F1Q2010 Earnings Call
October 21, 2010 11:00 am ET
Joseph Pititto - VP, IR & Corporate Communications
Jim McCann - Chairman & CEO
Bill Shea - SVP, Finance & Administration, Treasurer & CFO
Chris McCann - President, Director
Ingrid Chung - Goldman Sachs
Eric Beder - Brean Murray
David Cannon - First Midwest Securities
Good day everyone and welcome to the 1-800-Flowers.Com Inc. fiscal 2011 first quarter 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 and Corporate Communications Mr. Joseph Pititto. Mr. Pititto, please go ahead sir.
Thank you, Melina. Good morning and thank you everyone for joining us today to discuss 1-800-FLOWERS.COM’s financial results for our fiscal 2011 first quarter. For those of you who have not yet received a copy of our press release issued earlier this morning, the release can be accessed at the Investor Relation section of our website at 1800flowers.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 the structure, our call today will begin with brief formal remarks and then we'll 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'll make today maybe 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 supplemental financial measures that were not prepared in accordance with the 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 this morning.
The company expressly disclaims any intent or obligation to update any of the forward-looking statements made in today's call, or any recordings of today's call, the press release issued earlier today or any of it’s SEC filings except as maybe otherwise stated by the company.
I'll now turn the call over to Jim McCann.
Good morning everyone. Our first quarter’s results were in line with our expectations and with the trends that we have seen in our business segments. During the quarter which is typically our lowest in terms of revenues, we saw continued soft demand in our consumer floral business. This was somewhat offset by stronger sales in our BloomNet wire service business and solid e-commerce growth in our Gourmet Food and Gift Basket segments.
A little later in the call, Chris will highlight some of the initiatives we are implementing to help stimulate demand in our consumer floral business including new product development efforts and a re-tooling of our marketing programs. In terms of gross profit margin, we’ve told you that we are keenly focused on driving stronger margins across the enterprise and particularly in our consumer floral business. During quarter, we increased gross margin in the consumer floral by 120 basis points and consolidated gross margin grew a 130 basis points compared with the prior year period.
This was achieved through a combination of initiatives including among others more efficient use of promotion strategy we discussed in our last conference call. Combined with strong gross margins we are seeing our Gourmet Food and Gift Basket businesses that we have seen in those basket businesses. We expect to see continued improvement in consolidated gross margins throughout the fiscal year.
In terms of operating expenses, this is another key focus area for us where we have been successfully leveraging our business platform to reduce costs. Through the first quarter, we were able to keep operating expenses flat compared with the prior year period. We achieved this while continuing to innovate and invest for the future across a number of initiatives that we believe will help us drive growth in the years ahead.
Among these initiatives, our efforts in franchising, our technology investments in mobile and social commerce where we are recognized leader in this space. Our program is to enhance the floral industry supply chain and in Celebrations.com, our party planning, content and customer engagement sight where we are currently attracting more than 1 million unique business a month. Now we are the number one search result for the Keyboard Halloween parties.
We believe these efforts and others like them that we have underway, position us well for growth opportunities in the future. Regarding our investments as we head into our key yearend holiday season, we continue to see the benefits of the investments we have made and continue to make in our Gourmet Food and Gift Basket businesses, we have seen solid e-commerce growth in this category particularly in our Cheryl’s and [1-800-Baskets springs]. This growth is largely offsetting the softer demand we have seen in wholesale baskets.
Importantly gross margins and contributions margins in our Gourmet Food and Gift Baskets category continue and increased to a combination of sales growth, product mix, manufacturing efficiencies and reduced shipping costs. We expect these positive trends to continue throughout the fiscal year. I think it’s important to note that our newest brand in this category, 1-800-BASKETS.COM is still very much in infancy with significant growth opportunities in the years ahead.
Since we launched this business a year ago, we have learned a lot and quite frankly we are still learning. As we apply those earnings we refine and expand our product offering. We are seeing improvements in unit sales, average order value and gross margin. Most importantly, we have been able to cost efficiently introduce millions of customers to the 1-800-BASKETS.COM brand and our expanded range of gift baskets and gourmet food items by launching it on our dual branded websites. By in effect piggybacking on our flagship l-800-FLOWERS.COM brand, we are able to leverage its strong brand equity, our more then 30 million customer base, our technology platform and our substantial site traffic.
