and untrue, and yet the negative effect on Ionic Breeze net revenues was sudden and significant. The Company responded promptly with product enhancements that were already in
development, notably adding OzoneGuard by August 2005 to minimize the already low, and U.S. regulation compliant, by-product trace level of ozone, and with inventory adjustments and price promotions.

The Companys massage chair sales decrease by July 2005 resulted from the changes in the competitive landscape for massage chairs
under $1,000 with numerous new catalog, Internet and store retailers offering similar products. The third-party maker of all our under $1,000 massage chairs had greatly expanded their distribution of similar massage chairs, although with fewer
features, to other sellers. The negative effect on our massage chair sales was significant and sudden. To offset the revenue declines, inventory was reduced and the chairs were offered at promotional prices throughout the balance of 2005 and into
2006.

To meet the challenge presented by the sales declines in air purifiers and massage chairs, during the second half of
fiscal 2005 and continuing into 2006, the Company sought to address several key areas through the following actions:



| |  |  | Substantially reducing planned corporate overhead expenditures for 2006;
| | - |  | ------------------------------------------------------------------------



| |  |  | Reducing corporate office and distribution center head count by more than 20% and reducing store head count by 12% at the end of 2005 compared to one year ago;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reducing advertising expenditures by 30% for the fourth quarter of 2005 and budgeting a further 30% reduction in advertising for the fiscal year 2006, including
a planned decrease of 30% in catalog circulation, a planned decrease of 40% in single-product solo mailer circulation, and a planned 25% reduction in infomercial spending; although actual expenditures may differ from the budgeted amounts depending
upon market conditions;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reducing capital expenditures from approximately $34 million in 2005 to a planned $12 to $15 million in 2006;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | Slowing planned new store openings to six to eight in 2006, compared to 20 in 2005 and 28 in 2004;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | Eliminating commission-based compensation for retail sales associates, replacing it with an hourly expense structure and establishing selling incentive programs
that are more flexible;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Reducing January 31, 2006, inventory levels by approximately $19 million as compared to January 31, 2005;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | Maintaining a strong balance sheet; and
| | - |  | ---------------------------------------



| |  |  | Accelerating new product introductions.
| | - |  | ---------------------------------------



25



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##### Table of Contents

Notwithstanding these initiatives, the Company expects a net loss in the first quarter of
fiscal 2006 that significantly exceeds the net loss in the first quarter of fiscal 2005.

A summary of our operating
results is presented below. This discussion includes our results presented on the basis required by accounting principles generally accepted in the United States of America.

The following table presents our results of operations as a percentage of total revenues for the periods indicated:



|                                          |  |                               |    |  |                    |   |  |                    |  
|----------------------------------------- |  | ----------------------------- | -- |  | ------------------ | - |  | ------------------ | -
|                                          |  | Fiscal Year Ended January 31, |   
|                                          |  | 2006 (Fiscal 2005)            |    |  | 2005 (Fiscal 2004) |   |  | 2004 (Fiscal 2003) |  
|Revenues:                                 |  |                               |    |  |                    |   |  |                    |  
|Net store sales                           |  | 60.9                          | %  |  | 57.2               | % |  | 58.6               | %
|Net catalog sales                         |  | 13.1                          |    |  | 17.2               |   |  | 19.9               |  
|Net Internet sales                        |  | 16.0                          |    |  | 15.3               |   |  | 14.7               |  
|Net wholesale sales                       |  | 7.2                           |    |  | 7.7                |   |  | 4.2                |  
|Delivery                                  |  | 2.7                           |    |  | 2.6                |   |  | 2.6                |  
|List rental and licensing                 |  | 0.1                           |    |  | 0.0                |   |  | 0.0                |  
|                                          |  |                               |    |  |                    |   |  |                    |  
|Total Revenues                            |  | 100.0                         |    |  | 100.0              |   |  | 100.0              |  
|                                          |  |                               |   
|Costs and Expenses:                       |  |                               |    |  |                    |   |  |                    |  
|Cost of products                          |  | 51.1                          |    |  | 45.0               |   |  | 43.3               |  
|Buying and occupancy                      |  | 11.9                          |    |  | 9.3                |   |  | 9.0                |  
|Advertising                               |  | 17.0                          |    |  | 19.7               |   |  | 19.0               |  
|General, selling and administrative       |  | 23.9                          |    |  | 22.6               |   |  | 22.6               |  
|                                          |  |                               |    |  |                    |   |  |                    |  
|Operating income (loss)                   |  | (3.9                          | )  |  | 3.4                |   |  | 6.1                |  
|Other income (expense)                    |  | (0.1                          | )  |  | (0.1               | ) |  | 0.0                |  
|                                          |  |                               |    |  |                    |   |  |                    |  
|Earnings (loss) before income tax expense |  | (4.0                          | )  |  | 3.3                |   |  | 6.1                |  
|Income tax expense (benefit)              |  | (1.8                          | )  |  | 1.4                |   |  | 2.5                |  
|                                          |  |                               |    |  |                    |   |  |                    |  
|Net earnings (loss)                       |  | (2.2                          | )% |  | 1.9                | % |  | 3.6                | %
|                                          |  |                               |    |  |                    |   |  |                    |  

The following table presents the components of our revenues for the periods
indicated:



|                                       |  |                               |         |                    |   |                    |  |   |        
|-------------------------------------- |  | ----------------------------- | ------- | ------------------ | - | ------------------ |  | - | -------
|                                       |  | Fiscal Year Ended January 31,
|(Dollars in thousands)                 |  | 2006 (Fiscal 2005)            |         | 2005 (Fiscal 2004) |   | 2004 (Fiscal 2003)
|Revenues:                              |  |                               |         |                    |   |                    |  |   |        
|Net store sales                        |  | $                             | 407,098 |                    | $ | 434,696            |  | $ | 379,349
|Net catalog and direct marketing sales |  |                               | 87,945  |                    |   | 130,535            |  |   | 128,652
|Net Internet sales                     |  |                               | 107,222 |                    |   | 116,297            |  |   | 95,086 
|Net wholesale sales                    |  |                               | 47,986  |                    |   | 58,437             |  |   | 26,997 
|                                       |  |                               |         |                    |   |                    |  |   |        
|Total net sales                        |  |                               | 650,251 |                    |   | 739,965            |  |   | 630,084
|List rental and licensing              |  |                               | 723     |                    |   | 640                |  |   | 377    
|Delivery                               |  |                               | 18,019  |                    |   | 19,398             |  |   | 17,050 
|                                       |  |                               |         |                    |   |                    |  |   |        
|Total revenues                         |  | $                             | 668,993 |                    | $ | 760,003            |  | $ | 647,511
|                                       |  |                               |         |                    |   |                    |  |   |        

Year ended January 31, 2006 (fiscal 2005), compared to year ended January 31, 2005 (fiscal 2004)

Revenues.Total revenue decreased $91.0 million or 12.0% from the prior fiscal year. The decrease from
fiscal 2005 as compared to fiscal 2004 was attributable to decreases of $42.6 million in catalog and direct



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marketing sales, $27.6 million from store sales, $10.5 million in wholesale sales and $9.1 million from Internet sales. The decrease in total revenue for
fiscal 2005 as compared to fiscal 2004 was due primarily to an approximately $126 million decrease in net revenue from our air purification and our massage chair lines of products and decreased advertising spending, which generally affects sales in
all selling channels, offset in part by an approximately $35 million increase in net revenues, largely driven by sales of new products and branded electronics. The decrease in the sale of our air purification products resulted from negative media
coverage, increased competition and decreased advertising specifically designed for these products. The decrease in our massage chair product line resulted from increased competition at lower price points for similar products. A significant portion
of our direct response advertising is devoted to the air purification product line. We require a certain sales-to-advertising expenditure ratio to justify continued advertising and accordingly reduced direct response advertising expenditures as
sales of these products slowed.

The popularity of our Sharper Image Design and Sharper Image branded products continues to
be a key factor in driving sales in all our selling channels. Sales of Sharper Image Design and Sharper Image branded products decreased to approximately 67% of total revenues in fiscal 2005 from approximately 74% for fiscal 2004. We believe that
the decrease in the percentage of revenues attributable to Sharper Image Design and Sharper Image branded products was due to decreased sales of our air purification line of products and Sharper Image branded massage chairs during the year as well
as an increase in sales of brand name electronics. We believe that the continued development and introduction of new and popular products is a key strategic objective and important to our future success. Returns and allowances for fiscal 2005 were
10.2% of sales, as compared to 9.8% for fiscal 2004, resulting in a $3.1 million decrease in revenues. We believe that the increase in returns and allowances for fiscal 2005 as compared to fiscal 2004 is due primarily to negative media coverage
surrounding our air purification line of products and higher return rates on certain first generation electronic and toy products.

Net store sales for fiscal 2005 decreased $27.6 million, or 6.3%, while comparable store sales decreased by 16.0% from fiscal 2004. The decrease in net store sales was attributable primarily to a decrease of 16.0% in comparable store sales,
a 7.5% decrease in the average revenue per transaction and to promotional discounts relating to a portion of our new product introductions that proved less popular than those introduced in prior years. The decreases in comparable store sales and in
average revenue per transaction were primarily attributable to consumers lack of willingness to spend, the overall product mix offered, the decreases in sales of the air purification and massage chair product lines, and decreases in multimedia
advertising, including infomercial advertising highlighting Sharper Image Design and Sharper Image branded products, particularly air purification products that sell at relatively higher price points. The decrease in net store sales was partially
offset by the opening of 15 new stores, net, during fiscal 2005, resulting in a 3.4% increase in total store transactions for fiscal 2005. Average net sales per square foot for fiscal 2005 for all stores decreased to $505 from $618 in fiscal 2004.
Average net sales per square foot for our comparable store base for fiscal 2005 was $522 as compared to $665 in the same prior year period. Average net sales per square foot are calculated by averaging over all stores the amount of each stores
net sales divided by that stores total square footage under lease. Average revenue per transaction is calculated by dividing the amount of gross sales, exclusive of delivery revenue and sales taxes, per channel by the gross number of
transactions in that channel.

Comparable store sales is not a measure that has been defined under accounting principles
generally accepted in the United States of America. We define comparable store sales as sales from stores where selling square feet did not change by more than 15% in the previous 12 months and which have been open for at least 12 months. A store
opened on or prior to the 15thof a month is treated as open for the entire month. Stores generally become
comparable once they have a full year of comparable sales for the annual calculation. We believe that comparable store sales, which excludes the effect of a change in the number of stores open, provides a more useful measure of the performance of
our store sales channel than does the absolute change in aggregate net store sales. The 16.0% decrease in comparable store sales for fiscal 2005 as compared to fiscal 2004 was due to decreases in the sale of our air purification and our massage
chair lines and difficult comparisons to high store volumes generated after several years of strong sales results.



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Net catalog and direct marketing sales, which includes direct sales generated from
catalog mailings, single product mailers, print advertising and infomercials, decreased $42.6 million or 32.6% for fiscal 2005 from fiscal 2004. This decrease was due primarily to a decrease in sales of the Companys air purification and
massage chair line of products, a decrease of $14.5 million or 28.9% in infomercial advertising expense, a 21.5% decrease in The Sharper Image catalog pages circulated, and a 35.2% decrease in single product mailers circulated. The decrease in net
catalog and direct marketing sales for fiscal 2005 reflects a 5.9% decrease in average revenue per transaction, and a 21.3% decrease in transactions compared to fiscal 2004.

For fiscal 2005 and 2004, 33.9% and 31.1% of the net catalog and direct marketing sales were generated from infomercial direct sales. We intend to continue our multimedia advertising programs
during fiscal 2006 to attract new customers while achieving a favorable return on advertising investment. Our goal is to achieve direct response sales resulting in near breakeven results on all direct marketing advertising initiatives. Given our
declining sales in fiscal 2005, our current plan is to decrease overall direct marketing expenditures in fiscal 2006 by 30%. We continually review our advertising initiatives, including the pages and number of catalogs and single product mailers
circulated, and the amount of and return on investment from infomercial advertising in our efforts to improve revenues from catalog and direct marketing advertising. Actual advertising expenses for fiscal 2006 may be higher or lower than our current
plans.

Net Internet sales from our www.sharperimage.com Website and The Sharper Image and eBay auction Websites in fiscal
2005 decreased $9.1 million, or 7.8%, from fiscal 2004. This decrease was attributable primarily to an 8.6% decrease in Internet transactions and a 0.5% decrease in average revenue per transaction partially attributable to lower sales of
higher-priced products such as the Companys air purifier and massage chair line and a 1.6% decrease in Internet advertising which includes paid-for search engine key word placement and revenue share costs incurred for affiliate programs.

Net wholesale sales for fiscal year 2005 decreased $10.5 million, or 17.9%, compared to fiscal 2004. The decrease is
primarily due to decreasing Sharper Image Design product sales, particularly air purifiers, to our existing wholesale customer base and to test programs with new wholesale customers. We believe that the wholesale business, pursued with select
partners, will continue to strengthen our brand name and broaden our customer base.

Cost of Products. Cost of
products for fiscal 2005 increased $0.3 million, or 0.1%, from fiscal 2004. This increase is due primarily to changes in our merchandise mix. The gross margin rate for fiscal 2005 was 48.9% as compared to the fiscal 2004 rate of 55.0%. The decrease
in the gross margin rate was a result of a combination of higher unit costs for certain third-party products, primarily branded MP3 players, increases in promotional and incentive activities and product markdowns.Additionally,
declining sales of our air purification line of products had a negative impact on our gross margins as these products generally carry higher than Company average gross margins. We also focused on managing down our inventory levels in the fourth
quarter of 2005 and began aggressive promotional activities on many products, including air purification products and massage chair products. These actions are continuing into 2006.

Our gross margin rate fluctuates with changes in our merchandise mix, primarily Sharper Image Design and Sharper Image branded products,
which changes as we make new items available in various categories or introduce new proprietary products. The variation in merchandise mix from category to category from year to year is characteristic of sales results being driven by individual
products rather than by general product lines. Additionally, the auction sites and other selected promotional activities such as free shipping offers negatively impact the gross margin rate. Our gross margins may not be comparable to those of other
retailers since some retailers include the costs related to their distribution network in cost of products while we, and other retailers, exclude them from gross margin and include them instead in general, selling and administrative expenses. We
cannot accurately predict future gross margin rates although our goal is to increase sales of Sharper Image Design and Sharper Image branded products to capitalize on the higher margins realized on these products.



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Buying and Occupancy. Buying and occupancy costs for fiscal 2005 increased $9.0
million, or 12.8%, from fiscal 2004. This increase reflects a full year of occupancy costs for the 28 new stores opened in fiscal 2004, the occupancy costs associated with the 20 new stores opened in fiscal 2005 and rent increases for some existing
store locations upon lease renewal, partially offset by five store closures during fiscal 2005. Buying and occupancy costs as a percentage of total revenues increased to 11.9% in fiscal 2005 from 9.3% for fiscal 2004 primarily as a result of
declining sales. In fiscal 2005, we opened a total of 20 new stores. Our goal is to slow the pace of new store openings to approximately six to eight new stores in fiscal 2006. We cannot assure you we will achieve that number of store openings.

