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1-800- FLOWERS.COM (FLWS)

F2Q07 Earnings Call

January 24, 2007 11:00 am ET

Executives

Jim McCann - CEO

Bill Shea - CFO

Chris McCann - President

Joseph Pititto - IR

Analysts

Anthony Noto – Goldman Sachs

Jeff Stein - KeyBanc Capital Markets

Paul Keung - CIBC World Markets

Eric Beder - Brean Murray

Kristine Koerber - JMP Securities

Anthony Lebiedzinski - Sidoti & Co

Heath Terry - Credit Suisse

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2007 1-800-FLOWERS.COM conference call. (Operator Instructions) I would now like to turn the presentation over to Mr. Joseph Pititto, Vice President of Investor Relations. Please proceed, sir.

Joseph Pititto

Good morning and thank you all for joining us today to discuss 1-800-FLOWERS.COM financial results for our fiscal 2007 second quarter. My name is Joseph Pititto and I am Vice President of Investor Relations.

For those of you who have not received a copy of our press release issued earlier this morning, the release can be accessed at the Investors Relations section of our website at 1800FLOWERS.com or you can call Patti Entadono 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; and Bill Shea, CFO. Also joining us today for the Q&A section of our call is Chris McCann, our President.

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 risk 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 are not prepared in accordance with GAAP. 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 of the forward-looking statements made in today's call, any recordings 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 will now turn the call over to Jim McCann.

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Jim McCann

Good morning, everyone. As we announced in this morning's press release, we are pleased with our results for the fiscal second quarter. During the quarter, we achieved revenue growth of approximately 19% or $52 million to a record $330 million. We increased our gross profit margin 110 basis points to 46.1% through a combination of product mix, enhanced merchandising, and customer service programs. And, we improved our operating expense ratio by 130 basis points to 35.8%, reflecting our increased focus on leveraging our operations platform.

As a result of these factors, we achieved very strong bottom line performance including EBITDA growth of 54% to approximately $34 million and net income growth of 64% to approximately $17 million, or $0.26 a share. These results were driven by double-digit revenue growth and increased profit contributions from our key business categories: consumer floral, BloomNet Wire Service, and the gourmet food and gift basket businesses. These businesses most effectively leverage our operating platform and our unique collection of assets, including our database of more than 25 million, our strong brands, our service platform, our technology and our unique distribution capabilities.

Importantly, the strong top and bottom line contributions from these businesses enable us to more than offset the weaker performance in our home and children's gift businesses. I will discuss the specific steps that we are taking to address this category later in the call.

Before I turn the call over to Bill for his review of the metrics, I would like to highlight a few additional points. First in the floral category. Our call 1-800-FLOWERS.COM consumer floral business grew to approximately 11% to $115 million. We believe this growth on the largest base in the category further extends our market leadership position. We also enhanced our gross margin and operating leverage, resulting in a 43% improvement in category EBITDA to more than $13 million in the quarter.

In our BloomNet Wire Service business, we achieved revenue growth of more than 45% to $9.6 million. Here too we improved operating leverage and gross margin resulting in 114% increase in category EBITDA to $3.3 million. These results illustrate the successful growth of our membership base and the enthusiastic response from our florists to BloomNet's product and service offerings.

Second, in our fast-growing gourmet food and gift basket category, revenues grew almost 75% to $109 million. Gross margin increased 90 basis points to 48.4%. Category EBITDA grew almost 140% to more than $25 million. These results include the contribution from Fannie May Confections business, which we acquired in May of last year, as well as strong growth from our Cheryl&Co Bakery gift business. This business is on pace to generate nearly $200 million dollars this fiscal year, positioning us as a leading player in this fast-growing category.

Third, on the customer front. During the quarter we cost effectively attracted more than 1.2 million new customers, with 63% of them coming to us online. We achieved a repeat order rate of 53%, illustrating the continued success of our efforts to deepen the relationships we have with our customers. We saw continued success in our customer engagement initiatives such as our Fresh Rewards loyalty program, the first in the floral category. These efforts enable us to drive what we call enterprise customer value or ECV.

