1-800-FLOWERS.COM CEO Discusses F4Q2010 Results - Earnings Call Transcript

Aug.19.10 | About: 1-800 FLOWERS.COM, (FLWS)

1-800-FLOWERS.COM, Inc. (NASDAQ:FLWS)

F4Q2010 Earnings Call Transcript

August 19, 2010 11:00 am ET

Executives

Joseph Pititto – VP, IR

Jim McCann – Chairman and CEO

Bill Shea – SVP, Finance and Administration, Treasurer and CFO

Chris McCann – President

Analysts

Ingrid Chung – Goldman Sachs

Anthony Lebiedzinski – Sidoti and Company

Jeff Stein – Soleil

Operator

Good day everyone and welcome to the 1-800-FLOWERS.COM, Incorporated fiscal 2010 fourth quarter and full year results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the company's vice president of Investor Relations, Joseph Pititto. Mr. Pititto, please go ahead, sir.

Joseph Pititto

Thanks, Jeremiah [ph]. Good morning and thank you all for joining us today to discuss the 1-800-FLOWERS.COM financial results for our fiscal 2010 fourth quarter and full year. I am Joseph Pititto, and I’m vice president of Investor Relations. Those of you who have not received the copy of our press release issued only this morning, the release can be accessed at the investor relations section of our Website at 1-800-FLOWERS.COM, or you can call Patty Altadonna at 516-237-6113 to receive a copy of the release by email or fax.

In terms of structure, our call today will begin with brief formal remarks and then we will open the call to your questions. Presenting today will be Jim McCann, CEO; Chris McCann, president; and Bill Shea, CFO.

Before we begin, I need to remind everyone that a number of the statements that we will make today may be forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the applicable statements. For a detailed description of these risks and uncertainties, please refer to our press release issued this morning, as well as our SEC filings including the company's annual report on Form 10-K and quarterly reports on form 10-Q.

In addition, this morning we will discuss certain adjusted results and supplemental financial measures that were not prepared in accordance with Generally Accepted Accounting Principles. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures can be found in the tables accompanying the company's press release issued this morning.

The company expressly disclaims any intent or obligation to update any forward-looking statements made in today's call, any recording of today's call, the press release issued earlier today or in any of its SEC filings except as may be otherwise stated by the company.

I'll now turn the call over to Jim McCann.

Jim McCann

Good morning. Throughout fiscal 2010, the consumer was impacted by the continued uncertainty in the macro economy, particularly high unemployment and the slumping housing market. The persistence of those things has resulted in some of the lowest consumer confidence index numbers frankly on record. Consumers are justifiably nervous and as a result their discretionary gift purchasing has declined. This was clearly – this clearly impacted us particularly in our core consumer floral category.

With this in the backdrop, I’d like to point out a few things that we've achieved during fiscal 2010, adjusted EBITDA of approximately $29 million, positive adjusted EPS, free cash over approximately $25 million, and a reduction of more than $32 million in total outstanding debt. I believe these results illustrate the strength of our business model and the deep relationships we have with our millions of customers as their florist and gift shop. In addition, we continued to benefit from a number of initiatives we undertook over the past several years including several directly in response to the weakening economy. While some efforts have clearly worked better than others, overall, we continue to position our company for long term growth and enhanced profitability.

We have taken tens of millions of dollars of cost out of our operating platform during the past few years. This disciplined approach to managing our business has enabled us to generate solid cash flows, which we have used to pay down debt and strengthen our balance sheet. It has also given us additional leverage in our business model, which we believe will us to drive stronger profitability on any incremental revenue growth when consumer demand improves.

Importantly, this focus on driving operating efficiencies is now ingrained in our company DNA, and we expect further improvements from our operating programs. Our decision to invest in the expansion of our gourmet food and gift baskets category over the past several years has proven to be a good plan. We have built a great platform in this area through a combination of strategic acquisitions and internal development. As a result, we have quickly become a leading player in a category that our customers are increasingly turning to for their gifting and connecting needs. Indeed, this category has held up better in the current economy as consumers appear more willing to purchase our great chocolates, cookies, brownies, popcorn, gift baskets and – both as gifts and personal consumption.

Based on the strength of our brands, Fannie May, Cheryl's, the Popcorn Factory and our newest 1-800-BASKETS.COM business, we have been able to drive solid growth in our economic and our e-commerce channels. And our vertical integration in this category enabled us to implement manufacturing efficiencies that drive down our cost and increase our gross profit margins, as you've seen this past year.

Concurrent with our successful growth in our gourmet food and gift category, we have made a decision last year to divest what we determined to be a non-strategic asset in our home and children’s gift businesses. This is not an easy decision, but the right one for the long-term growth and profitability of our business. We used the proceeds on this sale to further pay down our term debt, and we also revised our bank credit facility extending terms and revising coverage to provide additional financial flexibility. I just like to point out that over the past two years we have used excess cash to pay down approximately $70 million of our term debt, strengthening our balance sheet and heading towards flexibility.

Looking ahead into fiscal 2011, we do not see any evidence that would indicate that the consumer economy will improve a great deal. With that in mind, we believe that we are positioned – we have positioned our company to perform well in the current environment through a number of key initiatives, some already launched and several just getting underway. Most importantly, we believe these initiatives will enable us to take advantage of any improvement in the economy over the long term to drive improved growth and profitability.