Advertising. Advertising expenses for fiscal 2005 decreased $36.1 million, or 24.0%, from fiscal 2004. The decrease
in advertising expense was attributable primarily to a decrease of $14.5 million, or 28.9%, in infomercial advertising expense, a 30.4% decrease in magazine and print advertising and a 35.9% decrease in radio advertising. Also contributing to the
decrease in advertising was a 21.5% decrease in the number of The Sharper Image catalog pages circulated and a 35.2% decrease in the number of solo mailers circulated. Although we believe these initiatives contributed to the decline in sales in the
stores, catalog and direct marketing and Internet channels, declining sales overall dictated that we reduce advertising spending in 2005 and there can be no assurance of the future success of these advertising initiatives.

General, Selling and Administrative. General, selling and administrative (GS&A) expenses for fiscal 2005 decreased
$11.7 million, or 6.8%, from fiscal 2004. Contributing to this was a decrease of approximately $11 million due primarily to variable expenses from lower net sales. Also contributing were decreases of $2.8 million for distribution center shipping
costs incurred for product delivery to our retail store locations and for airfreight costs due to the 2004 West Coast port slowdown that were not incurred in the current year and $0.2 million for professional fees, including legal and accounting
fees resulting from Sarbanes-Oxley compliance. These decreases were partially offset by an increase of $2.0 million for depreciation and amortization expense.

GS&A expenses for fiscal 2005 as a percentage of total revenues increased to 23.9%, as compared to 22.6% for fiscal 2004, primarily due to declining sales partially offset by cost savings
described above. To address the challenges of lower sales in fiscal 2005 during the second half of fiscal 2005, the Company acted vigorously to reduce our expense structure, notably in store and corporate payroll, advertising spending and other
general and administrative expenses. These expense reduction initiatives were expanded as we planned our fiscal 2006 budget, which includes further store and corporate payroll savings, including a redesign of our store compensation program whereby
the sales associates commission programs are replaced with a base pay plus incentive structure, reductions in officers salaries and board of directors fees, and further general and administrative expense reductions.

Other Income (Expense).The decrease is primarily due to higher interest income earned in fiscal 2005 due to higher interest
rates, partially offset by lower average investment balances in fiscal 2005 compared to 2004 and higher interest expense incurred on our revolving line of credit as borrowings for the holiday season were significantly higher in 2005.

Income Taxes. The effective tax rate was 44.4% for fiscal 2005 and 41.0% for fiscal 2004. The higher tax benefit rate in fiscal
2005 is primarily the result of a federal research and development tax credit accepted by the IRS and recorded by the Company in fiscal 2005.

Year
ended January 31, 2005 (fiscal 2004), compared to year ended January 31, 2004 (fiscal 2003).

Revenues. Total revenue increased $112.5 million or 17.4% from the prior fiscal year. The increase in total revenue for fiscal 2004 as compared to fiscal 2003 was due primarily to the opening of 26 net new stores during fiscal 2004,
increases in net wholesale sales and net Internet sales and, to a lesser extent, the decrease in returns and allowances described below. The popularity of our Sharper Image Design and Sharper Image branded products continues to be a key factor in
the increases in total revenues in all our selling channels. Sales of



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Sharper Image Design and Sharper Image branded products increased to approximately 74% of total revenues in fiscal 2004 from approximately 73% for fiscal
2003. We believe that the increase in the percentage of revenues attributable to Sharper Image Design and Sharper Image branded products was due to the modification of certain third party branded products to make them exclusive to Sharper Image
branded product offerings, the introduction of the Professional Series line of Ionic Breeze® Silent Air Purifiers in the third fiscal quarter of 2004, and other key Sharper Image Design proprietary products. We believe that the continued development and introduction of new and popular products is a key
strategic objective and important to our future success. The increase in net sales was partially offset by a comparable store sales decrease of 1.1% from fiscal 2003. We also believe that the increased investment in our advertising initiatives in
fiscal 2004 and 2003, which include the significant increase in infomercial advertising and Internet advertising, primarily highlighting selected Sharper Image Design and Sharper Image branded products and the 13.3% increase in catalogs circulated
contributed to the higher revenues in all selling channels. Returns and allowances for fiscal 2004 were 9.8% sales, as compared to 10.7% for fiscal 2003, resulting in a $6.6 million increase in total revenues in all selling channels. We believe that
the decrease in returns and allowances for fiscal 2004 as compared to fiscal 2003 is due primarily to improved quality control in the production of various top-selling Sharper Image branded products that have resulted from improvements made in
response to customer feedback and lower return rates on certain electronic products.

Net store sales for fiscal 2004
increased $55.3 million, or 14.6%, while comparable store sales decreased by 1.1% from fiscal 2003. The increase in net store sales was attributable primarily to the opening of 28 new stores during fiscal 2004, a 10.1% increase in total store
transactions for fiscal 2004 and a 6.5% increase in the average revenue per transaction, as compared to fiscal 2003. The increase in net store sales was partially offset by a comparable store sales decrease of 1.1% from fiscal 2003, a soft economy
marked by consumers lack of willingness to spend, some new production introductions that proved less popular than anticipated, and congestion at West Coast ports, particularly in the fourth quarter, which generated extra freight costs and
caused a shortage of key holiday items during critical selling weeks, and the closure of two stores at lease maturity. The increase in average revenue per transaction was attributable primarily to the overall product mix offered, and multimedia
advertising strategies, including infomercial advertising highlighting Sharper Image Design and Sharper Image branded products, particularly our air purification products. Average net sales per square foot for fiscal 2004 for all stores decreased to
$618 from $676 in fiscal 2003. Average net sales per square foot for the Companys comparable store base for fiscal 2004 was $665 as compared to $710 in the same prior year period. Average net sales per square foot is calculated by averaging
over all stores the amount of each stores net sales divided by that stores total square footage under lease. Average revenue per transaction is calculated by dividing the amount of gross sales, exclusive of delivery revenue and sales
taxes, per channel by the gross number of transactions in that channel.

Comparable store sales is not a measure that has
been defined under accounting principles generally accepted in the United States of America. We define comparable store sales as sales from stores where selling square feet did not change by more than 15% in the previous 12 months and which have
been open for at least 12 months. A store opened on or prior to the 15thof a month is treated as open for the
entire month. Stores generally become comparable once they have a full year of comparable sales for its annual calculation. We believe that comparable store sales, which excludes the effect of a change in the number of stores open, provides a more
useful measure of the performance of our store sales channel than does the absolute change in aggregate net store sales. The 1.1% decrease in comparable store sales for fiscal 2004 as compared to fiscal 2003 was due to lower than optimal inventory
levels of popular merchandise, product introductions that did not generate high demands during the fiscal year and high consumer demand for other popular gift items not available during the holiday season.

Net catalog and direct marketing sales, which include direct sales generated from catalog mailings, single product mailers, print
advertising and infomercials, for fiscal 2004 increased $1.9 million or 1.5%, from fiscal 2003. This increase was due primarily to a 23.2% increase in infomercial advertising expense, a 20.5% increase in The Sharper Image catalog pages circulated,
which includes a 13.3% increase in The Sharper Image catalogs



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circulated, partially offset by a 7.8% decrease in single product mailers circulated. The increase in net catalog and direct marketing sales for fiscal 2004
reflects an 8.5% increase in average revenue per transaction, partially offset by a 5.9% decrease in transactions compared to fiscal 2003. For fiscal 2004 and 2003, 31.1% and 29.4% of the net catalog and direct marketing sales were generated from
infomercial direct sales.

Net Internet sales, from our www.sharperimage.com Website and The Sharper Image and eBay auction
Websites in fiscal 2004 increased $21.2 million, or 22.3%, from fiscal 2003. This increase was attributable primarily to a 16.4% increase in Internet transactions and a 3.3% increase in average revenue per transaction resulting from a 40.8% increase
in Internet advertising which includes paid-for search engine key word placement and revenue share costs incurred for affiliate programs

Net wholesale sales for fiscal year 2004 increased $31.4 million, or 116.5%, compared to fiscal 2003. The increase is attributable primarily to increasing Sharper Image Design product sales to our existing wholesale
customer base and to test programs with new wholesale customers. We believe that the wholesale business, pursued with select partners, will continue to strengthen our brand name and broaden our customer base.

Cost of Products. Cost of products for fiscal 2004 increased $61.5 million, or 21.9%, from fiscal 2003. This increase is due
primarily to the higher sales volume. The gross margin rate for fiscal 2004 was 55.0% as compared to the fiscal 2003 rate of 56.7%. The decrease in the gross margin rate was a result of a combination of increased air freight related to the West
Coast port slowdown, higher unit cost for certain third-party products, increases in promotional and incentive activities and selective product markdowns offset by the increased gross margin from wholesale sales.

Our gross margin rate fluctuates with changes in our merchandise mix, primarily Sharper Image Design and Sharper Image branded products,
which changes as we make new items available in various categories or introduce new proprietary products. The variation in merchandise mix from category to category from year to year is characteristic of sales results being driven by individual
products rather than by general product lines. Additionally, the auction sites and other selected promotional activities, such as free shipping offers, in part tend to offset the rate of increase in gross margin rate. Our gross margins may not be
comparable to those of other retailers, since some retailers include the costs related to their distribution network in cost of products while we, and other retailers, exclude them from gross margin and include them instead in general, selling and
administrative expenses. We cannot accurately predict future gross margin rates, although our goal is to continue to increase sales of Sharper Image Design and Sharper Image branded products to capitalize on the higher margins realized on these
products.

Buying and Occupancy. Buying and occupancy costs for fiscal 2004 increased $12.8 million, or 22.0%, from
fiscal 2003. This increase reflects a full year of occupancy costs for the 25 new stores opened in fiscal 2003, the occupancy costs associated with the 28 new stores opened in fiscal 2004 and rent increases for some existing store locations upon
lease renewal, partially offset by two store closures during fiscal 2004 and by three store closures during fiscal 2003. Buying and occupancy costs as a percentage of total revenues increased to 9.3% in fiscal 2004 from 9.0% for fiscal 2003. In
fiscal 2004, we opened a total of 28 new stores, achieving our goal of a 15%-20% increase in the number of stores.

Advertising. Advertising expenses for fiscal 2004 increased $26.6 million, or 21.6%, from fiscal 2003. The increase in advertising expense was attributable primarily to a 23.2% increase in infomercial advertising expense, a 99.5%
increase in magazine and print advertising, and a 40.8% increase in Internet advertising, which includes search engine key word placement and revenue share costs incurred for affiliate programs, which was partially offset by a 28.7% decrease in
radio advertising. Also contributing to the increase in advertising was a 20.5% increase in the number of The Sharper Image catalog pages circulated, which includes a 13.3% increase in the number of The Sharper Image catalogs circulated.

Advertising expenses as a percentage of total revenues increased to 19.7% for fiscal 2004 compared to 19.0% for fiscal 2003. We
believe that expansion of all advertising initiatives contributed to the sales increases for fiscal 2004 and increased brand awareness.



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General, Selling and Administrative. General, selling and administrative
(GS&A) expenses for fiscal 2004 increased $25.3 million, or 17.3%, from fiscal 2003. Contributing to this increase was an increase of $10.0 million due primarily to variable expenses from increased net sales. Also
contributing to the increase were increases of $6.0 million for professional fees, including legal and accounting fees resulting from Sarbanes-Oxley compliance, $4.7 million for distribution center shipping costs incurred for product delivery to our
retail store locations and to increased airfreight costs due to the West Coast port slowdown and $1.4 million for depreciation and amortization expense related to technological enhancements and the expansion of our distribution centers.

GS&A expenses for fiscal 2004 as a percentage of total revenues remained consistent at 22.6% as compared to fiscal 2003.

Other Income (Expense).The increase in other expense is primarily due to the disposal of certain fixed assets,
partially offset by interest income earned on higher investment balances generated from the proceeds from our public stock offering and improved operating results.

Income Taxes. The effective tax rate was 41% for fiscal 2004 and 41.3% for fiscal 2003.

LIQUIDITY AND CAPITAL RESOURCES

We met our short-term liquidity needs and our capital requirements during
fiscal 2005 with cash generated from operations, reduction of inventories, borrowings from our line of credit, trade credits and existing cash balances.

Net cash provided by operating activities was $3.4 million for fiscal 2005 as compared to $57.8 million for fiscal 2004. Fiscal 2005 net cash provided by operating activities declined by $54.4 million
compared to fiscal 2004, which was due in part to a reduction in operating income and an increase in deferred catalog costs and other long-term assets as compared to fiscal 2004. The decrease in net cash between fiscal 2005 and 2004 was also due to
the decrease in accounts payable, accrued expenses and the increase in deferred income taxes and prepaid expenses and was partially offset by reductions in inventory and accounts receivable balances.

Net cash provided by investing activities totaled $22.4 million for fiscal 2005, which was primarily due to the net proceeds from
the sale and purchase of short-term investments. The proceeds from the sales of these investments were used for capital expenditures for new and remodeled stores, technological enhancements, tooling costs for Sharper Image Design products and the
expansion of our distribution facilities, totaling $34.1 million in fiscal 2005 compared to $49.6 million in fiscal 2004. In fiscal 2005, we opened 20 new stores and remodeled three stores, whereas we opened 28 new stores and remodeled eight
stores in fiscal 2004.

Net cash used by financing activities totaled $10.2 million during fiscal 2005, which was primarily
the result of our expenditure of $10.6 million to repurchase shares of our Common Stock. Net cash provided by financing activities totaled $2.4 million during fiscal 2004, which was primarily due to $4.2 million in proceeds from the issuance of
common stock in connection with our stock option plan, partially offset by our repurchase of our Common Stock of $1.8 million.

The Company has a revolving secured credit facility with Wells Fargo Bank, National Association, which was amended in February 2006. The credit facility expires on February 2, 2010, and allows borrowings and letters of credit up to a
maximum of $55 million. In addition, through October 31, 2007, the Company may, at its option, seek to increase the maximum amount by up to $30 million on no more than five occasions in minimum increments of $5 million provided that at no
time shall the maximum amount exceed $85 million. Borrowings outstanding under the credit facility prior to amendment in February 2006 bear interest at either the adjusted LIBOR rate plus 1.50% or at Wells Fargos prime rate less 0.25%.
Borrowings under the amended credit facility bear interest at either the LIBOR rate plus a margin ranging from 1.25% to 1.75% based on average excess availability or at Wells Fargos prime rate less up to .25% based on average excess
availability. Borrowings under the credit facility are secured by the Companys inventory, accounts receivable and specified other assets.