We are also driving ECV with our expanded cross-brand marketing programs, illustrated by the increase in our average order value and improved response rates from our marketing programs both online and off.

One other note on the quarter. In December we repurchased 3 million shares of our stock from JP Morgan. We saw this as a very attractive investment and it removed a potential overhang from the market. Looking ahead, we believe the strength of our business model, combined with the operating and customer focused programs that I have mentioned position us well to achieve our goals with double-digit revenue growth and enhanced bottom line results in the second half of this year.

I will now turn the call over to Bill, so that he can take you through the details of our financial results and the key metrics for the quarter.

Bill Shea

Thank you, Jim. During the fiscal second quarter, we achieved strong EBITDA and EPS growth, driven by improvements in two key focus areas that we identified going into fiscal 2007. First, enhancing our enterprise wide gross margins; and second, driving operating leverage across our business platform. Importantly, these accomplishments, combined with the contribution from our Fannie Mae acquisition, more than offset the underperformance of our home and children's gift category.

Regarding specific financial results and key metrics for the second quarter, total net revenues reached $329.9 million, an increase of 18.7% or $52 million compared with $277.8 million in the same period last year. During the quarter our ecommerce orders totaled 4.375 million compared with 4.285 million orders in the year-ago period. Average order size during the quarter increased to $61.69 compared with $60.33 in the prior year period. This increase primarily reflected a combination of product mix, increased add-on sales and pricing initiatives.

During the quarter, we added 1.246 million new customers with 780,000 or 63% coming to us online. This was achieved while concurrently stimulating repeat orders from existing customers, who represented approximately 53% of total revenues compared with 50.7% in the prior year period.

Gross profit margin for the quarter increased 110 basis points to 46.1% compared with the same period last year, primarily reflecting product mix as well as the continued improvements in customer service fulfillment and merchandising programs.

Operating expenses as a percentage of revenues, excluding depreciation and amortization, improved 130 basis points to 35.8 % compared with 37.1% in the prior year period. As we have previously stated, this is a key area of focus and we expect to continue to drive year-over-year improvement in operating leverage.

For the quarter, depreciation and amortization was $3.8 million, essentially unchanged compared with the prior year. I should note here that this number will increase in future quarters, based on our recent finalization of the valuation of intangible assets associated with the Fannie Mae acquisition.

GAAP net income for the second quarter increased 63.8% to $16.9 million or $0.26 per share, compared with $10.3 million or $0.16 per share in the prior year period. Pro forma net income was $17.6 million or $0.27 per share, compared with $11.2 million or $0.17 per share in the year ago period.

For the quarter, non-cash stock-based compensation was approximately $1 million pre-tax, $700,000 net of tax or approximately $0.01 per share, consistent with the prior year period.

In terms of category results, in our 1-800-FLOWERS.COM consumer floral business during the second quarter, revenues increased 10.9% to $114.6 million compared with $103.3 million in the prior year period. The ecommerce component of this category grew 11.6%, offsetting the planned transition of company-owned stores to franchise ownership.

Gross profit margin for the quarter increased 160 basis points to 39.7%, compared with 38.1% in last year's second quarter. Reflecting the revenue growth as well as the improved gross margins and increased operating leverage, category EBITDA grew 43% or $4 million to $13.3 million, compared with $9.3 million in the prior year period.

Just a reminder, we define category EBITDA as Earnings Before Interest, Taxes, Depreciation and Amortization and before the allocation of corporate overhead expenses.

In our BloomNet Wire Service business, revenues increased 45.5% to $9.6 million compared with $6.6 million in the year ago period. Gross profit margin increased 710 basis points to 59.9%, compared with 52.8% in the prior year period. Category EBITDA increased 114% to $3.3 million compared with $1.5 million in last year's second quarter. This reflects growth in florists membership and product and service offerings compared with the prior year.

In our specialty brands businesses, gourmet food and gift baskets, revenues increased 74.6% or $46.5 million to $108.9 million compared with $62.4 million in the prior year period. Gross margin increased 90 basis points to 48.4% compared with 47.5% in the year ago period. Category EBITDA grew 139% or $14.7 million to $25.3 million compared with $10.6 million in the prior year period.