Our new 1-800-BASKETS.COM business has gotten off to a good start. While we’ve no doubt made some mistakes along the way, we’ve learned a lot since its launch back this past November. These learnings support our belief that this can become a category leader over time. Our launch strategy allowed us to cost effectively introduce the 1-800-BASKETS brand to millions of customers by leveraging the strong brand recognition, site traffic, and large customer base of 1-800-FLOWERS.COM.

Our customers are discovering the great product designs featuring our neat collection of gourmet gift brands. As a result, they are beginning to bookmark us as their destination site for a broad range of celebratory occasions, thus giving us the opportunity to capture a large share of their gifting purchases.

We’re looking forward to expanding the 1-800-BASKETS.COM product offering and building on its successful launch, particularly in our fiscal second quarter to yearend holiday period. Another important initiative, our (Technical Difficulty) franchising program. As you've noticed (Technical Difficulty) Fannie May is an iconic brand with a rich history and tremendous customer loyalty in Chicago and throughout the Midwest. In fact, at one point in its history, Fannie May had more than 300 retail locations stretching from Chicago down to the west coast of Florida, and West Arizona.

Since we acquired Fannie May, we’ve grown the retail store base to more than 80 company-owned stores primarily all located in and around Chicago and its suburbs. We see (Technical Difficulty) through a franchise program that does not require significant capital on our part. These have (Technical Difficulty) excellent economics and we believe the franchise growth strategy represents a win-win win for our customers who love our Fannie May brand back in their home towns; for franchisees who get the leverage of a loved brand and a proven business model; and for our company, which can build (Technical Difficulty) create new franchise revenue streams, increase throughput and manufacturing efficiencies in our factory and help drive our Fannie May e-commerce business. We plan to ramp this program up gradually over the next several years and we are excited by its long term growth (Technical Difficulty)

We are also continuing to innovate and invest in the future in the fast-growing areas of mobile and social networking. In these areas, we have once again staked out our leadership position in our industry by embracing the latest technologies that enhance our customer engagement and interaction. This is illustrated by our early adoption of mobile commerce technology, for which we received the Retail Info Systems 2010 Mobile App of the Year award in the best shopping category for the 1-800-FLOWERS.COM mobile site. It’s also reflected in our ground breaking applications on Facebook and our strong presence on Twitter, and in the bloggers' field where we’re increasingly invite our customers behind the curtain to work directly with us in everything from party signs to the development of our marketing and advertising programs.

In terms of building customer engagement, we also continue to grow our Celebrations.com brand. On the Celebrations.com Website, we’ve seen substantial increases in business traffic, page views as people come to the site not to conduct the transaction but to take advantage of the great content there and contribute to it. This content is from both our celebrations experts, and increasingly, it's customer generated as people are eager to share their suggestions and experiences.

As a result, Celebrations.com has quickly become a leading site on search engines for everything from Super Bowl parties to Halloween celebrations. As our business abounds, we are keenly aware of the need to invest in these areas to position our company as the leader in the emerging social commerce space where customer engagement is an integral part of our business plan and our future growth.

I would now like to turn the call over to Bill for a view of our financials and customer metrics. After Bill’s remarks, I will ask Chris to outline some of the initiatives we have underway in our consumer core category, which is now heading up. But first, Bill.

Bill Shea

Thank you, Jim. As Jim noted, fiscal 2010 is characterized by continued weakness in the consumer economy. As we’ve done throughout the recent economic downturn, during fiscal 2010 we continued to focus on leveraging our business platforms to reduce operating expenses. During the year, we achieved operating cost reduction of $6.2 million. This positions us to drive improved bottom line results over the longer term. Also during the year, we completed divestiture of home and children’s gift segment, using the proceeds to further pay down debt and strengthen our balance sheet. Currently, we are working closely with our banks to revise the credit agreement to provide initial flexibility in our loan credits.

Our results for the fiscal fourth quarter and for the full year were impacted by several one-time charges mentioned in the press release this morning. This includes $1.9 million for the early termination of our marketing and merchandising agreement with Martha Stewart Living Omnimedia. We made this decision based on the lower than anticipated customer demand for the premium priced product line, ending the program with one year remaining on the original contract. $1 million associated with the ending in December of a third-party marketing program, and $900,000 in cost related to the settlement of a legal action. These non-recurring charges are excluded from the adjusted results reported in our press release this morning and as follows.

Regarding specific financial results in key metrics to continuing operations, for the fiscal fourth quarter total net revenues were $165.4 million, down 4.1%, compared with $172.5 million in the prior year period. Gross profit margin was 38.1%, down 50 basis points, compared with 38.6% in the prior year period. This primarily reflects the weakness in the consumer economy and the resulting increase in promotional activities, as well as the impact of the one-time charges on the consumer flow of business, offset in part by a significantly improved margin performance in our gourmet food and gift basket segment.

Operating expense ratio, excluding depreciation and amortization, and for the prior year goodwill and intangible impairment, improved 100 basis points to 36.9%, compared with 37.9% in the prior year period. As a result, adjusted EBITDA from continuing operations was $4.8 million, compared with $2.7 million in the prior year period. Adjusted net loss from continuing operations for the quarter improved by $1.6 million to a loss of $1.2 million or $0.02 per share, compared with adjusted net loss of $2.8 or $0.04 per share in the prior year period. Results from discontinued operations were a loss of $1.7 million or $0.03 per share, compared to a loss of $9.1 million or $0.14 per share in the prior year period. Including discontinued operations, net loss for the quarter was $5 million or $0.08 per share, compared with a net loss of $22.2 million or $0.35 per share in the prior period.