It’s worth knowing here that this strategy is part of an overall expansion of the products and services that we offer in our virtual flower and gift shop. Our flowers and our plants, balloons, stuffed animals, candles, chocolate, candy, bakery gifts and gift baskets help our customers with the products and services that they need to express themselves and to deliver smiles.
As you are seeing, with the weaker economy affecting discretionary purchases of flowers, our strategic expansion into Gourmet Foods and Gift Baskets has enabled us to actually deepen our relationships with our customers for an expanded range of the celebratory and gifting occasions.
We plan to build on this solid base during the upcoming holiday season and we continue to see significant growth opportunities and gift baskets as well as our entire gourmet food and gift category. I will now turn the call over to Bill for a view of financial and operating metrics. Bill?
Thank you, Jim. As our press release indicates Jim characterized the continued softness in demand in our consumer floral segment which will soon offset by the stronger performance in BloomNet and e-commerce channel for our Gourmet Food and Gift Basket category.
During the quarter, we also saw early positive results from our efforts to improve gross profit margins in both our consumer floral and Gourmet Food and Gift Basket categories. On this topic is worth noting that the gross margin percentage increase in consumer floral was achieved despite having to absorb the loss of approximately $1 million in high margin revenue associated with the third-party marketing program that we ended back in December last year.
As a result of our efforts in this area, we anticipate continued improvement in gross profit margin on a consolidated basis throughout the fiscal year regarding specific financial results and key metrics from continuing operations for the first quarter.
Total net revenues from continuing operations were $104.5 million, down 3.5% compared with $108.3 million in the prior year period. During the quarter our e-commerce orders totaled $1.136 million compared with $1.249 million in the year ago period. Average order value during the quarter was $62.67, up from an AOV of $59.93 in the prior year period.
During the quarter, we added 340,000 new customers. This was achieved while currently stimulating repeat orders from existing customers who represented 64% of total revenues compared with 63% in the prior year period. Gross margin for the quarter increased to 130 basis points to 41.7% compared with 40.4% in the prior year period. This is due to the combination effects, including product mix, reduced royalties as a result of last year’s termination of the Martha Stewart marketing agreement, reduced promotional pricing, manufacturing efficiencies and reduced shipment costs.
Operating expenses before depreciation and amortization were essentially flat year-over-year at 46.7 million compared with 46.6 million in the prior year period. Importantly, as you noted earlier, we were able to hold operating expenses flat while continuing to innovate and invest for the future in a number of key initiatives that offer growth opportunities. We continue to be highly focused throughout the enterprise on leveraging our business platform to effectively manage our operating expenses and we will continue to look for cost efficiencies throughout the enterprise to offset our investments and enhance our bottom line performance.
[Effecting] the lower revenues in the quarter, operating expense ratio for the period excluding depreciation and amortization increased a 170 basis points to 44.7% compared with 43% in the prior year period. This also includes non-cash compensation expense of $700,000 pre-tax compared with approximately $1 million pretax in the prior year period. For the quarter, depreciation and amortization was $5.1 million compared with $5 million in the prior year period. As a result of these factors, EBITDA loss from continuing operations for the quarter was $3.1 million compared with a loss of $2.8 million in the prior year period. The increased EBITDA loss includes the impact of approximately $1 million in revenues associated with the discontinued third party marketing program I mentioned earlier.
Net loss from continuing operations improved to $5.1 million or $0.08 per share compared with a net loss of $5.7 million or $0.09 per share in the prior year period. The lower net loss and lower EPS loss for the quarter reflects reduced interest expense compared to the prior-year period due to reduced debt and a higher effective tax-rate resulting in a larger tax benefit in the first quarter compared to the prior year period. Net loss from continuing operations was $5.1 million or $0.08 per share compared with a net loss of $7.3 million or $0.11 per share in the prior year period.