Results in this category reflects continued strong growth in our Cheryl&Co brand as well as revenue contribution of $42 million from the Fannie Mae business, which leveraged our operating platform and cross-brand marketing opportunities to achieve strong growth during the quarter.

In our home and children's gift category, revenues declined 7.7% to $98 million compared with $106.2 million in the prior year period. Gross margin was 48.8%, down 50 basis points compared with 49.3% in the same period last year. Category EBITDA was down 65.8% to $3.8 million compared with $11.2 million in the prior year period. This reflects the impact of lower revenues and gross margin as well as the increased cost associated with marketing and merchandising efforts to expand the category.

As we noted in our fiscal first quarter results conference call, category EBITDA results exclude costs associated with the company's enterprise shared services platform which includes among other services: IT, human resources, finance, legal and executive. These functions are operated under a centralized management platform providing support services to the entire organization. For the fiscal second quarter, corporate expense was $11.9 million compared with $10.7 million in the same period last year.

Turning to our balance sheet, our cash and investment position at the end of the quarter was approximately $26 million. This reflects $15.7 million used in December to repurchase 3 million shares of our stock. At the end of the quarter, we had no outstanding balance on our revolving credit facility. Capital expenditures during the quarter were $10.5 million compared with $13.1 million in the second quarter last year. Inventory of approximately $58.8 million was in line with management's expectations and reflects the buildup for the Valentine holiday and our spring gifting season, and includes approximately $18 million related to Fannie Mae.

It is important to note here that inventories associated with our home & children's gift brands have been successfully managed relative to their weaker sales and we do not have any significant excess inventories.

Regarding guidance, as we stated in this morning's press release, in terms of bottom line results, we have reiterated our guidance for growth of more than 100% in EBITDA and EPS. This reflects our stated focus on achieving continued improvements in gross margin and operating leverage.

In terms of top line, based on the lower revenue contributions from our home and children's gift category, we anticipate total revenue growth for the year will be at the low end of our guidance range of approximately 17% to 20%. Regarding the current fiscal third quarter which includes the Valentine holiday, we expect the period will represent 22% to 24% of our full fiscal year revenues.

In summary, as we enter the second half of our fiscal year, we are focused on driving solid revenue growth and continuing to enhance our bottom line performance. I will now turn the call back to Jim.

Jim McCann

To sum up, we had a strong second quarter. We achieved revenue growth of approximately 19%, or more than $50 million. We increased gross profit margin more than 100 basis points. We significantly improved our operating leverage, achieving a 130 basis point improvement in operating expense ratio. As a result, we increased EBITDA 54% to approximately $34 million and improved EPS by more than 60% to $0.26 share.

Our top line and bottom line performance was driven by double-digit revenue growth and increased profit contributions from our key business categories: consumer floral, the BloomNet Wire Service and gourmet food and gift baskets, the businesses that best leverage our operating platform and assets.

In terms of our home & children's gifts category, we are obviously very disappointed with the performance of this business unit and have taken immediate steps to address this issue. We have changed our senior management. We have reassigned our President of Specialty Brands to be President of this business group and he has already begun a thorough review to identify all the factors behind the second quarter results. He will report back to me and our senior management team with a new business plan by the end of the current quarter, and we plan to review all of our options as we develop our go-forward plans for this business unit.

Additionally, we have already adjusted spending plans in this category to mitigate the impact on the second half of our fiscal year. We are confident that we can achieve our overall bottom line targets through the combination of a continued strong performance in our key business categories and the increasing benefits from our numerous process improvement programs.

Looking ahead, our outlook for the current fiscal third quarter, including the important Valentine's holiday, is positive. In the consumer floral category, the strength of the 1-800-FLOWERS.COM brand enables us to cost-effectively attract millions of new customers. This allows us to introduce into an expanded range of innovative products and services, our customer engagement initiatives and our cross-brand marketing programs. These efforts help deepen our customer relationships, and thereby increase enterprise customer values.