In terms of full year results from continuing operations, revenues were $667 million, compared with $714 million in fiscal 2009. Gross profit margin improved 40 basis points to 39.8%, compared to 39.4% in the prior year, primarily reflecting product mix and manufacturing inefficiencies in that category, offset in part by the increased promotional activities and one-time charges in our consumer segment.

During the year, operating expenses excluding depreciation and amortization, and again for the part for a part of the year, goodwill and intangible impairment, were reduced by $6.2 million. However, reflecting the lower revenues for the year, operating expense ratio increased 150 basis points to 36.1%. As a result, adjusted EBITDA from continuing operations for the year was $28.6 million, compared with $36.5 million in the prior year. Adjusted net income from continuing operations was $542,000 or $0.01 per diluted share, compared with $7.4 million or $0.11 per diluted share in fiscal 2009.

Results from discontinued operations for the year were a net loss of $2.1 million, or $0.03 per share including the $5.2 million loss on disposal, compared with a net loss of $31.9 million or $0.50 per share in the prior year. Including discontinued operations, net loss of the year was $2.4 million, or $0.07 per share, compared with a net loss of $98.4 million, or $1.55 per share for fiscal 2009.

Turning to customer metrics from continuing operations, during the fourth quarter e-commerce orders totaled $2,351,000, compared with $2,393,000 orders in the year ago period. For the year, e-commerce orders totaled $8,432,000, compared with the $8,641,000 in fiscal 2009.

Average order value during the quarter was $67.69, essentially flat with $57.71 for the prior year period. For the year, average order value was $55.73, down 3.3%, compared to $57.65 in fiscal 2009.

During the fourth quarter, we had added 651,000 new customers, up from (inaudible) routine orders from existing customers who represented 64.8% [ph] of old customers. (Technical Difficulty) 2.3 million new customers, with repeat orders representing 52% of total costs.

In terms of category results, the popular launch of our new 1-800-BASKETS.COM (inaudible) fiscal 2010. The comparative results of (Technical Difficulty) flow and gourmet gift baskets category have been adjusted for the shift of our gift basket business for consumer flow into the gourmet food and gift basket category.

In our 1-800-FLOWERS.COM consumer business, revenues for the fiscal fourth quarter were $117.3 million, compared with $124.1 million in the prior year period. For the profit loss, it was 33.8%, down 320 basis points, compared with 37% in the prior year period. This primarily reflects the impact of the one-time charges described earlier as well as the increased promotional activity during this period and the loss of revenues associated with the ending of a third party offering program. As a result of the lower revenues and gross margin, category contributions were $7.5 million, compared with $13.3 million in the prior year period.

For the year, revenues in this category were $366.5 million, compared with $394.48 million in the prior year period. Gross profit margin was 35.3%, down 170 basis points, compared with 37% in fiscal 2009, again primarily reflecting the aforementioned one-time items as well as the increased promotional activity during the year.

As a result of these factors, category contribution margin for fiscal year was $22.1 million, compared with $38 million [ph] (Technical Difficulty) in the prior year. The defined category contribution margin, its earnings before interest, active depreciation, capitalization, goodwill, and intangible impairment and the before the allocation (Technical Difficulty).

In our BloomNet wire service business, revenue for the fiscal fourth quarter was $15.6 million, compared with $16.1 million in the prior year period, with profit loss was at 57%, compared with 55.2% in the prior year period. Category contribution margin was $5 million, compared with $4.2 million in the prior year period. For the year, revenues were $61.9 million, compared with $63.5 million in the prior year. Gross profit margin was 56.4%, compared with 55.7% in the prior year. And category contribution margin was $19.1 million, compared $18.8 million in the prior year.

In our gourmet foot and gift basket category, revenues for the fiscal fourth quarter were $32.4, compared with 32.8 million in the prior year. Gross profit margin increased 790 basis points to 43.7%, compared with 35.8% in the prior year, primarily reflecting product mix with increased e-commerce sales and lower wholesale revenues as a percent of total revenues as well as significant improvement in manufacturing productivity was a whole (inaudible) into this category. As a result, category contribution margin for the fourth quarter improved approximately $3.1 million and $382,000, compared with a loss of $2.7 million for the prior year period.

For the full year, revenues in this category were $239.9 million, down 7.3%, compared with $258.7 million in the prior year. This reflected the substantial decline in wholesale orders at the company's designed package gift position, which was somewhat offset by solid growth in the category and e-commerce channel.

Gross profit margin for the year increased 340 basis points to 42.1%, compared with 38.7% in the prior year, again reflecting the aforementioned product mix and significant manufacturing enhancements. With the short term gross margins more than offsetting lower revenues, category contribution margin increased $2.7 million or 11% to $27.3 million, compared with $24.6 million in the prior year.

As I stated earlier, category contribution wasn't exclusively associated with the company's enterprise services platform, which includes, among other services, IT, human resources, finance, legal, and executives. These functions are operated under a centralized management platform providing support services for the entire organization.

For the fiscal fourth quarter, corporate expenses from continuing operations, including stock-based compensation, was $10.9 million, compared with $13.5 million in the prior year period. For the full fiscal year, corporate expense was $43.7 million, compared with $48.3 million in the prior year.