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The credit facility contains financial covenants that only apply during an event of
default or when the borrowing base is drawn below a specified level. These financial covenants require the Company to maintain a minimum EBITDA (as defined) on a rolling 12-month basis of $25 million and to maintain capital expenditures below a
specified level based on the Companys projections. The credit facility contains limitations on incurring additional indebtedness, making additional investments and permitting a change of control. As of January 31, 2006, letter of credit
commitments outstanding under the credit facility were $3.6 million and borrowings outstanding were $0.2 million. The Company believes that it is in compliance with all of its debt covenants as of January 31, 2006.

Stock Repurchase Program

In October
2004, the Board of Directors authorized a stock repurchase program to acquire up to one million shares of outstanding common stock in the open market. As of January 31, 2006, we had repurchased and retired a total of 810,000 shares under this
program, including 710,000 shares repurchased and retired during fiscal 2005, at a weighted average cost of $14.99 per share and a total cost of approximately $10.6 million.

Stock Based Compensation

On January 23, 2006, the Compensation Committee
approved the accelerated vesting of all unvested options with an exercise price of and in excess of $11.95. This accelerated vesting, which became effective on the date of approval, affects options to purchase approximately 747,000 shares of our
common stock with exercise prices ranging from $11.95 to $21.99. The acceleration does not apply to unexpired options held by former employees.

The accelerated vesting is expected to eliminate future compensation expense we would otherwise recognize in our income statement with respect to such accelerated options due to our adoption of FASB Statement
No. 123R (Share-Based Payment) effective on February 1, 2006. Because these options have exercise prices significantly in excess of our stock price, which closed at $9.12 on January 23, 2006, the Committee believed that these options
would not offer sufficient incentive to employees when compared to the potential future compensation expense that would be attributable to such options. The estimated maximum future expense that is eliminated is approximately $5.4 million. We will
incur compensation expense in connection with FASB Statement No. 123R for all other options outstanding. In addition to the accounting consequences, the Committee believed that the accelerated vesting may have a positive effect on employee
morale and retention.

Commercial Commitments

The table below presents significant commercial credit facilities and their associated expiration dates as of January 31, 2006.

(Dollars in millions)

Maximum Amount of
Commitment Expiration per Period



|                               |  |                  |      |           |   |                        |  |   |     
|------------------------------ |  | ---------------- | ---- | --------- | - | ---------------------- |  | - | ----
|Maximum Commercial Commitments |  | Less than 1 Year |      | 1-4 Years |   | Total Amount Committed
|Revolving Credit Facility*     |  | $                | 50.0 |           | $ | 0.0                    |  | $ | 50.0
|                               |  |                  |      |           |   |                        |  |   |     
|Total Commercial Commitment    |  | $                | 50.0 |           | $ | 0.0                    |  | $ | 50.0
|                               |  |                  |      |           |   |                        |  |   |     

---

|* | On February 2, 2006, the Company entered into an amendment to the credit facility. See Liquidity and Capital Resources.
|- | -------------------------------------------------------------------------------------------------------------------------



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Contractual Obligations

The following table below presents significant contractual obligations at January 31, 2006.



|                                              |  |                  |      |           |   |           |  |               |      |       |   |       |  |   |      
|--------------------------------------------- |  | ---------------- | ---- | --------- | - | --------- |  | ------------- | ---- | ----- | - | ----- |  | - | -----
|(Dollars in millions) Contractual Obligations |  | Less than 1 Year |      | 1-3 Years |   | 4-5 Years |  | After 5 Years |      | Total
|Revolving Credit Facility Letters of Credit   |  | $                | 3.6  |           |   |          |  |               |     |       |   |      |  | $ | 3.6  
|Operating Leases(1)                           |  |                  | 39.9 |           | $ | 77.3      |  | $             | 72.6 |       | $ | 106.2 |  |   | 296.0
|Purchase Obligations(2)                       |  |                  | 37.2 |           |   |          |  |               |     |       |   |      |  |   | 37.2 
|                                              |  |                  |      |           |   |           |  |               |      |       |   |       |  |   |      
|Total Contractual Cash Obligations            |  | $                | 80.7 |           | $ | 77.3      |  | $             | 72.6 |       | $ | 106.2 |  | $ | 336.8
|                                              |  |                  |      |           |   |           |  |               |      |       |   |       |  |   |      

---

|(1) | Our operating leases are described in Note E of the Notes to the Financial Statements.
|--- | --------------------------------------------------------------------------------------

|(2) | As of January 31, 2006, we had $37.2 million of outstanding purchase orders, which were primarily related to orders for general merchandise inventories.
Such purchase orders are generally cancelable at the discretion of the Company until the order has been shipped. The table above excludes certain immaterial executory contracts for goods and services that tend to be recurring in nature and similar
in amount year after year.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For fiscal 2006, we plan to slow our new store unit growth goal to six to
eight new stores and to remodel six to eight of our existing store locations. We plan to continue our capital investment in tooling costs for proprietary products and continue enhancement of our technological systems at a more moderate pace than the
two previous years. We believe that our total capital expenditures for fiscal 2006 will be approximately $12 to $15 million.

Due to declining sales and an operating loss in 2005, partially offset by inventory reductions at the end of fiscal 2005 compared to fiscal 2004, we generated $3.4 million in cash provided by operating activities during 2005. Absent
unfavorable economic conditions or deviations from projected demand for our products, particularly during the fourth quarter, we continue to expect to achieve positive cash flow from operations on an annual basis, although we likely will need to
finance holiday and new-store increases in inventories through trade credits and our credit facility. We believe we will be able to fund our capital expenditures for new and remodeled stores, technological enhancements and tooling costs for Sharper
Image Design products through existing cash balances, investments, cash generated from operations, trade credits and, as necessary, our credit facility.

New Accounting Standards

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R) which replaces SFAS No. 123, supersedes Accounting Principles Board (APB) No. 25 and related
interpretations and amends SFAS No. 95, Statement of Cash Flows. The provisions of SFAS No. 123R are similar to those of SFAS No. 123; however, SFAS No. 123R requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statement as compensation cost based on their fair value on the date of the grant. The fair value of the share-based awards will be determined using an option-pricing model on the
grant date. SFAS No. 123R is effective at the beginning of the first fiscal year beginning after June 15, 2005. The Company will adopt SFAS No. 123R in the first quarter of fiscal 2006. Due to the accelerated vesting of certain stock
options in fiscal 2005 and fiscal 2004, the adoption of SFAS No. 123R is not expected to have a material impact on the Companys financial statements upon adoption in the first quarter of 2006, although the future impact of the adoption of
SFAS No. 123R is dependent upon the future issuance of stock option grants that will be determined by the Companys compensation committee.

In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn Amendment of Accounting Research Bulletin No. 43, Chapter 4 (SFAS No. 151). SFAS No. 151 clarifies that
abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred and not included in overhead. The provisions in SFAS No. 151 must be applied prospectively to the Companys inventory costs
incurred after January 1, 2006. The adoption of SFAS No. 151 is not expected to have an impact on the Companys financial statements.



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In March 2005, the FASB issued FASB Interpretation No. (FIN) 47,
Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143. This Interpretation clarifies that the term conditional asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of
settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The adoption of FIN 47 in the fourth quarter of
fiscal 2005 did not have a material effect on the Companys financial statements.

In May 2005, the FASB issued SFAS
No. 154, Accounting Changes and Error Corrections. SFAS No. 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle. Previously, voluntary changes in accounting principles were
generally recognized by way of a cumulative effect adjustment within net earnings during the period of change. SFAS No. 154 requires retrospective application to prior period financial statements, unless it is impracticable to determine either
the period-special effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the statement does not change the transition provisions of
any existing accounting pronouncements. The Company does not believe the adoption of SFAS No. 154 will have a material effect on its financial statements.

In October 2005, the FASB issued FSP FAS 13-1, Accounting for Rental Costs Incurred during a Construction Period, which addresses the accounting for rental costs associated with
operating leases that are incurred during a construction period. This FSP requires that rental costs associated with ground or building operating leases incurred during a construction period be recognized as rental expense and included in income
from continuing operations. The guidance in this FSP shall be applied to the first reporting period beginning after December 15, 2005, with early adoption permitted. The adoption of FSP FAS 13-1 will not have a material impact on the
Companys financial statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is
exposed to market risks, which includes changes in interest rates and, to a lesser extent, foreign exchange rates. The Company does not engage in financial transactions for trading or speculative purposes.

The interest payable on the Companys credit facility is based on variable interest rates and therefore is affected by changes in
market interest rates. If interest rates on the average balance of the Companys variable rate debt increased 0.725% (10% from the banks reference rate as of January 31, 2006), the Companys results from operations and cash
flows would not have been materially affected. In addition, the Company has fixed and variable income investments consisting of cash equivalents and short-term investments, which are also affected by changes in market interest rates. The Company
does not use derivative financial instruments in its investment portfolio.

The Company enters into a significant amount of
purchase obligations outside of the United States, which are settled in U.S. Dollars and, therefore, have only minimal exposure to foreign currency exchange risks. The Company does not hedge against foreign currency risks and believes that foreign
currency exchange risk is immaterial.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Stockholders of

Sharper Image Corporation:

We have audited the accompanying balance sheets of Sharper Image Corporation (the Company), as of January 31, 2006 and 2005, and the related statements of operations,
stockholders equity, and cash flows for each of the three fiscal years in the period ended January 31, 2006. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion
on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such
financial statements present fairly, in all material respects, the financial position of Sharper Image Corporation at January 31, 2006 and 2005 and the results of its operations and its cash flows for each of the three fiscal years in the
period ended January 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as of January 31, 2006 based on
the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report May 1, 2006 expressed an unqualified opinion on managements assessment
of the effectiveness of the Companys internal control over financial reporting and an adverse opinion on the effectiveness of the Companys internal control over financial reporting because of a material weakness.



|                            
|----------------------------
|/s/    DELOITTE & TOUCHE LLP
|                            
|San Francisco, California   
|May 1, 2006                 



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SHARPER IMAGE CORPORATION

BALANCE SHEETS



|                                                                                                                       |  |                 |         |                 |   |         |  
|---------------------------------------------------------------------------------------------------------------------- |  | --------------- | ------- | --------------- | - | ------- | -
|(Dollars in thousands, except per share amounts)                                                                       |  | January 31,2006 |         | January 31,2005 |  
|Assets                                                                                                                 |  |                 |         |                 |   |         |  
|Current assets:                                                                                                        |  |                 |         |                 |   |         |  
|Cash and equivalents                                                                                                   |  | $               | 42,808  |                 | $ | 27,149  |  
|Short-term investments                                                                                                 |  |                 | 10,350  |                 |   | 66,900  |  
|Accounts receivable, net of allowance for doubtful accounts of $1,098 and $1,578                                       |  |                 | 17,347  |                 |   | 25,638  |  
|Merchandise inventories                                                                                                |  |                 | 104,298 |                 |   | 124,038 |  
|Deferred income taxes                                                                                                  |  |                 | 15,809  |                 |   | 14,917  |  
|Prepaid expenses and other                                                                                             |  |                 | 19,873  |                 |   | 10,590  |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Total current assets                                                                                                   |  |                 | 210,485 |                 |   | 269,232 |  
|Property and equipment, net                                                                                            |  |                 | 106,828 |                 |   | 100,509 |  
|Deferred catalog costs and other assets                                                                                |  |                 | 11,448  |                 |   | 6,359   |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Total assets                                                                                                           |  | $               | 328,761 |                 | $ | 376,100 |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Liabilities and stockholders equity                                                                                   |  |                 |         |                 |   |         |  
|Current liabilities:                                                                                                   |  |                 |         |                 |   |         |  
|Accounts payable                                                                                                       |  | $               | 38,436  |                 | $ | 51,424  |  
|Accrued expenses                                                                                                       |  |                 | 16,173  |                 |   | 23,737  |  
|Accrued compensation                                                                                                   |  |                 | 4,705   |                 |   | 7,364   |  
|Reserve for refunds                                                                                                    |  |                 | 17,270  |                 |   | 19,609  |  
|Revolving loan                                                                                                         |  |                 | 237     |                 |   |        |  
|Deferred revenue                                                                                                       |  |                 | 35,814  |                 |   | 32,061  |  
|Income taxes payable                                                                                                   |  |                 |        |                 |   | 1,649   |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Total current liabilities                                                                                              |  |                 | 112,635 |                 |   | 135,844 |  
|Deferred taxes and other liabilities                                                                                   |  |                 | 35,693  |                 |   | 34,249  |  
|Commitments and contingencies                                                                                          |  |                 |        |                 |   |        |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Total liabilities                                                                                                      |  |                 | 148,328 |                 |   | 170,093 |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Stockholders equity:                                                                                                  |  |                 |         |                 |   |         |  
|Preferred stock, $0.01 par value:                                                                                      |  |                 |         |                 |   |         |  
|Authorized, 3,000,000 shares: Issued and outstanding, none                                                             |  |                 |        |                 |   |        |  
|Common stock, $0.01 par value:                                                                                         |  |                 |         |                 |   |         |  
|Authorized, 50,000,000 shares: Issued 14,948,730, and 15,737,260 shares. Outstanding 14,948,730, and 15,637,260 shares |  |                 | 149     |                 |   | 157     |  
|Additional paid-in capital                                                                                             |  |                 | 100,373 |                 |   | 105,090 |  
|Retained earnings                                                                                                      |  |                 | 79,911  |                 |   | 102,540 |  
|Treasury stock                                                                                                         |  |                 |        |                 |   | (1,780  | )
|                                                                                                                       |  |                 |         |                 |   |         |  
|Total stockholders equity                                                                                             |  |                 | 180,433 |                 |   | 206,007 |  
|                                                                                                                       |  |                 |         |                 |   |         |  
|Total liabilities and stockholders equity                                                                             |  | $               | 328,761 |                 | $ | 376,100 |  
|                                                                                                                       |  |                 |         |                 |   |         |  

See Notes to Financial Statements.