And to category results, in the 1-800-FLOWERS.COM Consumer Floral business during the first quarter, revenues in the category were $62.6 million compared with $68.0 million in the prior year period.
Gross margin for the quarter improved to 38.1 percent compared with 36.9 percent in last year's first quarter. This improvement reflects the fact as I mentioned earlier including the progress we are making in our initiatives to reduce promotional pricing. We expect to see benefits of these efforts in the aforementioned factors in the form of improved gross market volumes throughout the remainder of fiscal 2011.
Category contribution margin was $5.4 million compared with $7.3 million in the prior year period. The reduction in category contribution margin was primarily related to lower revenues, including the loss of revenues associated with the discontinued third-party marketing program mentioned earlier and the increased investments in future growth initiatives that we have discussed.
The Company defines Category contribution margin as earnings before interest, taxes, depreciation and amortization and before allocation of corporate overhead expenses.
Now BloomNet Wire Service business. Revenues was $15.0 million compared with $13.8 million in the prior year period, primarily reflecting increased wholesale product orders from florists, including the Company's new exclusive line of Yankee Candle products. Gross margin was 56.6 percent, compared with 58.2 percent in the prior year period, primarily reflecting product mix. Category contribution margin was $4.3 million compared with $4.1 million in the prior year period.
Now Gourmet Food and Gift Baskets segment revenues were $26.9 million, compared with $26.7 million, primarily reflecting increased ecommerce orders across the category somewhat offset by lower wholesale orders and lower retail store sales due to unseasonably hot weather that impacted Fannie May store traffic in July and August.
Gross margin increased 220 basis points to 41.6 percent compared with 39.4 percent, primarily reflecting a combination of product mix, manufacturing efficiencies and reduced shipping costs achieved through the Company's sourcing initiatives. Category contribution margin improved to a loss of $2.1 million compared with a loss of $2.9 million in the prior year period.
Turn to corporate expense. As I stated earlier, our category contribution margin results exclude cost associated with the company's enterprise shared services platform which includes among other services IT, HR, Finance, Legal and Executive, these functions are operated under a centralized management platform, providing support services to the entire organization. For the fiscal first quarter, corporate expense from continued operations including stock based compensation was 10.7 million compared with 11.4 million in the prior year period.
Turning to our balance sheet at the end of the first quarter our cash and investment position was approximately 9.1 million. Our borrowing under our credit facilities were $57 million in term debt and $30 million outstanding under our evolving credit line. The volumes under our credit line looks like the seasonality of our business specifically the increase in investments and inventory and other working capital for the upcoming holiday period.
Inventory from continuing operations was approximately 71 million was in line with managements expectations and reflect the aforementioned build up for the year-end holiday season. At this rate we will finish the current fiscal second quarter with significantly reduced inventories with zero volume under our revolving credit line and a strong cash position. In terms of our outlook for fiscal 2011, we expect continued challenges to top line growth particularly in our consumer floral business. Which we anticipate will be somewhat offset by revenue growth of the ecommerce channels for our Gourmet and Gift Baskets brands.
In summary, as we enter our key fiscal second quarter we remain focused on improving gross margins of the enterprise, managing operating expense by leveraging our business platform and seeking cost efficient ways of to simulate consumer demand across all of our brands and businesses. I will now turn the call to our President Chris McCann.
Thanks Bill. As we enter fiscal 2011 we said that there were several specific areas where we would be focusing on efforts to improve our performance, particularly in our consumer floral business. Toward these goals during the first quarter we launched several initiatives that are already providing good results.
We have made additional investments in our customer service platform significantly stepping up training for our network and sales service specialists. By making the visibility and accountability of our sales and service specialists and providing them with the recognition they deserve with building a culture that is offset with providing the very best service at every touch point. As part of this effort Jim and I both communicate personally on a regular basis with our sales and service specialists to let them know just how important they are in terms of are in terms of engaging with our customers and helping us deliver smiles everyday.