In our BloomNet Wire Service business, florists are increasingly embracing our superior value proposition including our expanding range of new products and services designed to help them grow their businesses profitably.

In our gourmet food and gift basket business, our cross-brand marketing programs are effectively introducing an increasing number of customers to the gift ideas from Fannie Mae and Cheryl&Co., 1-800-Baskets and The Popcorn Factory. We have become a leading player in this category and continue to see exciting growth opportunities here.

Enterprise-wide, we expect to drive higher gross profit margins through a combination of sourcing initiatives, process improvements and focused merchandising programs. In addition, we are seeing some early benefits from our numerous process improvement initiatives and we anticipate growing contributions from these efforts across all of our brands. We believe these factors, combined with our focus on achieving increased operating leverage, will enable us to enhance our results in the second half of fiscal 2007, and build long-term shareholder value.

That concludes our formal remarks and we would now like to open the call for your questions. Latasha, would you please give the Q&A instructions again?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Anthony Noto - Goldman Sachs.

Megan for Anthony Noto – Goldman Sachs

It's actually Megan in for Anthony. A couple of quick questions. According to our calculations, revenue growth in the Gourmet Food and Gift category was about 7% excluding Fannie Mae. We were just wondering what pressured this and if you had seen a step-up in competition from Amazon due to their grocery and food basket initiative?

Secondly, if you can give us any sense of how much EBITDA that Fannie Mae contributed during the quarter?

Bill Shea

With respect to what we have seen with organic growth during the quarter versus what was contributed by Fannie Mae, we are seeing organic growth at about 6% overall in the quarter. If we back out the Madison brands, that organic growth would be closer to 12%. In that particular category we saw nice growth within the Fannie Mae business. We probably saw 15% plus growth in the Fannie Mae business and we saw very strong growth in the Cheryl&Co. brand as well.

What we had earmarked going into this year that we were going to invest behind the businesses that have the highest operating margins for us. So that was the going to be Fannie Mae, that was going to be Cheryl & Co., that was going to be BloomNet and the 1-800-FLOWERS brand, Popcorn Factory which is in that category, we were looking to drive more bottom line performance on that and not invest behind growth in that category.

Jim McCann

What we are seeing is double-digit growth in all of our core categories. The 1-800-FLOWERS, the consumer business, BloomNet and the gourmet food & gift basket arena, all double-digit growth rates organically.

Megan for Anthony Noto – Goldman Sachs

Okay, and then just any insights into how much EBITDA Fannie Mae is contributing?

Bill Shea

We really don't break that down. What we can tell you is last year and the year prior to us acquiring Fannie Mae, they did approximately $12 million worth of EBITDA for the year ended April. They drive a lot of that EBITDA during this particular quarter, and that has been growing nicely since our ownership.

Megan for Anthony Noto – Goldman Sachs

Thanks.

Operator

Your next question comes from Jeff Stein - KeyBanc Capital Markets.

Jeff Stein - KeyBanc

Good morning, Jim. A question on the home & children's gift business. By my calculation the drop in profitability there cost you guys $0.06 or $0.07 a share in the quarter. So excluding that, it certainly would've been an extraordinary performance. This raises some concern on my part about the outlook for the balance of the year. How important a contributor is home & children's gift to the back half of the year and are you confident that the performance of your other core strategic businesses will be able to continue to offset the weakness you're seeing in home?

Jim McCann

Thanks, Jeff. The answer in summary is yes. Yes, we are confident that the biggest impact that we would have experienced from those brands occurred in this quarter. It is when they do the lion's share of their business. It is primarily a single quarter business. As Bill mentioned in his remarks, we have taken steps already with new management to mitigate any of the impact that could occur in the second half of the year, but keep in mind almost two-thirds of their business occurs during that fourth calendar, second fiscal quarter.

So yes, it had a big impact on us in this quarter so we are very pleased that the quarter still came out so good. Yes; we looked at what it could've been if we had better performance with those assets, which causes us to say what's the business plan for those assets? What are the investment characteristics for those brands? How do they leverage the assets that we've been fortunate enough to accumulate? How is their leverage of those assets different from the characteristics of what we identify as key growth areas and cause us to make capital allocation assumptions and strategic business decisions, which is why we've asked Tim to do the work that he is doing this quarter, so that we have all of the right information to make our go-forward plans and assumptions.