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SHARPER IMAGE CORPORATION

STATEMENTS OF OPERATIONS



|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|---------------------------------------------------------------------------------------- |  | ----------------------------- | ---------- | - | ------------------ | - | ---------- | ------------------ |  | - | ---------- | -
|                                                                                         |  | Fiscal Year Ended January 31, |           
|(Dollars in thousands, except per share amounts)                                         |  | 2006 (Fiscal 2005)            |            |   | 2005 (Fiscal 2004) |   |            | 2004 (Fiscal 2003) | 
|Revenues:                                                                                |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Net sales                                                                                |  | $                             | 650,251    |   |                    | $ | 739,965    |                    |  | $ | 630,084    |  
|Delivery                                                                                 |  |                               | 18,019     |   |                    |   | 19,398     |                    |  |   | 17,050     |  
|List rental and licensing                                                                |  |                               | 723        |   |                    |   | 640        |                    |  |   | 377        |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|                                                                                         |  |                               | 668,993    |   |                    |   | 760,003    |                    |  |   | 647,511    |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Costs and expenses:                                                                      |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Cost of products                                                                         |  |                               | 342,107    |   |                    |   | 341,823    |                    |  |   | 280,338    |  
|Buying and occupancy                                                                     |  |                               | 79,818     |   |                    |   | 70,771     |                    |  |   | 58,013     |  
|Advertising                                                                              |  |                               | 113,904    |   |                    |   | 149,958    |                    |  |   | 123,339    |  
|General, selling and administrative                                                      |  |                               | 160,079    |   |                    |   | 171,768    |                    |  |   | 146,465    |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|                                                                                         |  |                               | 695,908    |   |                    |   | 734,320    |                    |  |   | 608,155    |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Other income (expense):                                                                  |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Interest income                                                                          |  |                               | 1,160      |   |                    |   | 1,005      |                    |  |   | 785        |  
|Interest expense                                                                         |  |                               | (745       | ) |                    |   | (367       | )                  |  |   | (291       | )
|Other expense                                                                            |  |                               | (873       | ) |                    |   | (1,491     | )                  |  |   | (437       | )
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|                                                                                         |  |                               | (458       | ) |                    |   | (853       | )                  |  |   | 57         |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Earnings (loss) before income taxes                                                      |  |                               | (27,373    | ) |                    |   | 24,830     |                    |  |   | 39,413     |  
|Income tax expense (benefit)                                                             |  |                               | (12,144    | ) |                    |   | 10,180     |                    |  |   | 16,294     |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Net earnings (loss)                                                                      |  | $                             | (15,229    | ) |                    | $ | 14,650     |                    |  | $ | 23,119     |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Earnings (loss) per common equivalent share:                                             |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Basic                                                                                    |  | $                             | (1.01      | ) |                    | $ | 0.94       |                    |  | $ | 1.60       |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Diluted                                                                                  |  | $                             | (1.01      | ) |                    | $ | 0.90       |                    |  | $ | 1.51       |  
|                                                                                         |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Weighted average shares used in the computation of earnings per common equivalent share: |  |                               |            |   |                    |   |            |                    |  |   |            |  
|Basic                                                                                    |  |                               | 15,066,843 |   |                    |   | 15,634,355 |                    |  |   | 14,446,128 |  
|Diluted                                                                                  |  |                               | 15,066,843 |   |                    |   | 16,290,060 |                    |  |   | 15,333,235 |  



See Notes to Financial
Statements.



38



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##### Table of Contents

SHARPER IMAGE CORPORATION

STATEMENTS OF STOCKHOLDERS EQUITY



|                                                                                              |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------------------------------- | ------ | ------------ | - | ------ | -------------------------- | --- | - | --------------- | - | ------- | ----------------- |  | -------- | ----- |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|(Dollars in thousands)                                                                        |        | Common Stock |   |        | Additional Paid-in Capital |     |   | Treasury Shares |   |         | Retained Earnings |  |          | Total | 
|                                                                                              | Shares |              |   | Amount |                            |     |   | Shares          |   |         | Amount            |  |          |      
|Balance at February 1, 2003                                                                   |        | 12,638,952   |   |        | $                          | 126 |   |                 | $ | 49,950  |                   |  |         |       |  | $ |        |   |  | $ | 64,771  |   |  | $ | 114,847 |  
|Issuance of common stock for stock options exercised (including income tax benefit of $4,622) |        | 546,259      |   |        |                            | 6   |   |                 |   | 8,767   |                   |  |         |       |  |   |        |   |  |   |        |   |  |   | 8,773   |  
|Issuance of common stock due to stock follow-on offering (net of expenses)                    |        | 2,137,424    |   |        |                            | 21  |   |                 |   | 38,494  |                   |  |         |       |  |   |        |   |  |   |        |   |  |   | 38,515  |  
|Net earnings                                                                                  |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   | 23,119  |   |  |   | 23,119  |  
|                                                                                              |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   |         |   |  |   |         |  
|Balance at January 31, 2004                                                                   |        | 15,322,635   |   |        |                            | 153 |   |                 |   | 97,211  |                   |  |         |       |  |   |        |   |  |   | 87,890  |   |  |   | 185,254 |  
|Issuance of common stock for stock options exercised (including income tax benefit of $3,721) |        | 414,625      |   |        |                            | 4   |   |                 |   | 7,879   |                   |  |         |       |  |   |        |   |  |   |        |   |  |   | 7,883   |  
|Treasury stock purchased                                                                      |        |             |   |        |                            |    |   |                 |   |        |                   |  | (100,000 | )     |  |   | (1,780  | ) |  |   |        |   |  |   | (1,780  | )
|Net earnings                                                                                  |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   | 14,650  |   |  |   | 14,650  |  
|                                                                                              |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   |         |   |  |   |         |  
|Balance at January 31, 2005                                                                   |        | 15,737,260   |   |        |                            | 157 |   |                 |   | 105,090 |                   |  | (100,000 | )     |  |   | (1,780  | ) |  |   | 102,540 |   |  |   | 206,007 |  
|Issuance of common stock for stock options exercised (including income tax benefit of $42)    |        | 21,470       |   |        |                            |    |   |                 |   | 297     |                   |  |         |       |  |   |        |   |  |   |        |   |  |   | 297     |  
|Treasury stock purchased                                                                      |        |              |   |        |                            |     |   |                 |   |         |                   |  | (710,000 | )     |  |   | (10,642 | ) |  |   |        |   |  |   | (10,642 | )
|Treasury stock retired                                                                        |        | (810,000     | ) |        |                            | (8  | ) |                 |   | (5,014  | )                 |  | 810,000  |       |  |   | 12,422  |   |  |   | (7,400  | ) |  |   |        |  
|Net loss                                                                                      |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   | (15,229 | ) |  |   | (15,229 | )
|                                                                                              |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   |         |   |  |   |         |  
|Balance at January 31, 2006                                                                   |        | 14,948,730   |   |        | $                          | 149 |   |                 | $ | 100,373 |                   |  |         |       |  | $ |        |   |  | $ | 79,911  |   |  | $ | 180,433 |  
|                                                                                              |        |              |   |        |                            |     |   |                 |   |         |                   |  |          |       |  |   |         |   |  |   |         |   |  |   |         |  





See Notes to Financial Statements.



39



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##### Table of Contents

SHARPER IMAGE CORPORATION

STATEMENTS OF CASH FLOWS



|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|--------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ------------------ | - | -------- | ------------------ |  | - | -------- | -
|                                                                                        |  | Fiscal Year Ended January 31, |        
|(Dollars in thousands)                                                                  |  | 2006 (Fiscal 2005)            |         |   | 2005 (Fiscal 2004) |   |          | 2004 (Fiscal 2003) | 
|Cash provided by (used for) operating activities:                                       |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Net earnings (loss)                                                                     |  | $                             | (15,229 | ) |                    | $ | 14,650   |                    |  | $ | 23,119   |  
|Adjustments to reconcile net earnings to net cash provided by operating activities:     |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Depreciation and amortization                                                           |  |                               | 27,109  |   |                    |   | 21,056   |                    |  |   | 16,426   |  
|Tax benefit from stock option exercises                                                 |  |                               | 42      |   |                    |   | 3,721    |                    |  |   | 4,622    |  
|Deferred rent expenses and landlord allowances                                          |  |                               | (1,619  | ) |                    |   | 119      |                    |  |   | 97       |  
|Deferred income taxes                                                                   |  |                               | (6,925  | ) |                    |   | 6,106    |                    |  |   | (1,821   | )
|Loss on disposal of equipment                                                           |  |                               | 1,924   |   |                    |   | 1,437    |                    |  |   | 744      |  
|Change in operating assets and liabilities:                                             |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Accounts receivable                                                                     |  |                               | 8,291   |   |                    |   | (4,580   | )                  |  |   | (8,461   | )
|Merchandise inventories                                                                 |  |                               | 19,740  |   |                    |   | (14,614  | )                  |  |   | (35,099  | )
|Prepaid catalog costs, prepaid expenses and other                                       |  |                               | (12,045 | ) |                    |   | (2,905   | )                  |  |   | (2,575   | )
|Accounts payable, reserve for refunds and accrued expenses                              |  |                               | (29,925 | ) |                    |   | 19,991   |                    |  |   | 8,762    |  
|Deferred revenue, taxes payable and other liabilities                                   |  |                               | 12,020  |   |                    |   | 12,788   |                    |  |   | 15,323   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Cash provided by operating activities                                                   |  |                               | 3,383   |   |                    |   | 57,769   |                    |  |   | 21,137   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Cash provided by (used for) investing activities:                                       |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Property and equipment expenditures                                                     |  |                               | (34,124 | ) |                    |   | (49,573  | )                  |  |   | (35,195  | )
|Purchases of short-term investments                                                     |  |                               | (37,250 | ) |                    |   | (191,600 | )                  |  |   | (131,675 | )
|Sales of short-term investments                                                         |  |                               | 93,800  |   |                    |   | 173,300  |                    |  |   | 98,075   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Cash provided by (used for) investing activities                                        |  |                               | 22,426  |   |                    |   | (67,873  | )                  |  |   | (68,795  | )
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Cash provided by (used for) financing activities:                                       |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Proceeds from issuance of common stock upon exercise of stock options                   |  |                               | 255     |   |                    |   | 4,162    |                    |  |   | 4,151    |  
|Repurchase of common stock                                                              |  |                               | (10,642 | ) |                    |   | (1,780   | )                  |  |   |         |  
|Payments made for financing fees                                                        |  |                               |         |   |                    |   |          |                    |  |   | (770     | )
|Proceeds from revolving credit facility                                                 |  |                               | 36,837  |   |                    |   |         |                    |  |   |         |  
|Principal payments on notes payable and revolving credit facility                       |  |                               | (36,600 | ) |                    |   |         |                    |  |   |         |  
|Proceeds from issuance of common stock due to follow-on stock offering, net of expenses |  |                               |        |   |                    |   |         |                    |  |   | 38,515   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Cash provided by (used for) financing activities                                        |  |                               | (10,150 | ) |                    |   | 2,382    |                    |  |   | 41,896   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Net increase (decrease) in cash and equivalents                                         |  |                               | 15,659  |   |                    |   | (7,722   | )                  |  |   | (5,762   | )
|Cash and equivalents at beginning of period                                             |  |                               | 27,149  |   |                    |   | 34,871   |                    |  |   | 40,633   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Cash and equivalents at end of period                                                   |  | $                             | 42,808  |   |                    | $ | 27,149   |                    |  | $ | 34,871   |  
|                                                                                        |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Supplemental disclosure of cash paid for:                                               |  |                               |         |   |                    |   |          |                    |  |   |          |  
|Interest expense                                                                        |  | $                             | 417     |   |                    | $ | 192      |                    |  | $ | 131      |  
|Income taxes                                                                            |  | $                             | 6,749   |   |                    | $ | 7,876    |                    |  | $ | 9,615    |  

See Notes to Financial Statements.



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##### Table of Contents

SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS

Note ASummary of Significant Accounting Policies

Nature of
Operations and Basis of Presentation

Sharper Image Corporation (referred to as the Company, The
Sharper Image, Sharper Image and it) is a leading specialty retailer of innovative, high quality products that are useful and entertaining and are designed to make life easier and more enjoyable. The Company offers a
unique assortment of products in the electronics, recreation and fitness, personal care, houseware, travel, toy, gifts and other categories. The Sharper Image merchandising philosophy focuses principally on new and creative proprietary Sharper Image
Design products and exclusive Sharper Image branded products and, to a lesser extent, on third party branded products. The Company designs and develops its Sharper Image Design products, while Sharper Image branded products are generally designed by
the Company with third parties. The Company believes that its unique merchandising and creative marketing strategies have made The Sharper Image one of the most widely recognized retail brand names in the United States. The fiscal years ended
January 31, 2006, 2005 and 2004 represent fiscal years 2005, 2004 and 2003, respectively.

Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those estimates. The Companys significant accounting judgments and estimates include depreciable lives of long-lived assets, long-lived asset impairment, inventory
valuation and reserve for refunds.

Revenue Recognition

The Company recognizes revenue at the point of sale at its retail stores and at the time of customer receipt for its catalog and direct marketing sales, including the Internet. The Company
recognizes revenue for sales to resellers or sales made on a wholesale basis when title passes to the purchaser at the time the products are shipped. Estimated reductions to revenue for customer returns are based upon historical return rates.
Revenues are recorded net of sale discounts and other rebates and incentives offered to customers. Deferred revenue represents merchandise certificates, gift cards and reward cards outstanding and unfilled cash orders at the end of the fiscal
period. Delivery revenue is recognized at the time of delivery to customers.

Cost of Products

Cost of products includes total cost of products sold, inventory shrink, letter of credit fees, inventory write-downs, inbound freight
costs, costs to refurbish products for resale, inspection costs, cost of customer accommodations and promotions and costs to deliver product to customers.

Buying and Occupancy

Buying and occupancy includes salaries for merchandise buyers, occupancy costs for all
store locations and distribution facilities including rent, utilities, real estate taxes, common area maintenance, repairs and maintenance, depreciation on leasehold improvements and fixtures, janitorial services and waste removal.

General, Selling and Administrative

General, selling and administrative (GS&A) includes all costs related to sales associates and corporate personnel, including payroll and benefits; store supplies and signs; third party fees including credit card fees,



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



telemarketing expenses, Internet hosting charges, check guarantee fees and professional fees; telephone charges for the corporate office as well as toll-free
phone numbers for catalog and other direct marketing orders; freight charges related to delivery of product from distribution centers to stores and between distribution centers (freight out); purchasing, receiving and other warehouse costs;
corporate insurance; depreciation on corporate assets such as computers and distribution center facilities; and bad debt expense. Distribution center costs, which include personnel, payroll and benefits, supplies, freight out and professional fees
included in GS&A were $24.5 million, $29.1 million and $22.5 million for fiscal 2005, 2004 and 2003, respectively. Of the distribution costs incurred above, freight out was $12.7 million, $15.5 million and $10.8 million for fiscal 2005, 2004,
and 2003, respectively.

Start-up Activities

All start-up and pre-opening costs, which include supplies, payroll, benefits, store signs, rent and utilities, are expensed as incurred.

Other Expense

Other expense includes the net loss related to the disposal of fixed
assets. Net loss on disposal of assets totaled $1.9 million, $1.5 million and $0.7 million in fiscal 2005, 2004 and 2003.