Turning to our balance sheet, at the end of the year, our cash and investments position was $27.8 million, compared with $29.6 million at the end of fiscal 2009. And we had no borrowings under our revolving credit line. Inventory was at $45.1 million, compared to $45.9 million in fiscal 2009.

Regarding long term debt, we finished the year with approximately $60 million in outstanding debt. And based on our new credit facility, our closing debt payments are expected to be approximately $3.5 million going forward.

During fiscal 2010, the company generated approximately $25 million of free cash flow, with approximately $17 million coming from continuing operations, the company (inaudible) free cash flow, and net cash provided by operations less capital expenditures.

Regarding guidance, as we stated in this morning's press release, we are modifying how we provide forward guidance with the continued uncertainty in the consumer economy. We are eliminating specific guidance from revenues, EPS, EBITDA, and free cash flow.

Turning to our outlook for fiscal 2011, we do not anticipate significant improvements in consumer demand, the discretionary purchases. And therefore, we expect top line growth will continue to be challenged. (inaudible) volumes during fiscal 2011, we will continue to focus on our program to enhance operating efficiencies by leveraging our business platform or implement several initiatives designed to significantly improve gross profit margin, particularly in our consumer flow category.

We continue to invest in areas that we believe position the company for future growth opportunities, including our new 1-800-BASKETS.COM business, our mobile commerce initiatives, and our new Fannie May franchise program, among others.

Regarding capital expenditures during fiscal 2011, (inaudible) to maintain CapEx at approximately $15 million.

I will now turn the call over to Chris McCann.

Chris McCann

Thanks, Bill. As Jim and Bill have noted, we are operating our business in a difficult economic environment, one in which discretionary spending has impacted the entire retail landscape. Our response to the changes in the consumer flow or marketplace are focused on both near term and longer term initiatives. We have intensified our focus on enhancing our operating efficiencies to reduce costs and provide additional leverage for our business.

We have implemented a few management changes, wrapping our organization and adding talents in key areas, including merchandising and marketing. Also among these changes is Mike stepping in as president of our floral group and assuming direct day-to-day responsibility for the 1-800-FLOWERS.COM brand.

We have revamped our service center platform and intensified our efforts to improve our customers' total shopping experience. In this area, we are already seeing excellent results with significant, increases in our internal customer satisfaction metrics. Importantly, these efforts are also being recognized externally as illustrated by our recent number one rating customer satisfaction versus our competitors by Stella Service, an independent rating institute.

We have also increased our focus on new product development, working directly with the talented professional florists in our BloomNet network and soliciting input from our customers to create great product designs that are compelling and relevant in today's marketplace.

In addition to being responsive to the changes and consumer behavior, we also recognized that the disruption in the floral industry caused by the economic downturn offers some potential opportunities. As a category leader, we believe 1-800-FLOWERS.COM is uniquely positioned to lever our assets, including the strength of our brand, the deepening relationships we have with our customers and BloomNet florists, and our successful expansion into the gourmet food and gift basket businesses to enact changes that can provide long term benefits.

Towards this end, we're working to further integrate the 1-800-FLOWERS consumer business with our BloomNet Flowers network. We're designing programs to offer our florists new services and product lines that we are deeply positioned to provide, such as our growing line of beautifully-designed gift baskets and gift sets, our exclusive chocolates and other gourmet food gifts, our new lines of balloons from Anagram Balloons, plush stuffed animals, and our exclusive line of Yankee Candle products being offered to our BloomNet florists.

We are also working to revive florists re-supply chain, where we see the opportunity to lever our assets to improve the service and cost structure by working directly with key players, including growers, wholesalers, net market retailers, and our florists. We are continuing to evolve the BloomNet network, working to deepen our relationships with our florists and leverage our respective assets and skill sets to enhance growth and profitability over the long term.

We believe these initiatives, combined with our continued focus on our key strategic priorities, knowing and taking care of our customers, maintaining and enhancing our financial flexibility, and our continuance to innovative and invest in the future will enable us to create additional leverage within our business model that can drive and enhance the top line and bottom line performance over the long term, and thereby, enable us to be (inaudible) with the current challenging economy with the an even stronger position as the world's leading florist and gift shop.

Jim McCann

Thanks, Chris. That concludes our formal remarks. And we'll now open the call for your questions. Jeremiah, could you please restate the instructions to the Q&A portion?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Ingrid Chung with Goldman Sachs.

Ingrid Chung – Goldman Sachs

Thanks. Good morning. So a few questions on the – I was wondering if you could speak to consumer demand on a month-to-month basis in the quarter and how July looks. Secondly, I was wondering if you could talk about your design pack business and how ordering is shaping up for the holidays. And then finally, this is actually a serious question. I was wondering if you could quantify the up list from unrecoverable loss.

Jim McCann

Well, boun giorno [ph]. I understand you're bound to get on the airplane. I hope you have a great vacation. You had three questions there. The last one was on the impact of unrecoverable loss. The first one was on – before we're seeing, just (inaudible) wise, in terms of consumer volumes, Chris could handle that. And the middle question was?

Ingrid Chung – Goldman Sachs

Design packs into the holidays.

Jim McCann

Okay. I'll handle that. Chris, would you start with what we saw at the end there – what we saw into the last quarter?

Chris McCann

One thing as we look at consumer demand is it dropped the last year. Again, it continues to be soft, more so on the floral category than in our food (Technical Difficulty) stated previously, where any time there's change in economic downturn like this the consumer finds more value on food as a gift set. It's a little bit less discretionary maybe in the floral product.