Jeff Stein - KeyBanc

Jim, it seems to me that that business is really not -- and has not been for a couple of years -- it is really not core strategically. I'm wondering with the very strong interest we are seeing right now amongst private equity players, it would seem to me a pretty good list of strategic players out there. Is this an appropriate time to consider possibly divesting yourself of that business?

Jim McCann

Right now, what we are focused on, Jeff, is gathering all the information we need to improve the operating performance of that division and to help us define all of the options that we have in terms of reviewing all of our assets. As we stated in the most recent couple of calls, every asset we have we look at the capital allocation question, we look at a resource allocation beyond our financial capital and bandwidth; and which assets have the best possibility of leveraging the wonderful assets we have been fortunate enough to accumulate: the 25 million customers, our web capability, our IT platform, our unique distribution system.

If we were to determine that someone else could better benefit from our assets or have different leverage, say, than we had two, three, four, five, six years ago in those assets that would help us to come to different conclusions about what we do ultimately. But right now we are in the information-gathering mode and have not made any hard commitments in terms of what we will do there. Clearly as fiduciaries we have a responsibility to make sure we have the best set of leverageable assets.

Jeff Stein - KeyBanc

Great. Two other questions real quickly. I was wondering if you could just comment on the increased repeat rate year over year. It seems to be pretty significant in what factors may have driven that.

Secondly on your BloomNet Wire Service businesses, if you can just quickly talk about the number of florists that are currently in the network and your success in penetrating that customer base with some of the new services you are rolling out.

Jim McCann

I will ask Chris to address those questions but just as a preface to it, what we said in the last call is we give our membership numbers on an annual basis of BloomNet. But separate from that, Chris, can give you a lot of color in terms of our cross-brand marketing efforts which is the primary driver of our repeat rate and then some BloomNet color if you would, Chris.

Chris McCann

Just to begin, we are very pleased with the progress we continue to make while attracting a good number of new customers on a consistent basis. We continue to drive good repeat rates. It really is a lot of the effort behind enterprise customer value that Jim referenced in the formal remarks and our cross-brand initiatives.

Each brand looking, again, even to the point of leveragable assets that is where we are seeing a lot of leverage between the gourmet food & gift basket brands and the floral brands as well and looking at how we drive customers between those brands and introduce them to the extended product categories. Other efforts again just like the introduction of the Fresh Rewards loyalty program within flowers really helping to drive significant repeat rates as well. So we are very pleased with our results there.

From a BloomNet perspective, Jim addressed the membership issue but again, we look at the results that we are achieving in BloomNet and very pleased with the response we are getting in the marketplace. We continue to add programs into the marketplace. Clearly we have BloomNet products, we have the directory, credit card programs that we've previously introduced, very recent introductions from BloomNet technologies is our web site hosting capability for florists. Our florist management, POS order management systems that we have introduced into the community, so very good response that we are receiving in the BloomNet Network.

Jeff Stein - KeyBanc

Thanks.

Operator

Your next question comes from Paul Keung - CIBC World Markets.

Paul Keung - CIBC World Markets

Hi. I guess there's a couple of weeks before the busy Valentine's holiday, so I wonder what you are seeing on the advertising front? What increases are you seeing across the premium inventory? If so how much are you seeing? I noticed that despite the strong repeat, your new customers dropped 10%, so will that have an impact on the flow of business this holiday?

Bill Shea

One of the ways we look at the advertising for the holiday program, again, we look at the results we achieved from Q2 and we make adjustments accordingly as we move into Q3 and Q4. So our plans are set. We are ready for the Valentine Day holiday. I guess as we look at one component, search is always an important aspect of our marketing plan and in search this past quarter we had one competitor act very aggressively with their marketing spend overall, and specifically they're bidding on search. With that taking place we are very pleased with how we manage our position in search and the results we achieved which demonstrates the strength of our brands, specifically the 1-800-FLOWERS brand. So we believe we are very well positioned for the upcoming holidays in Q3 and Q4.