Deferred Catalog and
Advertising Costs

Direct costs incurred for the production and distribution of catalogs are capitalized and then
amortized, once the catalog is mailed, over the expected sales period, which does not exceed three months. Advertising costs reported as assets include $3.6 million and $4.9 million in deferred catalog as of January 31, 2006, and
January 31, 2005, respectively. In addition, the Company also reported $0.1 million and $0.4 million of advertising costs for prepaid newspaper and magazine advertisements that were recorded as assets as of January 31, 2006, and
January 31, 2005, respectively. Catalog and single product mailer expenses incurred were $42.0 million, $50.8 million, and $42.6 million for fiscal 2005, 2004 and 2003, respectively. Other advertising costs are expensed as incurred and amounted
to $71.9 million, $99.2 million and $80.7 million for the fiscal years ended January 31, 2006, 2005, and 2004, respectively.

Fair Value of
Financial Instruments

The carrying values of cash, short-term investments, accounts receivable and accounts payable
approximate their estimated fair values.

Cash and Equivalents

Cash and equivalents represent cash and short-term, highly liquid investments with original maturities of three months or less. Receivables from banks related to debit and credit cards are shown
in accounts receivable and totaled $2.5 million and $4.8 million at January 31, 2006, and 2005, respectively.

Short-term Investments

Investments consist of auction rate securities, which the Company normally liquidates within 35 days of purchase in an
auction process. These securities are held as available for sale and are therefore classified as short-term investments. The difference between the fair market value and cost of auction rate securities is immaterial.



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Merchandise Inventories

Merchandise inventories are stated at lower of cost (first-in, first-out method) or market. The Company reduces the carrying value of its inventory for estimated obsolescence or unmarketable
inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated useful lives of the various assets which range from three to 10 years for office furniture and equipment and transportation equipment, and 40 years for buildings. Leasehold
improvements are amortized using the straight-line method over the lesser of their estimated useful lives or the term of the applicable leases, which range from less than one year to 12 years.

Costs incurred in the development of the Companys Internet Website and enhancements to the Companys information
infrastructure are capitalized once the preliminary project stage is completed and management authorizes and commits to funding a computer software project and it is probable that the project will be completed and the software will be used to
perform the function intended. Costs incurred for training and ongoing maintenance are expensed as incurred.

Other Long-Term Assets

The Company designs and produces its own proprietary products for sale. External costs incurred for tooling, dies, patents and trademarks
are capitalized and amortized over the estimated life of these products, which is generally two years. At January 31, 2006, and 2005, capitalized costs included in other long-term assets, net of related amortization, were both at $4.0 million.

Income Taxes

Income
taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events then known to management that have been recognized in the
Companys financial statements or tax returns. In estimating future tax consequences, all expected future events then known to management are considered other than changes in the tax law or rates.

Store Closure Reserves

The present
value of expected future lease costs and other closure costs are recorded when the store is closed. Severance and other employee-related costs are recorded in the period in which the closure and related severance packages are communicated to the
affected employees. Accretion of the discounted present value of expected future costs is recorded in operations. Store closure reserves are reviewed and adjusted periodically based on changes in estimates. Approximately $25,000 was recorded for
store closure reserves as of January 31, 2006, and approximately $80,000 was recorded at January 31, 2005.

Accounts Payable and Accrued
Expenses

Accounts payable and accrued expenses represent amounts owed to third parties at the end of each period
presented.



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Reserve for Refunds

Our customers may return purchased items for an exchange or refund. The Company records a reserve for estimated product returns, net of cost of goods sold, based on historical return trends
together with current product sales performance. If actual returns, net of cost of goods sold, are different than those projected by management, the estimated sales returns reserve will be adjusted accordingly.

Deferred Rent

Rental expense is
recorded on a straight-line basis starting on the possession date. The difference between the average rental amount charged to expense or capitalized during the leasehold improvement construction period and the amount payable under the lease is
recorded as deferred rent. At January 31, 2006, and 2005, the balance of deferred rent was $10.8 million and $9.2 million, respectively, and is included in long-term liabilities on the accompanying balance sheets.

Stock-Based Compensation

The Company
has one stock-based employee compensation plan, as described in Note F. The Company accounts for stock-based employee compensation using the intrinsic value method in accordance with the provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees. No compensation expense is recognized for employee stock options because it is the Companys practice to grant stock options with an exercise price equal to the market price of the underlying common stock on the date of
grant.

On January 24, 2005, the Compensation Committee of the Companys Board of Directors approved the
accelerated vesting of all unvested options awarded to employees and officers which had exercise prices greater than $22 per share. Options to purchase approximately 875,000 shares became exercisable immediately as a result of the vesting
acceleration. The acceleration resulted in the recognition of an additional $8.6 million pre-tax expense included in the pro forma disclosures of stock-based compensation below and the exclusion of such amounts from compensation expense in future
years.

On January 23, 2006, the Compensation Committee of the Board of Directors of Sharper Image Corporation (the
Company) approved the accelerated vesting of all unvested options with an exercise price of and in excess of $11.95. This accelerated vesting, which became effective on the date of approval, affects options to purchase approximately
747,000 shares of the Companys common stock with exercise prices ranging from $11.95 to $21.99. The acceleration does not apply to unexpired options held by former employees.

The accelerated vesting is expected to eliminate future compensation expense the Company would otherwise recognize in its income
statement with respect to such accelerated options once FASB Statement No. 123R (Share-Based Payment) becomes effective on February 1, 2006. The estimated maximum future pre-tax expense that is eliminated is approximately $5.4 million. The
Company will incur compensation expense in connection with FASB Statement No. 123R for all other options outstanding.



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##### Table of Contents

SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



The following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to all stock-based employee compensation:



|                                                                                                                                               |  |                               |         |   |                   |   |        |                   |  |   |        |  
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ----------------- | - | ------ | ----------------- |  | - | ------ | -
|                                                                                                                                               |  | Fiscal year ended January 31, |        
|(Dollars in thousands, except per share amounts)                                                                                               |  | 2006(Fiscal 2005)             |         |   | 2005(Fiscal 2004) |   |        | 2004(Fiscal 2003) | 
|Net income (loss), as reported                                                                                                                 |  | $                             | (15,229 | ) |                   | $ | 14,650 |                   |  | $ | 23,119 |  
|Deduct: Total stock-based employee compensation expense determined under fair value-based method for all awards, net of related tax
effects(1) |  |                               | (3,555  | ) |                   |   | (8,017 | )                 |  |   | (2,006 | )
|                                                                                                                                               |  |                               |         |   |                   |   |        |                   |  |   |        |  
|Pro forma net income (loss)                                                                                                                    |  | $                             | (18,784 | ) |                   | $ | 6,633  |                   |  | $ | 21,113 |  
|                                                                                                                                               |  |                               |         |   |                   |   |        |                   |  |   |        |  
|Basic earnings (loss) per share:                                                                                                               |  |                               |         |   |                   |   |        |                   |  |   |        |  
|As reported                                                                                                                                    |  | $                             | (1.01   | ) |                   | $ | 0.94   |                   |  | $ | 1.60   |  
|Pro forma                                                                                                                                      |  | $                             | (1.25   | ) |                   | $ | 0.42   |                   |  | $ | 1.46   |  
|Diluted earnings (loss) per share:                                                                                                             |  |                               |         |   |                   |   |        |                   |  |   |        |  
|As reported                                                                                                                                    |  | $                             | (1.01   | ) |                   | $ | 0.90   |                   |  | $ | 1.51   |  
|Pro forma                                                                                                                                      |  | $                             | (1.25   | ) |                   | $ | 0.41   |                   |  | $ | 1.38   |  

---

|(1) | The Company estimates the fair value of stock option grants using the Black-Scholes option pricing model, with the following weighted average assumptions:
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------



|                        |  |                               |   |  |                   |   |  |                   |  
|----------------------- |  | ----------------------------- | - |  | ----------------- | - |  | ----------------- | -
|                        |  | Fiscal year ended January 31, |  
|                        |  | 2006(Fiscal 2005)             |   |  | 2005(Fiscal 2004) |   |  | 2004(Fiscal 2003) |  
|Dividend yield          |  |                              |   |  |                  |   |  |                  |  
|Expected volatility     |  | 48                            | % |  | 48                | % |  | 52                | %
|Risk-free interest rate |  | 4.50                          | % |  | 3.50              | % |  | 3.12              | %
|Expected life (years)   |  | 5                             |   |  | 5                 |   |  | 5                 |  

Comprehensive Income

Comprehensive income consists of net earnings or loss for the current period and other comprehensive income (certain income, expenses, gains and losses that currently bypass the income statement
are reported directly as a separate component of equity). Comprehensive income does not differ from the net earnings or losses for the Company for the years ended January 31, 2006, 2005 and 2004.

New Accounting Standards

In December
2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (Revised 2004), Share-Based Payment (SFAS No. 123R) which replaces SFAS
No. 123, supercedes Accounting Principles Board (APB) No. 25 and related interpretations and amends SFAS No. 95, Statement of Cash Flows. The provisions of SFAS No. 123R are similar to those of SFAS No. 123;
however, SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statement as compensation cost based on their fair value on the date of the grant. The fair
value of the share-based awards will be determined using an option-pricing model on the grant date. SFAS No. 123R is effective at the beginning of the first fiscal year beginning after June 15, 2005. The Company will adopt SFAS
No. 123R in the first quarter of fiscal 2006. Due to the accelerated vesting of certain stock options in fiscal 2005 and fiscal 2004, the adoption of SFAS No. 123R in the first quarter of 2006 is not expected to have a material impact on
the Companys financial statements, although



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



the future impact of the adoption of SFAS No. 123R is dependent upon the future issuance of stock option grants that will be determined by the
Companys Compensation Committee.

In November 2004, the FASB issued SFAS No. 151, Inventory CostsAn
Amendment of Accounting Research Bulletin No. 43, Chapter 4 (SFAS No. 151). SFAS No. 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs and spoilage should be expensed as incurred
and not included in overhead. The provisions in SFAS No. 151 must be applied prospectively to the Companys inventory costs incurred after January 1, 2006. The adoption of SFAS No. 151 is not expected to have an impact on the
Companys financial statements.

In March 2005, the FASB issued FASB Interpretation No. (FIN) 47,
Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143. This Interpretation clarifies that the term conditional asset retirement activity in which the timing and (or) method of
settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and (or) method of
settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The adoption of FIN 47 in the fourth quarter of
fiscal 2005 did not have a material effect on the Companys financial statements.

In May 2005, the FASB issued SFAS
No. 154, Accounting Changes and Error Correctionsa Replacement of APB No. 20 and SFAS No. 3. SFAS No. 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle.
Previously, voluntary changes in accounting principles were generally recognized by way of a cumulative effect adjustment within net earnings during the period of change. SFAS No. 154 requires retrospective application to prior period financial
statements, unless it is impracticable to determine either the period-special effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however,
the statement does not change the transition provisions of any existing accounting pronouncements. The Company does not believe the adoption of SFAS No. 154 will have a material effect on its financial statements.

In October 2005, the FASB issued FSP FAS 13-1, Accounting for Rental Costs Incurred during a Construction Period, which
addresses the accounting for rental costs associated with operating leases that are incurred during a construction period. This FSP requires that rental costs associated with ground or building operating leases incurred during a construction period
be recognized as rental expense and included in income from continuing operations. The guidance in this FSP shall be applied to the first reporting period beginning after December 15, 2005, with early adoption permitted. The adoption of FSP FAS
13-1 will not have a material impact on the Companys financial statements.

Note BProperty and Equipment

Property and equipment is summarized as follows:



|                                                              |  |             |         |      |   |        
|------------------------------------------------------------- |  | ----------- | ------- | ---- | - | -------
|                                                              |  | January 31,
|(Dollars in thousands)                                        |  | 2006        |         | 2005
|Leasehold improvements                                        |  | $           | 55,021  |      | $ | 44,076 
|Furniture, fixtures and equipment and other capitalized costs |  |             | 147,243 |      |   | 139,554
|Land                                                          |  |             | 53      |      |   | 53     
|Building                                                      |  |             | 2,874   |      |   | 2,874  
|                                                              |  |             |         |      |   |        
|                                                              |  |             | 205,191 |      |   | 186,557
|Less accumulated depreciation and amortization                |  |             | 98,363  |      |   | 86,048 
|                                                              |  |             |         |      |   |        
|                                                              |  | $           | 106,828 |      | $ | 100,509
|                                                              |  |             |         |      |   |        



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Note CRevolving Loan and Notes Payable

The Company has a revolving secured credit facility with Wells Fargo Bank, National Association. The credit facility allows borrowings
against a borrowing base determined by inventory levels and specified accounts receivable. The credit facility is secured by the Companys inventory, accounts receivable, and specified other assets. Borrowings under the credit
facility bear interest at either the adjusted LIBOR rate plus 1.50% or at Wells Fargos prime rate less 0.25%.

On
February 2, 2006, the Company entered into an amendment to the credit facility. The amendment extended the maturity date to February 2, 2010, and allows borrowings and letters of credit up to a maximum of $55 million. In
addition, through October 31, 2007, the Company may, at its option, seek to increase the maximum credit amount by up to $30 million on no more than five occasions in minimum increments of $5 million, provided that at no time shall the maximum
credit amount exceed $85 million. Borrowings under the amended credit facility bear interest at either the LIBOR rate plus a margin ranging from 1.25% to 1.75% based on average excess availability or at Wells Fargos prime rate less up to
0.25% based on average excess availability. As of January 31, 2006, the interest rate on outstanding borrowings was 7.25%.

The credit facility contains financial covenants that only apply during an event of default or when the borrowing base is drawn below a specified level. These financial covenants require the Company to maintain a minimum EBITDA (as defined)
on a rolling 12-month basis of $25 million and to maintain capital expenditures below a specified level based on the Companys projections. The credit facility contains limitations on incurring additional indebtedness and making additional
investments and does not permit a change of control. As of January 31, 2006, letter of credit commitments outstanding under the credit facility were $3.6 million and $0.2 million of borrowings outstanding. The Company believes that it is in
compliance with all of its debt covenants as of January 31, 2006.