Overall, roughly last year, we've seen the trend get slightly better. And we continue to operate in that environment where we see business slightly get stable consumer demand in the last couple of months.

Bill Shea

Yes, (inaudible) fiscal '09, we were down double-digit (inaudible) down each of the quarters. Q1 of last fiscal year, we were down about 10%. And then, we've been more mid-single-digit (Technical Difficulty).

Jim McCann

And in terms of design pack, we did – a couple of points there, Ingrid, one is the reason why we purchased that business was to use it as a (inaudible) of our capabilities to build out our 1-800-BASKETS and just that business. That was our primary correlation. Clearly, what we said was that the wholesale business wasn't something we're looking to grow. But I will tell you, we were not looking for it to decline the way it did. I think there are two reasons why it declined.

So the disappointment with the decline, the decline had two reasons. One is management failure to grow the customer base. We've made management changes there. We've made pricing changes there. And we think can improve that business. It will take a couple of selling cycles to fully recover. So it's disappointing. But the business will go on and the capabilities we got from our 1-800-BASKETS are all what he hoped for. What we've done too is we retooled 1-800 – we retooled the size of that business so that it can be profitable at a lower level and still have all of these supporting structures and platforms to build the 1-800-BASKETS.

We launched 1-800-BASKETS at the consumer on November 1st. It's been good a launch. And clearly, we've made some mistakes in that process. But the mistakes that were – if I could characterize, it's good mistakes. We sold out too quickly. We were too promotional when we didn't need to be. So we learned from those lessons. And we're very happy with the 1-800-BASKETS piece that have sold. So while we didn't buy the business to grow the wholesale business, we're disappointed in its decline. We think we have things in place to remedy that. It will take a couple of cycles to sell through.

But the other reason why it declined is some of our biggest customers just pulled back dramatically in the gift basket gift set category fearing the consumer demand going more towards staples and less towards gifting product. We are starting to see a little recovery in that. And I think it's mostly – where we're seeing improvement is when we share data with those customers of where that gift packet product sells so well for us beyond Christmas, at Valentine's Day, Father's Day, spring holidays. We're starting to see an uptick in the interest in carrying those products of those products throughout a broader sense of gifting seasons. And that we think speaks well for the future of our business.

And in terms of unrecoverables, there are a number of things. One, I think Chris did a fantastic job this (Technical Difficulty). He was (Technical Difficulty) for a couple of weeks there doing the hard work. And I got the – I had the opportunity to do the easy work and (inaudible) in the process. (Technical Difficulty) like what we do every day.

So the impact has been nothing short of extraordinary. Clearly, it makes – it impacts the consumer, but the impact to us from our team members around the world has just been – just overwhelming. The consumers we've heard from thousands and thousands of consumers. And yes, there have been several proposals of marriage to Chris and (Technical Difficulty) we are keeping score on that.

But the really interesting response that we've gotten in business is from our florists. We've heard from thousands, literally, of florists, mostly from – again at BloomNet, but not all. And what they're saying is how proud they were about how florists were positioned, with these dedicated, caring community members and professionals. The craftsman side of our business, well it is what we actually do; how we impact people's lives, how we put smiles on faces every day. So the overwhelming sentiment of pride and enthusiasm from florists I think has been the biggest and most pleasant surprise.

Many of them are asking to possibly increase the depth of our relationship. And that's not just coming from those or are already a part of BloomNet, but from those not part of BloomNet seeking out information as to how they can be a part of BloomNet. So we've had huge response to us. And the (inaudible). And that whole cycle has started again. So today, about 30 million people have seen between the first area, the second area, and individual views that they've done on ULU and cbs.com in between. So from a brand point of view, it's been nothing sort of overwhelming.

Ingrid Chung – Soleil

Great. Thank you.

Operator

Our next question comes from the line of Eric Beder with Brean Murray.

Unidentified Analyst – Brean Murray

I'm actually filling in for Eric today. I was just hoping to get a little bit more color on what you were happy with during the quarter, especially in regards to the gourmet food and gift baskets category, which was performing well. Where do you think the opportunity is looking ahead for the fall and holiday season? And what do you think you could have done a little bit better?

Jim McCann

I think we made a lot of (Technical Difficulty) this year. With the food category that you asked about, that's one of the plusses on my list. When I say that list, we achieved operating efficiencies. We've actually (Technical Difficulty) retail business. So that business is running well and getting better all the time. Our franchise initiative that we just introduced in Fannie May will help us to grow our business in a capital efficient way going forward.

So as you look at – over the course of the year, the biggest impact in the food category has been the second fiscal quarter or the fourth calendar quarter, which is the holiday quarter. So we are – we feel good about where we're positioned for this holiday period, especially with – and we feel, frankly, the decisions we've made over the last several years to emphasize that part of our merchandising mix in our flower and gifts shops that has emphasized the gourmet food and gift product category in our shop and in our brand has held itself well. And the fact that we think we can grow those businesses even in this tough time in (Technical Difficulty) capital efficient ways without big risk associated with them says our decisions that we made over the last years were good ones.

So we think our business is good, stable, and doing well, even in the tough time. It's gaining market share. They're increasing opportunities for us there. It makes good use of our customer relationships. It makes good use of the flexible balance sheet we have. And (Technical Difficulty) we're really well-positioned to grow at a prudent and safe way with the existing brands, the new (Technical Difficulty) brands that we've built in our category in the last (Technical Difficulty).