The results of these efforts have been a steady improvement in our internal customer satisfaction metrics. Importantly our efforts in this area have also been recognized externally within the ecommerce industry where 1-800-FLOWERS.COM was recently rated number one among our competitors with the score of excellence for customer satisfaction by STELLAService and independent rating institute. On the product front we have significantly upgraded our product development team adding a fusion of new talent as well as working more closely with -- more closely than ever with our BloomNet professional florists to our expanded design council. Historically 1-800-FLOWERS.COM has always been the leading product innovator in our industry with such unique product as our signature flower birthday cakes, our flower cup cake line and our happy hour arrangements. Our design team is focused on creating truly original products flowers that help our customers express themselves perfectly to the important people in their lives and we are inviting our customers behind the curtain engaging with them directly, asking them to help us rate and chose the best product designs.
Some of the early results of these efforts can be seen on our site currently and I invite you to take a look at what I believe is the best Halloween collection we have every offered. Along with truly original product designs and our obsession with service, we are also re-tooling our marketing programs to stimulate demand and drive better effectiveness. This includes reallocating some of our marketing investments into areas where based on the testing we’ve done, we anticipate better returns, both offline and online.
For example, some of you may already have heard our new radio spots, part of the campaign we launched a few weeks ago that is already generating some nice buzz for our brand.
Overall we are confident that the initiatives in marketing, merchandizing and customer service along with the efforts to improve gross profit margin which Jim and Bill touched on earlier, will enable us to improve the performance of this business segment and position us from renewed growth in the years ahead.
I will turn the call back to Jim now for some wrap up.
Hope we continue to focus our efforts on managing the key aspects of our business that we can control, our operating costs, our relationship with our customers, our technology innovations and our financial structure. We believe this focus combined with the initiatives we have outlined will create additional leverage within our business model and provide for a long term growth opportunities that will enable us to emerge from the current economy with an even stronger position as the world’s leading flower and gift shop.
That concludes our formal remarks and I invite you now to ask any questions you may have. Maria, could you restate instructions for questions.
Thank you sir. (Operator Instructions) our first question comes from Ingrid Chung with Goldman Sachs.
Ingrid Chung - Goldman Sachs
Thanks good morning, so first of all actually I have a few questions I was wondering if you can talk about operating efficiency in the back drop of continued weak consumer demand how much more is there in terms of what you can do in terms improving efficiencies if you could put in terms of the baseball game which inning do you think you are in. the second question I have is just wondering if you can talk about the pull back in promotional activity while I understand that it doesn’t make sense to over promote in a soft economy or is wondering if there is a time in the future where you see it does make sense to increase promotional activity again and then finally on a longer term basis I was wondering if you think the consumer floral business can return to its former revenue levels in a better economic environment and if not do you think the Baskets business can grow quickly enough to make up for that softness?
Ingrid we are only allowing one question.
Ingrid Chung - Goldman Sachs
All right we’ll keep pulling it. Bill could you take the first part?
Just with regard to operating efficiency and more on that more in the border term of the leverage within our business model I think what we are already been demonstrating is if only the Gift Basket channel, we have been generating better bottom line results despite the fact we had some top line issues because of the wholesale Basket side of the business we demonstrating it within BloomNet by continuing to have short contribution margin despite the impact of the lower florist orders that we have, we’re continuing to demonstrate strong cash flow from continuing operations and these are somewhat offset by the fact that over the last two years we’ve had weaker performance on floral. While stated in the call this morning also is that we are going to continue to invest in certain areas to help drive future growth. So whether it be franchising efforts for both the consumer floral and our food group, investments in mobile and social commerce, floral supply chain in Celebrations.com. So we are going to continue to invest and we are offsetting these things with some operating efficiencies.
I think the real focus of taking quota out of business has shifted to kind of the gross margin side of the business and generating operating efficiencies within gross margins, that’s why you hear us talk about our manufacturing efficiencies, we’ve talked about the lean manufacturing in that area. So there is still quotes to be taken out of the business, but more of the focus is on the gross margins right now.