Note DIncome Taxes



|                       |  |                               |         |   |                    |   |                    |  |   |        |  
|---------------------- |  | ----------------------------- | ------- | - | ------------------ | - | ------------------ |  | - | ------ | -
|                       |  | Fiscal year ended January 31, |        
|(Dollars in thousands) |  | 2006 (Fiscal 2005)            |         |   | 2005 (Fiscal 2004) |   | 2004 (Fiscal 2003) | 
|Current:               |  |                               |         |   |                    |   |                    |  |   |        |  
|Federal                |  | $                             | (6,070  | ) |                    | $ | 3,478              |  | $ | 15,439 |  
|State                  |  |                               | 851     |   |                    |   | 596                |  |   | 2,676  |  
|                       |  |                               |         |   |                    |   |                    |  |   |        |  
|                       |  |                               | (5,219  | ) |                    |   | 4,074              |  |   | 18,115 |  
|                       |  |                               |         |   |                    |   |                    |  |   |        |  
|Deferred:              |  |                               |         |   |                    |   |                    |  |   |        |  
|Federal                |  |                               | (4,459  | ) |                    |   | 5,212              |  |   | (1,555 | )
|State                  |  |                               | (2,466  | ) |                    |   | 894                |  |   | (266   | )
|                       |  |                               |         |   |                    |   |                    |  |   |        |  
|                       |  |                               | (6,925  | ) |                    |   | 6,106              |  |   | (1,821 | )
|                       |  |                               |         |   |                    |   |                    |  |   |        |  
|                       |  | $                             | (12,144 | ) |                    | $ | 10,180             |  | $ | 16,294 |  
|                       |  |                               |         |   |                    |   |                    |  |   |        |  



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##### Table of Contents

SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



The difference between the effective income tax rate and the United States federal
income tax rate is summarized as follows:



|                                            |  |                               |   |  |                    |   |  |                    |  
|------------------------------------------- |  | ----------------------------- | - |  | ------------------ | - |  | ------------------ | -
|                                            |  | Fiscal year ended January 31, |  
|                                            |  | 2006 (Fiscal 2005)            |   |  | 2005 (Fiscal 2004) |   |  | 2004 (Fiscal 2003) |  
|Federal tax rate                            |  | 34.0                          | % |  | 35.0               | % |  | 35.2               | %
|State income tax, less federal benefit      |  | 5.9                           |   |  | 6.0                |   |  | 6.1                |  
|Benefit of R&D tax credits from prior years |  | 2.0                           |   |  |                   |   |  |                   |  
|Other                                       |  | 2.5                           |   |  |                   |   |  |                   |  
|                                            |  |                               |   |  |                    |   |  |                    |  
|Effective tax rate                          |  | 44.4                          | % |  | 41.0               | % |  | 41.3               | %
|                                            |  |                               |   |  |                    |   |  |                    |  

Deferred taxes result from differences in the recognition of expense for income
tax and financial reporting purposes. The principal components of deferred tax assets (liabilities) are as follows:



|                          |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|------------------------- |  | ------------------- | ------ | ------------------------ | - | ------------------- |  | ------------------------ | ------ |  | - | ------
|                          |  | January 31,        
|                          |  | 2006                |        | 2005                    
|(Dollars in thousands)    |  | Deferred Tax Assets |        | Deferred Tax Liabilities |   | Deferred Tax Assets |  | Deferred Tax Liabilities
|Current:                  |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|Nondeductible reserves    |  | $                   | 16,500 |                          |   |                    |  | $                        | 15,615 |  |   |      
|Deferred catalog costs    |  |                     |        |                          | $ | 691                 |  |                          |       |  | $ | 732   
|State taxes               |  |                     |       |                          |   |                    |  |                          | 34     |  |   |      
|                          |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|Current                   |  |                     | 16,500 |                          |   | 691                 |  |                          | 15,649 |  |   | 732   
|                          |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|Noncurrent:               |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|Deferred rent             |  |                     | 2,888  |                          |   |                    |  |                          | 2,299  |  |   |      
|Depreciation              |  |                     |       |                          |   | 4,582               |  |                          |       |  |   | 9,740 
|Deductible software costs |  |                     |       |                          |   | 6,667               |  |                          |       |  |   | 6,060 
|Other                     |  |                     | 3,055  |                          |   |                    |  |                          | 2,162  |  |   |      
|                          |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|Noncurrent                |  |                     | 5,943  |                          |   | 11,249              |  |                          | 4,461  |  |   | 15,800
|                          |  |                     |        |                          |   |                     |  |                          |        |  |   |       
|Total                     |  | $                   | 22,443 |                          | $ | 11,940              |  | $                        | 20,110 |  | $ | 16,532
|                          |  |                     |        |                          |   |                     |  |                          |        |  |   |       

The net of the current deferred tax assets and liabilities is recorded in deferred
taxes on the accompanying balance sheets. The net of the federal noncurrent deferred tax assets and liabilities is recorded in deferred taxes and other liabilities on the accompanying balance sheets. The net of the deferred state tax assets and
liabilities is recorded in deferred catalog and other assets. The current income tax receivable as of January 31, 2006, is recorded in prepaid expenses and other on the accompanying balance sheet.



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Note ELeases

The Company leases retail facilities, offices and equipment under operating leases for terms expiring at various dates through 2017. Under the terms of certain of the leases, rents are adjusted
annually for changes in the consumer price index and increases in property taxes. The aggregate minimum annual lease payments under leases in effect at January 31, 2006, are as follows:



|                                |  |   |        
|------------------------------- |  | - | -------
|(Dollars in thousands)          |  |  
|Fiscal year ending January 31,  |  |   |        
|2007                            |  | $ | 39,879 
|2008                            |  |   | 39,164 
|2009                            |  |   | 38,184 
|2010                            |  |   | 37,129 
|2011                            |  |   | 35,437 
|Thereafter                      |  |   | 106,193
|                                |  |   |        
|Total minimum lease commitments |  | $ | 295,986
|                                |  |   |        

Many of the Companys leases contain predetermined fixed escalations of the
minimum rentals during the initial term. For these leases, the Company has recognized the related rental expense on a straight-line basis and has recorded the difference between the expense charged to income or capitalized in fixed assets and
amounts payable under the leases as Other Liabilities on the accompanying balance sheet. Some store leases also contain provisions that the Company pay percentage rent for sales that exceed a certain threshold.

Some store leases contain renewal options for periods ranging up to five years. Most leases also provide for payment of operating
expenses, real estate taxes and many for additional rent based on a percentage of sales.

Rental expense for all operating
leases was as follows:



|                                     |  |                               |        |                    |   |                    |  |   |       
|------------------------------------ |  | ----------------------------- | ------ | ------------------ | - | ------------------ |  | - | ------
|                                     |  | Fiscal year ended January 31,
|(Dollars in thousands)               |  | 2006 (Fiscal 2005)            |        | 2005 (Fiscal 2004) |   | 2004 (Fiscal 2003)
|Minimum rentals                      |  | $                             | 39,865 |                    | $ | 35,281             |  | $ | 30,108
|Percentage rentals and other charges |  |                               | 17,470 |                    |   | 15,640             |  |   | 12,286
|                                     |  |                               |        |                    |   |                    |  |   |       
|                                     |  | $                             | 57,335 |                    | $ | 50,921             |  | $ | 42,394
|                                     |  |                               |        |                    |   |                    |  |   |       

Note FStockholders Equity

During fiscal 2000, the Company adopted the 2000 Stock Incentive Plan. The 2000 Stock Incentive Plan is divided into four separate equity
incentive programs and will allow the issuance of non-qualified options to key employees, non-employee Board members and consultants. An automatic increase of shares available for issuance will occur on the first trading day of each fiscal year,
beginning with fiscal 2001, by an amount equal to 3% of the total number of shares of common stock outstanding on the last trading day of the immediately preceding fiscal year. In no event will the annual increase exceed 500,000 shares.

In October 2004, the Board of Directors authorized a stock repurchase program to acquire up to 1,000,000 shares of outstanding common
stock in the open market. During fiscal 2004 and 2005, the Company repurchased 810,000 shares of its common stock at a total cost of approximately $12.4 million, a weighted average cost of $15.34 per share.



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Options issued to key employees and consultants will generally vest over a four- to
six-year period from the date of the grant and are priced at 100% of the fair market value at the date of the grant. Options issued to non-employee Board members will be immediately exercisable, vest over one year of board service from the date of
the grant and are priced at 100% of the fair market value at the date of the grant. Any shares purchased under the option plan will be subject to repurchase by the Company at the exercise price paid per share, upon the optionees cessation of
Board service prior to vesting.

On January 23, 2006, the Compensation Committee of the Board of Directors of Sharper
Image Corporation (the Company) approved the accelerated vesting of all unvested options with an exercise price of and in excess of $11.95. This accelerated vesting, which became effective on the date of approval, affects options to
purchase approximately 747,000 shares of the Companys common stock with exercise prices ranging from $11.95 to $21.99. The acceleration does not apply to unexpired options held by former employees.

The accelerated vesting is expected to eliminate future compensation expense the Company would otherwise recognize in its income
statement with respect to such accelerated options once FASB Statement No. 123R (Share-Based Payment) becomes effective on February 1, 2006. The estimated maximum future pre-tax expense that is eliminated is approximately $5.4 million. The
Company will incur compensation expense in connection with FASB Statement No. 123R for all other options outstanding.

On January 24, 2005, the Companys Compensation Committee of the Board of Directors approved the accelerated vesting of all unvested options awarded to employees and officers which had exercise prices greater than $22 per share.
Options to purchase approximately 875,000 shares became exercisable immediately as a result of the vesting acceleration.

The following table reflects the activity under this plan:



|                                                |  |                   |   |  |                                 |      
|----------------------------------------------- |  | ----------------- | - |  | ------------------------------- | -----
|                                                |  | Number of Options |   |  | Weighted average exercise price
|Balance at January 31, 2003                     |  | 2,695,371         |   |  | $                               | 9.83 
|Granted (weighted average fair value of $10.97) |  | 580,500           |   |  |                                 | 23.18
|Exercised                                       |  | (546,259          | ) |  |                                 | 7.20 
|Canceled                                        |  | (41,960           | ) |  |                                 | 9.99 
|                                                |  |                   |   |  |                                 |      
|Balance at January 31, 2004                     |  | 2,687,652         |   |  | $                               | 13.24
|                                                |  |                  
|Granted (weighted average fair value of $12.78) |  | 455,550           |   |  | $                               | 26.62
|Exercised                                       |  | (414,625          | ) |  |                                 | 10.03
|Canceled                                        |  | (16,800           | ) |  |                                 | 24.66
|                                                |  |                   |   |  |                                 |      
|Balance at January 31, 2005                     |  | 2,711,777         |   |  | $                               | 15.91
|                                                |  |                  
|Granted (weighted average fair value of $6.36)  |  | 624,400           |   |  | $                               | 12.99
|Exercised                                       |  | (21,470           | ) |  |                                 | 8.06 
|Canceled                                        |  | (274,500          | ) |  |                                 | 17.61
|                                                |  |                   |   |  |                                 |      
|Balance at January 31, 2006                     |  | 3,040,207         |   |  | $                               | 15.21
|                                                |  |                   |   |  |                                 |      
|Exercisable at January 31, 2004                 |  | 1,272,652         |   |  | $                               | 10.88
|                                                |  |                   |   |  |                                 |      
|Exercisable at January 31, 2005                 |  | 2,235,837         |   |  | $                               | 16.86
|                                                |  |                   |   |  |                                 |      
|Exercisable at January 31, 2006                 |  | 2,984,127         |   |  | $                               | 15.37
|                                                |  |                   |   |  |                                 |      



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



|                         |  |                               |  |                                                     |  |                                 |       |                               |           |                                |   |      
|------------------------ |  | ----------------------------- |  | --------------------------------------------------- |  | ------------------------------- | ----- | ----------------------------- | --------- | ------------------------------ | - | -----
|Options outstanding      |  | Options exercisable          
|Range of exercise prices |  | Number of options outstanding |  | Weighted average remaining contractual Life (years) |  | Weighted average exercise price |       | Number of options exercisable |           | Weighted average exerciseprice
|$   2.00  $  3.99       |  | 5,533                         |  | 2.5                                                 |  | $                               | 3.54  |                               | 5,533     |                                | $ | 3.54 
|4.00      7.99          |  | 209,990                       |  | 6.0                                                 |  |                                 | 6.89  |                               | 153,910   |                                |   | 6.88 
|8.00    11.99           |  | 998,744                       |  | 5.0                                                 |  |                                 | 9.53  |                               | 998,744   |                                |   | 9.53 
|12.00    14.99          |  | 851,040                       |  | 8.8                                                 |  |                                 | 13.55 |                               | 851,040   |                                |   | 13.55
|15.00    23.99          |  | 561,700                       |  | 7.9                                                 |  |                                 | 22.39 |                               | 561,700   |                                |   | 22.39
|24.00    35.99          |  | 413,200                       |  | 8.9                                                 |  |                                 | 27.00 |                               | 413,200   |                                |   | 27.00
|                         |  |                               |  |                                                     |  |                                 |       |                               |           |                                |   |      
|$   2.00  $35.99        |  | 3,040,207                     |  | 7.2                                                 |  | $                               | 15.21 |                               | 2,984,127 |                                | $ | 15.37
|                         |  |                               |  |                                                     |  |                                 |       |                               |           |                                |   |      

Note GEarnings per Share

Basic earnings per share are computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net
income by the weighted average number of common shares and dilutive common equivalent shares (stock options) outstanding during the period. The following is a reconciliation of the number of shares used in the Companys basic and diluted
earnings per share computations:



|                                                                                                                       |  |                               |  |                    |  |                   
|---------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- |  | ------------------ |  | ------------------
|                                                                                                                       |  | Fiscal year ended January 31,
|                                                                                                                       |  | 2006 (Fiscal 2005)            |  | 2005 (Fiscal 2004) |  | 2004 (Fiscal 2003)
|Basic weighted average number of shares outstanding                                                                    |  | 15,066,843                    |  | 15,634,355         |  | 14,446,128        
|Application of treasury stock method on stock options outstanding:                                                     |  |                               |  |                    |  |                   
|Assumed options exercised due to exercise price being less than average market price, net of assumed stock repurchases |  |                              |  | 655,705            |  | 887,107           
|                                                                                                                       |  |                               |  |                    |  |                   
|Diluted weighted average number of shares outstanding                                                                  |  | 15,066,843                    |  | 16,290,060         |  | 15,333,235        
|                                                                                                                       |  |                               |  |                    |  |                   

The potential effects of stock options were excluded from the diluted earnings per
share for the year ended January 31, 2006 because their inclusion in net loss periods would be anti-dilutive to the earnings per share calculation. The computations of diluted earnings per share in fiscal 2005, 2004 and 2003 exclude options to
purchase 1,392,940, 447,450 and 31,100 common shares, respectively, because their exercise price exceeded the average market price for the period and thus their effect would have been anti dilutive.

Note H401(k) Savings Plan

The
Company maintains a defined contribution 401(k) Savings Plan covering all employees who have completed one year of service with at least 1,000 hours and who are at least 21 years of age. The Company makes employer matching contributions at its
discretion. Company contributions amounted to $258,000, $274,000, and $190,000 for the fiscal years ended January 31, 2006, 2005 and 2004, respectively.

Note ICommitments and Contingencies

The Company is party to various legal proceedings arising from
normal business activities. Except as noted below, management believes that the resolution of these matters will not have a material adverse effect on the Companys financial position or results of operations.