Chris McCann

Just a couple of other specific things, Jim already noted that we're happy with the food business. We did recently re-branded Cheryl & Company to be Cheryl (Technical Difficulty), representing our focus (Technical Difficulty) go out there is that we've had – Cheryl is putting their focus not just on cookies, but now into brownies, and trying to stake out a leadership in the brownie gifting sector. And that's growing nicely. And the Cheryl's branding is where we keep in our customer base.

Jim McCann

And it's early to say, but one of the things that we've done on Cheryl is we have a few retail stores (Technical Difficulty) with our Cheryl's brand. And our management team that we charged with coming up with (Technical Difficulty) concepts in eco-stores are even more attractive and more successful. So that we can have a decision, it's whether or not we roll it out either in a franchise model in some other way.

When we re-launched our flagship store, which was in Eaton Town Center. And it only reopened about five weeks (Technical Difficulty). And frankly, those first five or six weeks down there – six weeks ago, the results are terrific. Too early to say, but it's an example of the state – what we're doing to build future opportunities to explore our growth initiatives.

We think we're going to have good success – we know we've got good success in going – maybe the retail side of the business. We think we can be very successful in growing our franchise model. But I want you to know that we have other things in the oven in terms of other growth opportunities in the gift food market sales. (Technical Difficulty) – we now have two of those business on our newly (Technical Difficulty) platform. It became a good (Technical Difficulty) really did when we announced the growth in e-commerce. (Technical Difficulty).

Unidentified Analyst – Brean Murray

Okay. In regards to Fannie May retail store franchising part, how large are you thinking it's going to be for next year? And then next year, for the long term, what are your thoughts on that?

Jim McCann

Huge, or maybe not so huge. The Fannie May business is – as we've said, we've grown it to about 80 stores now, mostly in and around Chicago. The original footprint of – when the company was owned by a private equity from the past, they already owned over 300 stores. (Technical Difficulty) 300 stores were, we know that they were – one market's around the sale perhaps. We have a blueprint of where we can very safely expand that blueprint, leveraging on manufacturing capability, extending all brands, and getting us the opportunity to grow our e-commerce business in this capital efficient way of using the franchise model. It's something we're familiar with.

So we just – we've just got registered in the last couple of – few weeks to do that. So we expect, in the first year, to have a very modest growth. We'll pick up a couple of few new markets. We want to make sure we have the right partners. We'll continue to expand our – a few (Technical Difficulty) stores in the market that we have, strong, strong indications that they'll do well at the same time. So it'll be modest growth this year. But this is the year to put the next layer of bricks on that foundation for what we expect to be cautious, but even more robust growth next.

Unidentified Analyst – Brean Murray

Okay. And then one last question, the consumer floral budget business has been heavily dependent on promotions. Can you highlight any specific promotions that pretty much we're responding well to? And how are you thinking about promotions going forward eventually? Do you plan to wean them off of them? And how do you plan on – how are you thinking about that?

Chris McCann

If we look into consumer floral business and we look at what's been taking place in the competitive landscape, it becomes a very promotional category (Technical Difficulty) we can say we're continuing to build that – deepen our relationship with our customers. And with the renewed focus on our product development efforts, really, it will eventually break out. Working with our BloomNet flowers, it's a great product of value to the consumer.

By value, I do not necessarily mean cheap price. I mean good value for your money, good creative design. We believe we'll be able to shift and be less reliant on discount promotional – discounts. We’re always going to work with good promotional partners to extend our reach and extend our brand. Things we're doing in our purchasing business is an example of that and other companies that we’ll look to work with on a promotional basis going forward.

Unidentified Analyst – Brean Murray

Okay. Are there any specific call out promotions that you thought were especially helpful in driving sales, or …?

Jim McCann

Yes. I think that we've learned that it’s part of one program that is successful. Any way that we reached out and engaged our customer in a creative kind of way, whether there’s a purchase or not, helps us to build our brand, extend our customer reach, and develop our potential future customers down the road. So I’d say that it’s a matter of approach that you’ve seen us use for each of our holiday periods and (Technical Difficulty) grab large samples of the promotional effort you’ll see. Not necessarily price promotion, but engagement opportunities to please our customers.

Unidentified Analyst – Brean Murray

Okay. Great. Thank you very much and the best of luck.

Jim McCann

Thank you.

Operator

Our next question comes from the line of Anthony Lebiedzinski, from Sidoti and Company.

Anthony Lebiedzinski – Sidoti and Company

Good morning. My first question is about 1-800-BASKETS. You had mentioned that you have learned a few things from a launch back in November. Can you tell us about what you've learned and what would you plan to do differently going forward?

Jim McCann

I’d say on the marketing side, Anthony, one of the things we've learned is, one, consumers love the product. The acceptance to the product, the rave reviews coming from customers have been really encouraging. The second thing on the marketing side is that we don't need to take big risk in marketing that brand and that line of product, and that we have one of the most highly trafficked e-commerce Web sites in the world at 1-800-FLOWERS.COM. And we've also learned that by exposing our customers base who already bought that gift product usually elsewhere, now can see that we carry it on a brand that is clearly a sister brand, the 1-800-BASKET and it gives Chris particular confidence that the multi-branded portal strategy that he has been steering us down is the right way to go. Because we’re able to build a new product category and a new brand without big marketing risk. We're just leveraging existing traffic.