To summarize there, I think a couple of points that I’d add to Bill’s. One is if you took out the wholesale team of baskets which way underperformed in the last couple of years. Our consumer business, our direct-to-the-consumer business which is obviously our primary focus is growing nicely in our GFGB mix of all of those brands, so that business is growing. The growth is disguised by the mix in the wholesale basket side. Again we rather it didn’t happen. We will take steps to improve that over the next couple of years, we don’t want to grow much larger than we had say a couple of years ago because it distorts our business. But it gives us good energy and feel in our overall platform.
So growth in the GFGB, X the wholesale basket piece and as you see Ingrid, we have a mix of products and at different times there will be different growth opportunities for each of those products. Floral has seen some stress in the last couple of years, but to answer your question specifically I think it can return to its former levels and I think the things that Chris and the team is doing product innovation that is knitting us more and more closely to our BloomNet network, all the different programs we have going on there, I think certainly restored it to where it was and grow it beyond.
And regarding promotional activities specifically, we are retailers. So there’s always a role of promotional activities. However, you will continue to see us get more and more focused on managing our brands and the value proposition that those brands deliver to our customers. So while there will always be a place for promotional activities, they were used, much more judiciously in the past. The value really for us customers means, they’re getting value for their dollar. It’s not about low price points, it’s not about discounts. So you’ll continue to see that evolve in our brand messaging.
And then again, to just point adding onto the consumer flow, while we believe consumer flow can perform better than it has over the past year or two certainly, now again, we look at our business from an overall perspective especially when you look at the dual branded website between 1800baskets and 1800flowers. As long as the consumer is purchasing from either of those product categories and increasing their stickiness, their retention of frequency with us, that’s our focus over the long term.
And in the long term, not only do we think that the floral business can resume growth, but we think the basket business can become as big as the floral business.
Our next question comes from Eric Beder with Brean Murray.
Eric Beder - Brean Murray
Could you talk to us about going forward, what’s the impact from the marketing program that you cancelled is going to be?
The third party marketing is still that can (inaudible) but as you saw in this quarter, we had a beneficial impact from canceling the Martha program which was a marketing program. That had a positive contribution. That was offset by the negative contribution which we have build to quantify from our third party marketing and that will anniversary in this next quarter. We'll finish that in the fourth calendar quarter, our second fiscal and will be gone then, Bill.
So approximately a $1 million in this quarter with the impact both top and bottom line of not comping against that third party marketing program, that’s probably about a $1.2 million to $1.3 million in the second quarter, Eric. And then after as Jim indicated we terminated in December.
Eric Beder - Brean Murray
The floral business was down and BloomNet was up, how do those two kind of work together and how should we think about that?
I think you can say that, while there is some relationship between the amount of business that 1-800-Flowers generates and BloomNet, I think what you have seen is our efforts over the last couple of years have not made them totally in parallel and what I mean by that is that the 1-800-Flowers management team that Chris now directly leads with a very much flattened organization is knitting itself much closer together with BloomNet so that the things we do in the Flowers brand can specifically benefit BloomNet.
But independent of those activities, the programs of BloomNet that’s been introducing over the last couple of years and the product category where we’ve developed this terrific relationship with Yankee Candle benefiting all our BloomNet Floral partners where we have introduced the Lotsa Love plus program. Again products that 1-800-Flowers will be featuring that our florists can now carry on a very good cost basis and delivering good value to our customer helping them to deliver smiles in unique and different ways.
The (inaudible) programs which we are just introducing now as another example in the product category how BloomNet is growing independent of its relationship with Flowers yet growing more entwined with it everyday.
In addition to services, the directory, the website hosting, the education and training programs, the marketing programs we just had a big introduction of our new floral university training center that we physically opened in our Jacksonville facility just a couple of days ago. That’s called the [Floralogy Institute] wonderfully received by scores of florists who attended the First Wedding Training program there, the florists who came to view the sector and participate, the people from around the industry.
It proves in terms to how even in tough time, we are investing in our relationship with our BloomNet florists and training and marketing and promotion and finding the right product (inaudible) collection, to help them compete, to help them to serve our customers and to help them to better integrate the offerings they have so that 1-800-Flowers as step on the gas that has this engine behind for fulfillment or embracing our [florishness]. So I think there is a relationship, but no longer a direct correlation which has been evidenced by the performance you have seen over the last three quarters.