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



On or before April 15, 2006, there were five Class Actions filed against the
Company alleging inaccurate advertising claims on behalf of the Ionic Breeze Quadra, including its failure to perform as claimed. The actions are filed on behalf of purchasers of the Ionic Breeze Quadra in the State Courts of California (San
Francisco) and Florida (Jacksonville), as well as the U.S. District Courts of Maryland and Florida (Miami). Only the San Francisco action has been certified for class representation, a ruling which is on appeal by the Company. The Florida
State Court action is stayed pending resolution of the ongoing San Francisco case. The Maryland and Florida federal cases are in the initial stages of procedure. The Company believes these lawsuits, which are virtually identical, are
without merit and has been and intends to continue resisting them vigorously. Recognizing that the combined claims of the plaintiffs, if fully successful, would result in several millions of dollars of liability, the Company does not believe that
the ultimate resolution of these lawsuits will have a material adverse effect on the financial position of the Company, although an adverse outcome in one or more of these lawsuits will have a material adverse effect on the results of operations for
any one period. Further, litigation can consume substantial financial and management resources and no assurances can be given that any adverse outcome would not be material to the financial position of the Company.

Note JSegment Information

The
Company classifies its business interests into three reportable segments: retail stores, catalog and direct marketing and Internet. The accounting policies of the segments are the same as those described in the Summary of Significant Accounting
Policies (Note A). The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income taxes. The Companys reportable segments are
strategic business units that offer the same products and utilize common merchandising, distribution and marketing functions, as well as common information systems and corporate administration. The Company does not have intersegment sales, but the
segments are managed separately because each segment has different channels for selling the products.



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Financial information for the Companys business segments is as follows:



|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|----------------------------------- |  | ---------------------- | ------- | - | ------------------ | - | ------- | ------------------ |  | - | ------- | -
|                                    |  | Year ended January 31, |        
|(Dollars in thousands)              |  | 2006 (Fiscal 2005)     |         |   | 2005 (Fiscal 2004) |   |         | 2004 (Fiscal 2003) | 
|Revenues                            |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Stores                              |  | $                      | 407,098 |   |                    | $ | 434,696 |                    |  | $ | 379,349 |  
|Catalog and direct marketing        |  |                        | 87,945  |   |                    |   | 130,535 |                    |  |   | 128,652 |  
|Internet                            |  |                        | 107,222 |   |                    |   | 116,297 |                    |  |   | 95,086  |  
|Other                               |  |                        | 66,728  |   |                    |   | 78,475  |                    |  |   | 44,424  |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Total revenues                      |  | $                      | 668,993 |   |                    | $ | 760,003 |                    |  | $ | 647,511 |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Operating contributions             |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Stores                              |  | $                      | 18,381  |   |                    | $ | 57,378  |                    |  | $ | 54,212  |  
|Catalog and direct marketing        |  |                        | (5,536  | ) |                    |   | 5,132   |                    |  |   | 20,652  |  
|Internet                            |  |                        | 6,358   |   |                    |   | 11,896  |                    |  |   | 15,345  |  
|Unallocated                         |  |                        | (46,576 | ) |                    |   | (49,576 | )                  |  |   | (50,796 | )
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Earnings (loss) before income taxes |  | $                      | (27,373 | ) |                    | $ | 24,830  |                    |  | $ | 39,413  |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Depreciation and amortization       |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Stores                              |  | $                      | 14,145  |   |                    | $ | 10,386  |                    |  | $ | 7,734   |  
|Catalog and direct marketing        |  |                        |        |   |                    |   |        |                    |  |   |        |  
|Internet                            |  |                        | 1,740   |   |                    |   | 2,253   |                    |  |   | 3,071   |  
|Unallocated                         |  |                        | 11,224  |   |                    |   | 8,417   |                    |  |   | 5,621   |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Total depreciation and amortization |  | $                      | 27,109  |   |                    | $ | 21,056  |                    |  | $ | 16,426  |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Capital asset expenditures          |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Stores                              |  | $                      | 23,782  |   |                    | $ | 28,176  |                    |  | $ | 21,774  |  
|Catalog and direct marketing        |  |                        |        |   |                    |   |        |                    |  |   |        |  
|Internet                            |  |                        | 927     |   |                    |   | 2,895   |                    |  |   | 1,727   |  
|Unallocated                         |  |                        | 9,415   |   |                    |   | 18,502  |                    |  |   | 11,694  |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Total capital asset expenditures    |  | $                      | 34,124  |   |                    | $ | 49,573  |                    |  | $ | 35,195  |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Assets                              |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Stores                              |  | $                      | 74,596  |   |                    | $ | 65,854  |                    |  | $ | 51,197  |  
|Catalog and direct marketing        |  |                        |        |   |                    |   |        |                    |  |   |        |  
|Internet                            |  |                        | 1,700   |   |                    |   | 2,513   |                    |  |   | 1,974   |  
|Unallocated                         |  |                        | 252,465 |   |                    |   | 307,733 |                    |  |   | 262,162 |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  
|Total assets                        |  | $                      | 328,761 |   |                    | $ | 376,100 |                    |  | $ | 315,333 |  
|                                    |  |                        |         |   |                    |   |         |                    |  |   |         |  



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SHARPER IMAGE CORPORATION

NOTES TO FINANCIAL STATEMENTS(Continued)



Note KQuarterly Financial Information (Unaudited)



|                                                 |  |                                                       |         |   |               |   |         |                  |  |   |                  |   |  |   |         |  
|------------------------------------------------ |  | ----------------------------------------------------- | ------- | - | ------------- | - | ------- | ---------------- |  | - | ---------------- | - |  | - | ------- | -
|                                                 |  | Fiscal Year Ended January 31, 2006 Three months ended |        
|(Dollars in thousands, except per share amounts) |  | April 30, 2005                                        |         |   | July 31, 2005 |   |         | October 31, 2005 |  |   | January 31, 2006 |  
|Revenues                                         |  | $                                                     | 144,882 |   |               | $ | 137,296 |                  |  | $ | 123,115          |   |  | $ | 263,700 |  
|Expenses                                         |  |                                                       |         |   |               |   |         |                  |  |   |                  |   |  |   |         |  
|Cost of products                                 |  |                                                       | 66,337  |   |               |   | 71,276  |                  |  |   | 62,212           |   |  |   | 142,282 |  
|Buying and occupancy                             |  |                                                       | 18,827  |   |               |   | 19,574  |                  |  |   | 19,771           |   |  |   | 21,646  |  
|Advertising                                      |  |                                                       | 32,484  |   |               |   | 22,603  |                  |  |   | 23,272           |   |  |   | 35,545  |  
|General, selling and administrative              |  |                                                       | 34,970  |   |               |   | 34,941  |                  |  |   | 36,451           |   |  |   | 53,717  |  
|Other income (expense)net                       |  |                                                       | 109     |   |               |   | (197    | )                |  |   | (137             | ) |  |   | (233    | )
|Earnings (loss) before income taxes              |  |                                                       | (7,627  | ) |               |   | (11,295 | )                |  |   | (18,728          | ) |  |   | 10,277  |  
|Income tax expense (benefit)                     |  |                                                       | (3,051  | ) |               |   | (4,518  | )                |  |   | (8,228           | ) |  |   | 3,653   |  
|Net earnings (loss)                              |  | $                                                     | (4,576  | ) |               | $ | (6,777  | )                |  | $ | (10,500          | ) |  | $ | 6,624   |  
|                                                 |  |                                                       |         |  
|Net earnings (loss) per share                    |  |                                                       |         |   |               |   |         |                  |  |   |                  |   |  |   |         |  
|Basic(1)                                         |  | $                                                     | (0.30   | ) |               | $ | (0.45   | )                |  | $ | (0.70            | ) |  | $ | 0.44    |  
|Diluted(2)                                       |  | $                                                     | (0.30   | ) |               | $ | (0.45   | )                |  | $ | (0.70            | ) |  | $ | 0.44    |  
|                                                 | 
|                                                 |  | Fiscal Year Ended January 31, 2005 Three months ended |        
|(Dollars in thousands, except per share amounts) |  | April 30, 2004                                        |         |   | July 31, 2004 |   |         | October 31, 2004 |  |   | January 31, 2005 |  
|Revenues                                         |  | $                                                     | 156,405 |   |               | $ | 148,963 |                  |  | $ | 153,623          |   |  | $ | 301,012 |  
|Expenses                                         |  |                                                       |         |   |               |   |         |                  |  |   |                  |   |  |   |         |  
|Cost of products                                 |  |                                                       | 62,760  |   |               |   | 66,380  |                  |  |   | 71,041           |   |  |   | 141,642 |  
|Buying and occupancy                             |  |                                                       | 16,049  |   |               |   | 16,963  |                  |  |   | 16,970           |   |  |   | 20,789  |  
|Advertising                                      |  |                                                       | 37,072  |   |               |   | 28,755  |                  |  |   | 33,030           |   |  |   | 51,101  |  
|General, selling and administrative              |  |                                                       | 37,393  |   |               |   | 36,768  |                  |  |   | 38,775           |   |  |   | 58,832  |  
|Other income (expense)net                       |  |                                                       | 116     |   |               |   | 62      |                  |  |   | (107             | ) |  |   | (924    | )
|Earnings (loss) before income taxes              |  |                                                       | 3,247   |   |               |   | 159     |                  |  |   | (6,300           | ) |  |   | 27,724  |  
|Income tax expense (benefit)                     |  |                                                       | 1,332   |   |               |   | 66      |                  |  |   | (2,583           | ) |  |   | 11,365  |  
|Net earnings (loss)                              |  | $                                                     | 1,915   |   |               | $ | 93      |                  |  | $ | (3,717           | ) |  | $ | 16,359  |  
|                                                 |  |                                                       |         |  
|Net earnings (loss) per share                    |  |                                                       |         |   |               |   |         |                  |  |   |                  |   |  |   |         |  
|Basic(1)                                         |  | $                                                     | 0.12    |   |               | $ | 0.01    |                  |  | $ | (0.24            | ) |  | $ | 1.04    |  
|Diluted(2)                                       |  | $                                                     | 0.12    |   |               | $ | 0.01    |                  |  | $ | (0.24            | ) |  | $ | 1.01    |  

---

|(1) | Basic earnings per share is calculated for interim periods including the effect of stock options exercised in prior interim periods. Basic earnings per share for
the fiscal year are calculated using weighted shares outstanding based on the date stock options were exercised. Therefore, basic earnings per share for the cumulative four quarters may not equal fiscal year basic earnings per share.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Diluted net earnings per share for the fiscal year and for quarters with net earnings are computed based on weighted average common and common equivalent shares
outstanding which include common stock equivalents (stock options). Net loss per share for quarters with net losses is computed based solely on weighted average common shares outstanding. Therefore, the net earnings (loss) per share for each quarter
do not sum up to the earnings per share for the full fiscal year.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.

The Company conducted an evaluation, under the supervision and with the participation of the Companys management, including the
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the Exchange Act)) as of the end of the period covered by this report. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the
circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. The evaluation included consideration of the
facts and circumstances surrounding the recording of complex, non-routine transactions and the timeliness of the Company close process described below. Based on such evaluation, and the material weakness described below, the Chief Executive Officer
and Chief Financial Officer concluded that the Companys disclosure controls and procedures were not effective as of January 31, 2006.

Managements Annual Report on Internal Control Over Financial Reporting

The Companys
management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial
reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

The Companys management has assessed the effectiveness of its internal control over financial reporting as of
January 31, 2006. This evaluation was based on the framework in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management has concluded that
as of January 31, 2006, the Company did not design and implement adequate controls over the selection and application of accounting policies for complex, non-routine transactions and the Company did not timely close the books at year end.
Additionally, certain audit adjustments to the 2005 financial statements, which were not material individually, but which affected various financial statement line items, were necessary to present the financial statements in accordance with
generally accepted accounting principles. Management has determined that these control deficiencies collectively constituted a material weakness in the design of its internal controls. A material weakness is a control deficiency, or combination of
control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Because of the existence of the material weakness, management concluded that the Company did not maintain effective internal control over
financial reporting as of January 31, 2006, based on the criteria described in the COSO Internal ControlIntegrated Framework.

Managements assessment of the effectiveness of the Companys internal control over financial reporting as of January 31, 2006, has been audited by Deloitte & Touche LLP, the Companys
independent registered public accounting firm, as stated in their report which appears herein.



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Material Weakness in Internal Control Over Financial Reporting

The material weakness resulted in accounting errors related to treasury stock retirement, long lived asset impairment, and income taxes.
The Company did not properly account for the retirement of its treasury stock, which resulted in a reclassification between equity accounts. There was no net effect on shareholders equity. The Company retired its treasury stock for only the
second time in its history and therefore accounting for retirement of treasury stock was not only complex but non-routine. In its year end determination of long lived asset impairment, the Company did not properly calculate whether two under
performing stores were impaired. Initially, the Company determined that an impairment charge would be required, but subsequent calculation revealed that no such impairment existed. The Company reversed the initial impairment
entry. The Company also did not properly account for income taxes. A key member of the accounting staff, who accounted for income taxes in prior years, left the Company in late December 2005. While a new tax manager was hired in late December 2005,
it was not possible to transition all of the knowledge and experience in such a short period of time. However, as of January 31, 2006, the tax accounts have been properly stated. Additionally, due to numerous unplanned events including
departure of key accounting personnel in December 2005, the Company needed additional time to complete the year-end closing process. The untimely closing of the books resulted in the delay in filing of the Form 10-K.

Remediation of Material Weakness

The Company is in the process of creating a formal process related to the design and implementation of control over the selection and application of accounting policies for complex, non-routine transactions. This process will include the
early identification of complex, non-routine transactions and documentation by the Companys accounting staff. Regular meetings with accounting staff and executive level officers involved and familiar with accounting issues related to complex,
non routine transactions, will be held to review the initial documentation. As required, outside legal and/or accounting advice will be obtained. In addition, the Company is evaluating adding additional accounting resources and making system
enhancements in order to shorten its closing process.

Changes in Internal Control over Financial Reporting

Except for changes related to the material weakness described above, there were no changes in the Companys internal control over
financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15(e) or 15d-15(e) that was conducted during the last fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Companys internal control over financial reporting.

The Companys management is
responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control over financial reporting is a
process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.



56



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Sharper Image Corporation:

We have audited managements assessment, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting that Sharper Image Corporation (the
Company) did not maintain effective internal control over financial reporting as of January 31, 2006, because of the effect of the material weakness identified in managements assessment based on criteria established in
Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Companys management is responsible for maintaining effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the Companys internal control over
financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our
audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures
as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A
companys internal control over financial reporting is a process designed by, or under the supervision of, the companys principal executive and principal financial officers, or persons performing similar functions, and effected by the
companys board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.

A material weakness is a significant
deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has
been identified and included in managements assessment: the Company did not design and implement adequate controls over the selection and application of accounting policies for complex, non-routine transactions and did not timely close the
books at year end. Additionally, certain audit adjustments to the 2005 financial statements, which were not material individually, but which affected various financial statement line items, were necessary to present the financial statements in
accordance with generally accepted accounting principles. These deficiencies were concluded to be a material weakness due to the actual misstatements identified, the potential for additional misstatements, and the lack of other mitigating controls
to detect the misstatements. This material weakness was considered in determining the



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nature, timing and extent of audit tests applied in our audit of the financial statements and financial statement schedule of the Company as of and for the
year ended January 31, 2006, and this report does not affect our reports on such financial statements and financial statement schedule.