The second thing on the operation side we learned is that it was much better received than we thought it would be. And therefore, we sold out way too quickly and so we didn't get a good read of what the demand was for the holiday. And we were promotional on that product thinking that you had to be promotional in that line when we learned that we really didn’t need to be that promotional. Good product is good value, it drives consumer demand. You don't necessarily need promotional activity from a price point of view and around it.

So those are the thing we learned. What we're also seeing is that customers are responding to good price points. Our average order values, were good than what we expected, but we can really increase the range of our average order values in the gift pack product line. And we can significantly improve our gross margin as long as we bring good quality, creative products to our customer.

Anthony Lebiedzinski – Sidoti and Company

Okay. And as far as your initiatives really for fiscal ’11, obviously you're not giving any specific guidance. But you did mention that you are looking to enhance your operating efficiencies and also improve the gross margins. Can you just give us some details, some specific initiatives as to how you plan to go about this?

Jim McCann

What we're saying here, Anthony, is (Technical Difficulty) difficult marketplace out there. It's difficult for us to forecast. Frankly, I see that even the professionals – the professional forecasters have such a broad range of expectations about what will happen in the next year. They seem to be befuddled. We're obviously not better than they are. So that's why we're reluctant here.

We know 5 or 10 things that are positive that could really influence the year. We also know five or six things that have been a negatively impact – actors this year. A little example, if we do as well as hope this year, we're going to pay out big bonuses. That will have a negative influence on the bottom line that we clearly have to overcome with performance. So we have a list of negatives and a list of positives.

We also know that we – we can't know all the negatives that'll come. I mean, clearly, that's something we know. We can't know everything that could negatively impact our business in the macro environment. So we have some initiatives we'll continue to launch, our new businesses, our celebrations business, our 1-800-BASKETS business. We have a handful of key initiatives that we're focused, that Bill spoke about, that Chris spoke about a little bit earlier on, where we think we can really significantly take advantage of the challenges that exist in the environment. People in the floral side did not just – they have really positioned us for possible – for future growth and for future profitability. And we're investing in those now because we can.

And finally, on the operating side, we made mistakes last year in gross margin. They are flexible. But we think we did some good things on our operating expense line. And you're starting to see the margins improve already. We think that can improve significantly.

And on the operations side, it's now part of what we do. We took out a lot of money in our operating expenses for the last two, three years. We'll continue to do that, and we can take more out. So we have a list of things that we say our process. We have a list of things that could negatively influence it, but we're preparing for it. And there're some things that we don't know.

But net-net, we'll continue to manage our expenses. We'll continue to innovate in our product line. We'll work hard on improving our gross margins and we will see success there. And we'll continue to invest behind these half a dozen or so key initiatives that we think take advantage of the challenges in our marketplace and speak to the assets that we uniquely have to take advantage of.

Anthony Lebiedzinski – Sidoti and Company

During the year, you guys did a good job of generating free cash flow. I realized that you haven't given guidance for free cash flow. But what would your objective be for free cash flow usage during fiscal '11?

Jim McCann

Well, I think you have to look historically first to get the best indication. And what we've seen here is, over the last two years – and I'll answer this because Bill is suffering terribly here from a cold. And he'd like to, but he's suffering. What we've done with free cash flow is, we've said – we used to say we have three usages for our free cash flow, return it to our shareholders, make strategic investments, or improve our balance sheet and pay down debt.

Well frankly, in this environment, we're not looking to return it to shareholders. We're looking to maintaining our flexibility, increase our flexibility. So this year, we paid down $32 million in term debt. And over the last two years, it's over $60 million that we paid down our debt. So the evidence, historically, is as we're fortunate enough to generate excess free cash flow, we're using that to strengthen our balance sheet.

Going forward, we'll continue to strengthen our balance sheet. We'll continue to be prudent in the use of that cash. And generally, we hope to increase our cash generation over time from our operating side of the business and use that to draw business either by improving the flexibility in our balance sheet or perhaps there's something we find that would be a perfect fit with one of our platforms that we already have in place that offers a broader package and leverage in revenue activities we get into.

Anthony Lebiedzinski – Sidoti and Company

Okay. Thanks.

Jim McCann

Good.

Operator

(Operator Instructions) And our next question comes from Jeff Stein from Soleil.

Jeff Stein – Soleil

Jim, I'm wondering on the franchising side with Fannie May, is now the right time to launch a franchise program. It's pretty tough for entrepreneurs to get financing these days. And further, you certainly want them to be successful coming out of the gate. And it seems to be a very difficult environment to be opening up a store selling highly discretionary products like candy, so any thoughts on that?

Jim McCann

Indeed, Jeff. And thank you for the question. What you say is exactly the case and what we see as well. And there are challenges. And that's why we're being very reserved in our expectations and what we're speaking about in terms of what successes we expect here.

But let's look at the factors we have here. Our chocolate business has held up very well during these past couple of years. The store (inaudible) Fannie May are really good, really sound. We've had great success in all of the stores we've opened up and all of the contents we've introduced in Fannie May, including broadening the product lines to include really good quality Fannie May dessert business and ice cream business, in particular, which carries that business through the summertime.