Eric Beder - Brean Murray
Okay, can we get an update on the franchising for both I guess Fannie Mae and for the 1-800-Flowers, as where you are looking for that, I know you’ve talked about the franchising for Fannie Mae before, where we are in that stage and how is looking for the other one?
Frankly our only active franchise effort, that’s already on the dance floor so to speak is our Fannie Mae franchising efforts and that effort is we introduced the idea in our last conference call that we will be rolling out the first stage for that. We were completely certified or registered in all the necessary states come July and I would say that we are right on plan in terms of seeking out the first handful of partners that will open a collection of stores in the geographies adjacent to our rollout area, our core concentration area, radiating out from the Chicago side say, we are right on track. We will be opening a collection of franchise stores this fiscal year with good partners, so we can continue to build on. So that’s right on track and that’s the only program that we are really active on right now.
Eric Beder - Brean Murray
Okay, and then finally your wholesale gift basket business obviously it’s had a lot of, it’s been affected by the economy. How do you look at that going forward in terms of trying to recapture some of that share. I mean do we look at it as you have lost share just because the economy on that or because of competitors, kind of what's your thoughts for that business going forward?
On the basket business, remember we purchased a company called DesignPac to give us a unique capability to launch 1-800-Baskets. We needed the design capability, we needed the confection capability, we needed a physical plan for our training of our BloomNet florists in the future, we needed the sourcing capabilities, the Asian reach, the global reach including the major of our different sourcing capabilities. We got to look at that.
We didn’t plan on growing the wholesale business. Frankly, it grew a little bit faster then we expected. In the first year, we had it and in the next two years it went backwards. And it went backwards in a fairly dramatic fashion and as we analyzed what happened, it was a combination of things, the macroenvironment with some of the key customers of that wholesale effort in the past went out of the business. And definitely I think we misexecuted, I think we have analyzed that. We made significant management changes, I think the GFGB leadership now is properly convinced that we can grow that wholesale business over the next two years back to the level we wanted to be which all it does then is it continues to give us a good reach, good capabilities and a nucleus for building what is much more important to us which is 1-800-Baskets.
So, we didn’t want to go backwards with it. We have analyzed what is within our control and what’s without and we are certain over the next couple of years that we can build it back to that, let’s call it that $40 million to $55 million level that we’ve been achieving on regular basis and get it there, and really I feel the intention goes bigger than that because our bandwidth is being sucked up by the local 1-800-BASKETS.
Thank you, ladies and gentlemen (Operators Instructions) Our next question comes from David Cannon with First Midwest Securities.
David Cannon - First Midwest Securities
Good first question is on the wholesale basket business what was the approximate decline year-over-year and what's the delta between that segments gross margin and the over all blended gross margins of the company?
Overall the company is targeting something around a 40% gross margin in the basket business and it will be a little more generous than that so we are approaching 40 in the overall the basket business has been traditionally on the consumer side a little bit better than that but on the whole sale we run high teens, to low 20s in gross margin.
The size of that last year was about 22 million. So it went from fiscal 09 to fiscal 10 it dropped about 22 million
And I might point out there that since that time David, so I said two things happened some of our customers, you know we only have two customer in the wholesale side some of those customers just went out of the category others we lost market share in, we lost market share to a couple of competitors who by the way some of them really struck me a couple filed for bankruptcy so we wouldn’t sell our profit at a loss some of our competitors I think unknowingly did and I think that will write itself in the next couple of years now as the market is rationalized because you cant sell a product at a loss.
David Cannon - First Midwest Securities
Alright so most of the drop in revenue came from the wholesale basket business which is a very low gross margin of business relative to everything else is that correct?
Last year that was very much the case David. But I would point out that even in a 20% margin it still has a decent contribution so we wouldn't throw it out. But yes, we are focused on growth and our energy is focused on growing the direct (inaudible), which has normal retail markets.