In our opinion, managements assessment that the Company did not maintain effective internal control over financial reporting as of January 31, 2006, is fairly stated, in all material respects, based on the
criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, because of the effect of the material weakness described above on the
achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of January 31, 2006, based on the criteria established in Internal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in
accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements and supplementary financial statement schedule as of and for the year ended January 31, 2006, of the Company and our
reports dated May 1, 2006 expressed unqualified opinions on those financial statements and financial statement schedule.



|                                     
|-------------------------------------
|/S/    DELOITTE & TOUCHE
LLP         
|                                     
|San Francisco, California May 1, 2006

ITEM 9B. OTHER INFORMATION

On February 2, 2006, the Company issued a press
release announcing sales and other data for the month of January, the fiscal fourth quarter and fiscal 2005. The information in the press release is superseded by the information contained in this annual report on form 10-K.



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PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding the
Directors of the Company is incorporated herein by reference from the Companys 2006 Proxy Statement to Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Companys 2005
fiscal year. Information regarding the Executive Officers of the Company is contained in Part I of this Annual Report on Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated
herein by reference from the Companys 2006 Proxy Statement to Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Companys 2005 fiscal year.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

Except as set forth below, information required by Item 12 is incorporated herein by reference from the Companys 2006 Proxy
Statement to Shareholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Companys 2005 fiscal year.

EQUITY COMPENSATION PLAN INFORMATION

The Sharper Image has one equity based
compensation plan, the 2000 Stock Incentive Plan which was approved by its security holders. The following table sets forth information as of January 31, 2006, of the Companys equity compensation plan.



|                                                      |  |                                                                     |  |                                                                |       |                                                                                                                                            |        
|----------------------------------------------------- |  | ------------------------------------------------------------------- |  | -------------------------------------------------------------- | ----- | ------------------------------------------------------------------------------------------------------------------------------------------ | -------
|Plan Category                                         |  | Number of Securitiesto be Issued UponExercise ofOutstanding Options |  | Weighted Average PerShare Exercise Price ofOutstanding Options |       | Number of SecuritiesRemaining Available forFuture Issuance
UnderEquity Compensation Plan(Excluding SecuritiesReflected in the FirstColumn)
|Equity compensation plan approved by security holders |  | 3,040,207                                                           |  | $                                                              | 15.21 |                                                                                                                                            | 244,598

The Company has an evergreen provision that allows for an automatic increase of
shares available for issuance, by an amount equal to 3% of the total number of shares of common stock outstanding on the last trading day of the immediately preceding fiscal year. In no event will the annual increase exceed 500,000 shares.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Not applicable.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14
is incorporated herein by reference from the Companys 2006 Proxy Statement to Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Companys 2005 fiscal year.



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PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(1) List of Financial Statements.

The following financial statements of Sharper Image Corporation and the related notes thereto are included herein in Part
V, Item 8:



|                                                                                       |  |   
|-------------------------------------------------------------------------------------- |  | --
|Report of Independent Registered Public Accounting Firm                                |  | 36
|                                                                                       | 
|Balance Sheets at January 31, 2006, and 2005                                           |  | 37
|                                                                                       | 
|Statements of Operations for the years ended January 31, 2006, 2005 and 2004           |  | 38
|                                                                                       | 
|Statements of Stockholders Equity for the years ended January 31, 2006, 2005 and 2004 |  | 39
|                                                                                       | 
|Statements of Cash Flows for the years ended January 31, 2006, 2005 and 2004           |  | 40
|                                                                                       | 
|Notes to Financial Statements                                                          |  | 41

(2) List of Financial Statement Schedules



|                                                                                 |  |   
|-------------------------------------------------------------------------------- |  | --
|Schedule IIValuation and Qualifying Accounts                                    |  | 63
|                                                                                 | 
|Report of Independent Registered Accounting Firm on Financial Statement Schedule |  | 64

(3) List of Exhibits

Incorporated herein by reference is a list of the Exhibits contained in the Exhibit Index, which begins on page 63 of this report.



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                          |  |                                                                                       |  |     |  |                                                        
|------------------------- |  | ------------------------------------------------------------------------------------- |  | --- |  | -------------------------------------------------------
|SHARPER IMAGE CORPORATION |  | SHARPER IMAGE CORPORATION                                                            
|                          |  |                                                                                       | 
|By:                       |  | /S/    RICHARD J.
THALHEIMER                                                          |  | By: |  | /S/    TRACY Y.
WAN                                    
|                          |  | Richard J. Thalheimer Chief Executive Officer, Chairman (Principal Executive Officer) |  |     |  | Tracy Y. Wan President Chief Operating Officer Director



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POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard J. Thalheimer and Tracy Y. Wan, and each of them, as such persons true
and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for such person and in such persons name, place, and stead, in any and all capacities, to sign any and all amendments to this report, and to file the
same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every
act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or
his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.



|                                                   |  |                                                                                                                  |  |            
|-------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------- |  | -----------
|Signature                                          |  | Title                                                                                                            |  | Date       
|                                                   |  |                                                                                                                 
|/S/    RICHARD J.
THALHEIMER Richard J. Thalheimer |  | Chief Executive Officer, Chairman (Principal Executive Officer)                                                  |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/S/    TRACY Y.
WAN Tracy Y. Wan                   |  | President, Chief Operating Officer, Director                                                                     |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/S/    JEFFREY P.
FORGAN Jeffrey P. Forgan         |  | Executive Vice-President, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/s/    ALAN
THALHEIMER Alan Thalheimer             |  | Director                                                                                                         |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/s/    GERALD
NAPIER Gerald Napier                 |  | Director                                                                                                         |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/s/    MORTON
DAVID Morton David                   |  | Director                                                                                                         |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/s/    GEORGE
JAMES George James                   |  | Director                                                                                                         |  | May 1, 2006
|                                                   |  |                                                                                                                 
|/s/    PAMELA
JOYNER Pamela Joyner                 |  | Director                                                                                                         |  | May 1, 2006



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SHARPER IMAGE CORPORATION

SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS



---

(Dollars in thousands)



|                                |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|------------------------------- |  | ------------------------------ | ------ | ------------------------------------ | - | ------ | ---------- |  | - | ------------------------ | --- |  | - | ------
|COLUMN A                        |  | COLUMN B                       |        | COLUMN C                             |   |        | COLUMN D   |  |   | COLUMN E                
|DESCRIPTION                     |  | Balance at Beginning of
Period |        | Additions Charged to Costs & Expense |   |        | Deductions |  |   | Balance at End of Period
|ACCOUNTS RECEIVABLE             |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|                                |  |                                |        |                                     
|YEAR ENDED JANUARY 31, 2006:    |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|Allowance for doubtful accounts |  | $                              | 1,578  |                                      | $ | 187    |            |  | $ | 667                      |     |  | $ | 1,098 
|                                |  |                                |        |                                     
|YEAR ENDED JANUARY 31, 2005:    |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|Allowance for doubtful accounts |  | $                              | 1,339  |                                      | $ | 525    |            |  | $ | 286                      |     |  | $ | 1,578 
|                                |  |                                |        |                                     
|YEAR ENDED JANUARY 31, 2004:    |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|Allowance for doubtful accounts |  | $                              | 1,045  |                                      | $ | 1,527  |            |  | $ | 1,233                    |     |  | $ | 1,339 
|                                |  |                                |        |                                     
|SALES                           |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|                                |  |                                |        |                                     
|YEAR ENDED JANUARY 31, 2006:    |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|Reserve for refunds             |  | $                              | 19,609 |                                      | $ | 79,778 |            |  | $ | 82,117                   |     |  | $ | 17,270
|                                |  |                                |        |                                     
|YEAR ENDED JANUARY 31, 2005:    |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|Reserve for refunds             |  | $                              | 17,161 |                                      | $ | 82,880 | (1)        |  | $ | 80,432                   | (1) |  | $ | 19,609
|                                |  |                                |        |                                     
|YEAR ENDED JANUARY 31, 2004:    |  |                                |        |                                      |   |        |            |  |   |                          |     |  |   |       
|Reserve for refunds             |  | $                              | 12,498 |                                      | $ | 76,366 | (1)        |  | $ | 71,703                   | (1) |  | $ | 17,161

---

|(1) | The 2005 and 2004 additions and deductions for the reserve for refunds
have been revised to present activity on a gross basis that was previously presented on a net basis.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders
of

Sharper Image Corporation

We have audited the financial statements of Sharper Image Corporation as of January 31, 2006 and 2005, and for each of the three fiscal years in the period ended January 31, 2006, managements
assessment of the effectiveness of the Companys internal control over financial reporting as of January 31, 2006, and the effectiveness of the Companys internal control over financial reporting as of January 31, 2006, and have
issued our reports thereon dated May 1, 2006 (the report on the effectiveness of the Companys internal control over financial reporting expressed an adverse opinion due to a material weakness); such financial statements and reports are
included elsewhere in this Form 10-K. Our audits also included the financial statement schedule of the Company listed in Item 15. This financial statement schedule is the responsibility of the Companys management. Our responsibility is to
express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.



|                                     
|-------------------------------------
|/s/    DELOITTE & TOUCHE
LLP         
|San Francisco, California
May 1, 2006



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EXHIBIT INDEX



|      |  |                                                                                                                                                                                                                                               
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1   |  | Certificate of Incorporation. (Incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1 (Registration No. 33-12755)).                                                                                               
|      | 
|3.1.1 |  | Certificate of Amendment of the Restated Certificate of Incorporation, dated as of September 6, 2005 (Incorporated by reference to Exhibit 3.1 to Form 10-Q for the quarter
ended July 31, 2005).                                             
|      | 
|3.2   |  | Amended and Restated Bylaws of Sharper Image Corporation as of June 6, 2005 (Incorporated by reference to Exhibit 3.2 to Form 10-Q for the quarter ended April 30,
2005).                                                                     
|      | 
|3.3   |  | Form of Certificate of Designation of Series A Junior participating Preferred Stock. (Incorporated by reference to Exhibit 3.01 to Amendment No. 2 to the Registration
Statement on Form S-2).                                                
|      | 
|4.1   |  | Form of Rights Certificate. (Incorporated by reference to Exhibit 4.01 to Amendment No. 2 to the Registration Statement on Form S-2).                                                                                                         
|      | 
|4.2   |  | Form of Rights Agreement dated June 7, 1999. (Incorporated by reference to Exhibit 4.02 to Amendment No. 2 to the Registration Statement on Form S-2).                                                                                        
|      | 
|10.1  |  | Cash or Deferred Profit Sharing Plan, as amended. (Incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-1 (Registration No.
33-12755)).                                                                              
|      | 
|10.2  |  | Cash or Deferred Profit Sharing Plan Amendment No. 3. (Incorporated by reference to Exhibit 10.15 to Form 10-K for fiscal year ended January 31,
1988).                                                                                       
|      | 
|10.3  |  | Cash or Deferred Profit Sharing Plan Amendment No. 4. (Incorporated by reference to Exhibit 10.16 to Form 10-K for fiscal year ended January 31,
1988).                                                                                       
|      | 
|10.4  |  | Form of Director Indemnification Agreement. (Incorporated by reference to Exhibit 10.42 to the Registration Statement on Form S-1 (Registration No.
33-12755)).                                                                               
|      | 
|10.5  |  | The Sharper Image 401(K) Savings Plan. (Incorporated by reference to Exhibit 10.21 to the Registration Statement on Form S-8 (Registration No. 33-80504) dated June 21,
1994).                                                                
|      | 
|10.6  |  | Officer Non-Qualified Deferred Compensation Plan. (Incorporated by reference to Exhibit 10.27 to Form 10-Q for the quarter ended October 31, 2003).                                                                                           
|      | 
|10.7  |  | Employment Agreement dated October 21, 2002 between the Company and Richard Thalheimer. (Incorporated by reference to Exhibit 10.26 to Form 10-Q for the quarter ended
October 31, 2003).                                                     
|      | 
|10.8  |  | Loan and Security Agreement dated October 31, 2003 between the Company and Wells Fargo Retail Finance, LLC. (Incorporated by reference to Exhibit 10.1 to Form 10-Q for the
quarter ended October 31, 2003).                                  
|      | 
|10.9  |  | Agreement dated October 20, 2003 between the Company and Tracy Y. Wan to extend medical benefits beyond employment term with the Company (Incorporated by reference to
Exhibit 10.16 to Form 10-K for the fiscal year ended January 31, 2005).
|      | 
|10.10 |  | Lease Agreement dated May 11, 2004 between the Company and Sri Hills Plaza Venture LLC (Incorporated by reference to Exhibit 10.1 to Form 10-Q for the quarter ended April
30, 2004).                                                         
|      | 
|10.11 |  | First Amendment to Loan and Security Agreement dated February 6, 2004, between the Company and Wells Fargo Retail Finance, LLC. (Incorporated by reference to Exhibit 10.1
to Form 10-Q for the quarter ended October 31, 2004).              
|      | 
|10.12 |  | Second Amendment to Loan and Security Agreement dated July 6, 2004 between the Company and Wells Fargo Retail Finance, LLC. (Incorporated by reference to Exhibit 10.2 to
Form 10-Q for the quarter ended October 31, 2004).                  
|      | 
|10.13 |  | Form of Indemnification Agreement between the Company and Officers of the Company (Incorporated by reference to Exhibit 10.20 to form 10-K for the fiscal year ended
January 31, 2005).                                                       



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##### Table of Contents

|      |  |                                                                                                                                                                                                                 
|----- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.14 |  | Third Amendment to Loan and Security Agreement dated February 18, 2005 between the Company and Wells Fargo Retail Finance, LLC. (Incorporated by reference to Exhibit 10.1
to Form 8-K filed February 22, 2005).
|      | 
|10.15 |  | Fourth Amendment to Loan and Security Agreement dated November 1, 2005 between the Company and Wells Fargo Retail Finance, LLC.                                                                                 
|      | 
|10.16 |  | Fifth Amendment to Loan and Security Agreement dated February 2, 2006 between the Company and Wells Fargo Retail Finance, LLC. (Incorporated by reference to Exhibit
10.1 to form 8-K filed February 7, 2006).  
|      | 
|10.17 |  | Offer letter dated August 18, 2005 between the Company and Jeffrey P. Forgan (Incorporated by reference to Exhibit 10.1 to Form 8-K/A filed August 30,
2005).                                                   
|      | 
|23.1  |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                       
|      | 
|31.1  |  | Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.                                                         
|      | 
|31.2  |  | Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.                                                         
|      | 
|32.1  |  | Certification by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                             
|      | 
|32.2  |  | Certification by Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.