Regarding the customer metric issue to that was primarily driven by the home and children's gift brands and the declining revenue and our scaling back on prospecting that.

Paul Keung - CIBC World Markets

So you are saying most of that 10% decline in new customers is largely home and children's being down?

Jim McCann

Yes it is. And on the Flowers brand which obviously is most important to Q3 and Q4, the new customer metrics are up.

Paul Keung - CIBC World Markets

How much more are you spending on Valentine's this holiday versus a year ago?

Jim McCann

Our marketing spend that we forecast for the year will be broken down on a quarterly basis so we are not going to give specific numbers in terms of our marketing spend because it's not finally determined. Clearly, what we saw in the last quarter was we managed our marketing, particularly our online marketing spend very effectively. There were other competitors who were very, very aggressive in this category. We didn’t have to be, which as Chris said, demonstrates the strength of our brand.

Paul Keung - CIBC World Markets

Then on the free cash flow I was trying to get the numbers worked out. I noticed the last two quarters your free cash flow during last year, I think the mix of the business changed somewhat. What should we expect the next couple quarters as we don't really have the benefit of making formal adjustments and are you on track to make $25 million free cash flow this year in fiscal '07?

Bill Shea

As you know with free cash flow, basically the component of free cash flow, we're giving guidance on EBITDA that we would be doubling our EBITDA interest with the Fannie Mae acquisition and you can compute what the interest is. We've given guidance on CapEx to be about 2% of revenues in that $18 million to $20 million range. The only other component really is the change in working capital. With the businesses that we have acquired, having some inventory investments in those businesses doing well and growing, there are increases in working capital. So there is an investment in working capital this year in that $5 million to $10 million range. So you can work through those numbers and it still generates us north of $20 million free cash flow number.

Paul Keung - CIBC World Markets

So what I saw in the AR/AP this quarter is really it's the assumption of a working capital increased on $10 million, but you still hit $20 million, $25 million?

Bill Shea

Yes for the year and what you saw this quarter that jumped out is receivables jumped up. The Fannie Mae business they have a wholesale component to their business and they therefore have receivables. That all gets paid down in this quarter.

Paul Keung - CIBC World Markets

Got it. If you don't mind just one last one has to do with your capital structure itself. I noticed you did some buybacks here. When you think longer term, what is the right debt ratio for something like yourself that's not too capital-intensive and would you consider higher debt levels at the same time while you are buying back stock?

Bill Shea

For us to continue to grow our EBITDA and our earnings, and with the relatively light level of debt that we have on our books, we saw an opportunity with the Fannie Mae transaction. We entered into a credit facility to provide the funding for that, but we still have plenty of leverage in the business. If opportunities come along for us to lever up our balance sheet, our very strong balance sheet that we have to acquire a company, we would do that.

Paul Keung - CIBC World Markets

Thanks a lot.

Operator

Your next question comes from Eric Beder - Brean Murray.

Eric Beder - Brean Murray

Good morning. Looking at all your costs and benefits programs, what's your initial impression of what you are saying and how quickly you can implement this and where are you in the process?

Jim McCann

I'll ask Chris to give color on it. I will just give you the top line. Top line for us, Eric, is that we delivered a terrific quarter in spite of a big piece of our legacy business experiencing very slow growth; in fact, going backwards. So it went very well for us and that is primarily a reflection of the great growth drivers we've seen in our key focus areas of the business and also as a result of our process of good leadership.

So that gives us, even in its earliest couple of quarters now of activity there, the future quarters will be even more effective. Chris is there anything you want to add there?

Chris McCann

We are seeing some short-term benefit which you are seeing reflected in our operating leverage and our gross margin improvements during this past quarter. [Inaudible] And then on a longer-term basis, help to structure the company [inaudible].

Eric Beder - Brean Murray

For BloomNet I see you guys started web hosting in January. What are the next thoughts in terms of services that you still want to fill in and what has the response been to a week or two of web hosting?