David Cannon - First Midwest Securities
Now, in the press release you make a statement we expect to see continued improvements in gross margins for the year. That sounds great, going forward I know in front of you, you have a seasonally much stronger quarter. However, my question is on the OpEx line, are you going to try to kind of hold things were they are and should we expect with these improved gross margins and expansion any operating margin are do you think OpEx will chase the improvement in gross margin?
Dave I think we went into this on our August call but we are not giving specific guidance on this year.
Clearly we are focused on improving gross margins. Clearly we're focused on keeping our operating expenses flat even as expect to even working toward achieving growth again.
So if this were successful in expanding our gross margins, if we're successful in trading and growth this and next, then we'd certainly see an improvement in our operating margin. We are not predicting that, but that clearly didn’t (inaudible).
David Cannon - First Midwest Securities
And then, how do you feel about inventory levels going into the strong holiday season?
Bill will give you the specifics, but keep in mind that last year our inventory levels were going to be higher because we still had our children's division. So that had a particularly disproportionate impact on the first quarter when we were reviewing the inventory but we feel we we’re right on where we should be. As you look at the holiday function in the light, of the Christmas holiday. The flora brand increasingly had a typical challenge because they didn’t have the right character to appeal to customers in the earlier part of the selling cycle. So that’s why the company and particularly why Chris has focused our efforts on building on confectionary brands, our Gift Basket products so that we have the right mix of products into our shop we’re merchandising correctly, so when the customers come to us for gifts that help them put smiles on their business customer’s faces and on their family faces in November and in October when we have Halloween and December that we have the right products.
Those products require inventory investment and we feel very good at not only the product mix that we have now but the inventory levels.
As normal inventory at the end of the first quarter was about $71 million on this year, up from $45 million at the end of last year, we are back down to that level as we come out of another season. So we are very comfortable with where the inventory is. As Jim was mentioning, there are certain categories that we have to make more investments in and other categories that we’re managing to reset on.
David Cannon - First Midwest Securities
So, in the December quarter, the company should generate meaningfully cash flow assuming that the case, things go according to plan. Do you feel that it’s good use of your cash to buy back stock to somehow return that to shareholders by buying back stock and hopefully increasing EPS and so forth?
I think you correct that the December ending quarter and I have the June quarter, the quarter that we generate our majority of our free cash flow. Obviously the summer quarters the one we are investing for this holiday period. And what we said in the past, I think what you can see from the evidence about our behavior over the last couple of years, that we are focused on preserving shareholder value and using our access free cash flow we perform enough to be generating to do more than two things either invest back in the companies because we think we can get good growth in that either our initiatives that we identify or there are class to acquisition that might be identified over obviously nothing there to report, on the other side of that is what do we do with that excess free cash flow that we don’t use in one of those two areas and the options available to us are that we focus on either buying back our stock or reducing our debt.
Those decisions will be made based on the climate and our continued success, let me point to the fact that over the last two years and continuing to this year, last two years we reduced our debt and improve the flexibility of our balance sheet and our financing arrangements paid down debt to the $278 million and this year we plan to reduce at least our debt by at least another 15 million. So, we will be judicious about making sure we have the right capital reserves, the right cash on hand and a right banking relationships and make those determinations as we achieve the cash flow generation that we anticipate.
I'm sorry no further questions at this time.
Thank you Melina and thank you all for your questions and your interest and we would be happy to have any further dialogue that you'd like, you know how to contact us and as Chris already mentioned we really have a really great Halloween Gift line up. At the Flower shop, Halloween was never a big and improvement holiday for us but over the last four or five years that we expanded the merchandising mix on shop to accommodate our customers to help them with the gifting and collective needs to help input smiles on the faces of the important people in their lives with our Fannie Mae chocolates our, Cheryls product our, Popcorn Factory product, I think we have great mix I invite you to come to the site and when you’re in the Flowers site see the 1-800-Baskets collection and I think you should do your research and sample those products and put some smiles on the faces to your friends, your family, your loved ones. So, until next time or until we chat thanks so much for your interest to that.
Ladies and gentlemen thank you for your participation in today's conference. This does conclude the conference. So, you may now disconnect.
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