So business is good. It's a growing business. The flowers business is going particularly well. The store has helped that goal. And yes, it's a difficult environment for people to get financing. But what we're finding in our early discussions, Jeff, is that there's lots of interest. Lots of people are getting pushed out of the corporate America. A lot of them have a buy-on package. A lot of them are realizing, "Hey, I have to provide for myself. There's not going to be this any magical refining program. I need to control my own destiny." And that's usually when franchise businesses, usually, are trying to pick up growth. They pick up enough momentum during tough times because of that displacement of individuals.

We're probably not focused on a lot of mom-and-pop people. Those people, during the early stages, we have been having discussions with very well-financed, experienced operators who'd likely do a market in the area, so we'd like to build our market in the areas that we want to go where we have great evidence in success in.

So we've counter-cyclical. We've been doing well the (Technical Difficulty) separation. The potential franchisees come with financing in place and with a good track record in a variety of different concepts. So we think we're taking a good impact here and why we think we're going to be pretty successful.

Jeff Stein – Soleil

Got it, one final follow-up question. Thank you for that. Can you talk a little bit about the health of the florist network because clearly, with floral being the toughest area right now, one has to think that many of your florists are suffering? Have you been experiencing higher than normal contraction due to bankruptcies, shop closings? And are they paying – are the vast majority of them current on their payments?

Jim McCann

Jeff, I think it's fair to say, as we pointed out for a while now, that floral industry is experiencing challenges in all of its quarters, that is florists are struggling, distribution has become a challenge, wire services have been challenged, obviously, we introduced hours on these (Technical Difficulty) five years ago. It is growing. It continues to take market share. We think by a lot or maybe through foresight, our assets are particularly well-suited to take advantage of this cost structure.

And specific to the retail florists, we have a depth of value proposition. And our (inaudible) speak to the specific (inaudible) proposition and how it's holding up. But what we're seeing is, a number of florists are struggling. And we heard that even with their contact was around – unrecoverable loss. They continue to struggle. And yes, we continue to see closures. But our network, in size, has held up pretty constant. Our receivables are well in check and have – we haven't seen the evidence there. I think it's because – although Chris talked about, we're offering the best value proposition. And it gets better every day.

So we think that the challenges that are impacting us and other people in the retail florist base actually give us some very interesting opportunities. And I will tell you that I think – we all think that almost – that the handful of key initiatives that we are hard-focused on this year, believe me, is at the top of my list.

Chris McCann

I think Jim, clearly, one of the things he'd said that has been our strategy into this business, right? Our strategy, different than our competitors has not really been around large numbers of buyers on that line. We're only focusing on the quality aspect of the network (Technical Difficulty). So I think that clearly had benefited us. If I think – seeing the shop closures and stuff, and how did that work? It still exists, but the pace has slowed down.

And that allows us to focus really delivering value now to that network of customers, again, introducing our (inaudible) candle products, (inaudible) exclusive (inaudible). This is a whole retail for introducing our line of gifts baskets on, which was 1-800-BASKETS, and how we can bring that to the table.

We just recently introduced Anagram balloons. And we're providing those products. And again, combining that, as I mentioned earlier, Jeff, now we're integrating a deeper relationship with the consumer flower brand so that what (Technical Difficulty) Yankee Candle products have helped that turn in the (inaudible). We've got Anagram balloons that helped that turn into flowers.

So really to have integration and to focus on good products, this element with our florists that provide great value to our customers puts us in that unique position to lever those (inaudible) as Jim mentioned.

Bill Shea

It's a continuation, Jeff, of what we've been seeing for the last few years, that is have a (inaudible) shop. We're responsible for the merchandise of that shop, with our flowers and plants, giftware, our greetings, products like balloons, our plush stuffed animals, our confectionary products, our gourmet gift food products, and because that's anchored on a merchandising area for our shops, which is all in the advantaged platform.

So what you see is a continuing execution against that vision, and now working with our florists to make sure that they can benefit from our success in the balloon category, our success in the chocolate business. And as that gets deeper and deeper into our florist to get a little turbo-charging going on because now we can go more aggressively to market, for example, as Chris just mentioned, we Yankee Candle products. So we introduced the Yankee Candle arrangement during the holidays. And there's a good continued take there.

And there's a whole imbedded customer base as the Yankee Candle fans, our florists can now benefit from the things that we can do on a national basis on a product share and on the distribution basis by bringing in products that are here for them. And very few florists are able to carry that product line now that we can – we have it for them. Frankly, we have it for them exclusively. So as we get – it's a little kick in the egg [ph] as we get the product in the marketplace as we achieve a certain penetration level, we can now put national marketing behind that product and turbo charge the sell through for them and the pull through for them.

Jeff Stein – Soleil

Thank you.

Operator

(Operator Instructions) And sir, I'm showing no further questions in the queue.

Jim McCann

Well thank you, Jeremiah. As you can see, we're sober about what the situation is in the broader marketplace. We're focused on managing our expenses, broadening our pipeline, investing for our future on our growth categories, and pursuing on key initiatives. So what we talked about that there are challenges that we've enumerated and discussed here, we think, frankly, we're pretty well-positioned and maybe uniquely positioned to turn those challenges into opportunities for us and for our shareholders.

In closing, I'd like to mention that I encourage you to come to our site, in 1-800-FLOWERS.COM and other sites of brands, and see how some of (Technical Difficulty) campaign for the summer is running right now. It's been a lot of fun. It's something we're having good success with. And I encourage you to put a smile on someone (inaudible) face with one of our Happy Day bouquets.

So enjoy the rest of your summer. And we look forward to chatting with you soon.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.

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