Chris McCann

I referenced that earlier. [Inaudible] the introduction of our florists order management system, very strong results so far, very good responses. We have just basically been in the marketplace for about a week so we are very pleased with the results. But again, even leading up to that, how we take with our customers about what is important to and what to introduce we are focused on doing what they need and so we are not surprised by the response.

Eric Beder - Brean Murray

Thank you.

Operator

Your next question comes from Kristine Koerber - JMP Securities.

Kristine Koerber - JMP Securities

Hi. A couple of questions. First of all, you mentioned in your introduction the cost to expand the home and children's gift category. Can you elaborate on that, what the costs are related to and why you would be expanding it?

Bill Shea

Yes. Our plan called for us this year to try to go after some successes that we had seen in a couple of product categories. So we had product category expansion planned and moving them out under of a couple of self brands. So therefore there was prospecting, catalog development costs associated with that, ultimately showing up in the marketing expense line. Those are in the Problem Solvers category line and more in the Home Furnishings line. We did not see the success that we anticipated there and therefore are curtailing back on those spends.

Kristine Koerber - JMP Securities

Then your loyalty program, it appears it is going quite well according to your release and your commentary. How many customers do you have in your Fresh Rewards loyalty program at this point?

Jim McCann

Just to give you some background there. We have had the Fresh Rewards loyalty program for over 20 years now.

Kristine Koerber - JMP Securities

Right. But you are now promoting it.

Jim McCann

Now we are promoting it and we've retooled it to better focus its efforts on our ecommerce customers. So it's a retooled program. We reintroduced our program this summer. We are very happy with the results. At the end of the year we will probably give you some more specific number color on it, but what we're seeing is a couple of things I will give you some anecdotal information on. One is that the interest rate on the customers is very high. It's a platform that helps us with ECV. What I mean by that is the enterprise customer value creation because there is an opportunity for us to expose very cost effectively our new gourmet food and gift basket brands to our customers in a very cost-effective way and fun kind of way using those brands as rewards and incentives within the Fresh Rewards program. So we will continue to do that this year.

The surprise thing that I can tell you is that many more of our customers who enrolled in Fresh Rewards are new customers which, frankly, is surprising us. I hope by the end of year when we report more specific metrics on that that we give you even more information and that it holds up, but right now it's nearly one-fifth of the customers who are enrolling in Fresh Rewards are newer customers. So that is very exciting for us. So our program is solid, growing well for us and we think long term has a tremendous benefit especially in that ECV environment.

Kristine Koerber - JMP Securities

Okay. That's what I wanted to know, how many new customers you have adopted. Then lastly, inventory of 51%. How much of that is related to the home and children's category? Is JP Morgan completely out of the stock at this point?

Jim McCann

I'll answer the first part, Bill will give you the inventory information. Yes. JP Morgan, we purchased their entire position and now of course the JP Morgan Partners Group is now called CCMP Capital and Jeff Walker who runs that company is still on our Board, but we bought their entire position.

Bill Shea

With regards to inventory the big increase year-over-year really relates to Fannie Mae. About $18 million of the increase relates to Fannie Mae.

With respect to the home and children's gift category we don't break out the inventory by each of the areas; but with the weaker sales in there we did a very good job of managing the inventory and we are very comfortable with where that inventory is. We didn't have any issues about the write down of the inventories in the second quarter or is going to impact the future.

Kristine Koerber - JMP Securities

Thank you.

Operator

Your next question comes from Anthony with Sidoti & Co.

Anthony Lebiedzinski - Sidoti

Good morning.

Jim McCann

Are you going by one name now like Madonna?

Anthony Lebiedzinski - Sidoti

I guess my last name is too difficult to pronounce. It's Anthony Lebiedzinski, just for the record.

Jim, you mentioned before about the product sourcing initiatives so maybe you could just discuss that a little bit further and also any further opportunities to cut costs?

Jim McCann

Well as Chris mentioned, with our performance improvement initiatives that we referenced on the last couple quarters, what we've done is we've hired a team of people that is really gelling well. So the fact that we had such good performance this quarter in spite of the poor performance in the one category of the home and children's gifts is partially a testament to the strength of those brands, the marketing successes we had in those other three categories and the performance improvement programs we've initiated.

As Chris mentioned, the first half that fits in the first let's call it six months of those efforts, are going to be the low-hanging fruit kinds of things. I think as we get later into this fiscal year you'll continue to see those benefits which enables us to reaffirm our guidance for more than doubling our bottom line performance this year. Then as we give guidance for the next years, that is when we start to see bigger benefits as they get into more meaty kinds of projects. One of them is around product sourcing.

So yes, we have done some things that have been beneficial to us, but as we have assembled this terrific collection of assets, now it's how to get the most leverage out of them; how to get them to work together and one of those critical areas is sourcing, and one that they are focused on. In fact, we just hired a specialist just to focus on the sourcing initiatives. Someone who has done this professionally for years and that is his primary focus, working that whole process improvement team. He is singly focused on the sourcing issues.

Anthony Lebiedzinski - Sidoti

In terms of the D&A expenses, I know it was relatively flat year over year. There was a big drop-off from the first fiscal quarter in terms of D&A expenses. What is the reason behind that?

Bill Shea

What we did during this quarter was we finalized the valuation of the intangibles related to the Fannie Mae transaction. We estimated, as GAAP allows you to do, what that value was so we were amortizing at a higher value and we had a slight pick-up this quarter. That is why I mentioned that it will go back up next quarter. So it will be up let's say, $0.5 million or so next quarter.

Anthony Lebiedzinski - Sidoti

Got it. Lastly, in terms of the tax rate it was down from the first fiscal quarter and down also versus the year ago period. What is the reason there? What should we expect for the full fiscal year in terms of the tax rate?

Bill Shea

The tax rate is right around the very low 40% range. It is impacted a little bit by stock-based compensation so you don't get a full benefit of stock-based compensation components of that. We also had during this settlement of a IRS review for prior years and so we had a very small pickup with regard to that, that impacted the second quarter. For the full year 40.7% is an accurate number for us.

Anthony Lebiedzinski - Sidoti

Thank you.

Operator

Your next question comes from Heath Terry - Credit Suisse.

Heath Terry - Credit Suisse

I was wondering if you could just talk to us a little bit and give us an update on where you are right now from a store count standpoint, both your own and then the licensed stores that are out there? Particularly by brand, if you could, and what your plan is for growing or how you're going to grow or shrink that store count base over the coming months, years?

Jim McCann

Sure, Heath. As we've mentioned several times in the past we feel that our 1-800-FLOWERS stores, other than the few that we have hanging off of our design center here in the New York area, are best owned and operated by our franchisees. These are good family-run businesses. They have advantages, frankly, that in a corporate environment we can't replicate. So our plan is to slowly migrate from company ownership there to franchisee ownership and you'll see several stores moved in the last quarter from company ownership to franchise ownership. That would be true, too, of the design centers where there's a good franchise operator who will take over the staffing in those stores who will be able to grow them more effectively and be able to leverage their capability to expand their own retail franchise, this will allow that to happen too.

So 1-800-FLOWERS store counts coming down. We are up a couple of stores now in the Fannie Mae arena. We started just seven months ago with the 50 stores that came with the acquisition. They had in their plan a couple of store increase and that has happened. We have a few stores that came with some Cheryl&Co. and we continue to look at those models and expand them; but there is no expansion plan to speak of there.

Heath Terry - Credit Suisse

Great, thank you.

Operator

I show no further questions in the queue. I would now like to turn the call over for closing remarks.

Jim McCann

Thank you, operator. Thank you all for your questions and your interest. If you have any additional questions please don't hesitate to contact us.

In closing, as is our custom, I would like to give you a little public service reminder and that is, the Valentine holiday is fast approaching. It is never too early to call, click or come in to 1-800-FLOWERS.COM, your florist of choice for all the great gifts for all the sweethearts in your life.

Thanks for your time and attention today and we look forward to chatting with you more in the future.

Operator

This concludes the presentation.

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Source: 1-800-FLOWERS.COM F2Q07 (Qtr End 12/31/2006) Earnings Call Transcript
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