Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Executives

Kevin A.Green – President, Chief Executive Officer & Director

Analysts

[Mike Regan – Hawkshaw Capital Management, LLC]

Bill Lauber – Sterling Capital Management

Kian Ghazi – Hawkshaw Capital Management, LLC

Celebrate Express, Inc. (BDAY) F2Q08 Earnings Call January 4, 2008 8:30 AM ET

Operator

Good day ladies and gentlemen and welcome to the second quarter fiscal 2008Celebrate Express results conference call. My name is Carissa and I will be your coordinator for today. At this time all participants are in a listenonly mode. We will be facilitating aquestion and answer session towards the end of today’s conference. (Operator Instructions) I would now like to turn the presentationover to your host for today’s conference Mr. Kevin Green, President & CEOof Celebrate Express. Please proceedsir.

Kevin A. Green

Good morning everyone. Thank you for joining us to review the results of our second quarter offiscal 2008 ended November 30, 2007. Before we begin I need to remind you that this call containsforward-looking statements which represent our expectations or beliefs aboutfuture events and financial performance. These statements are subject to known and unknown risks anduncertainties including but not limited to those described in the company’sannual report on Form 10K for the fiscal year ended May 31, 2007 and thecompany’s quarterly report on Form 10Q for the quarter ended August 31,2007. You are cautioned not to placeundue reliance on these forward-looking statements which speak only as of thedate of this call. Celebrate Expressundertakes no obligation to revise or update any forward-looking statements toreflect events or circumstances after the date hereof.

During the second quarter we made significant progress inmany key areas including a 290 basis point improvement in our gross marginpercentage from the prior year. Revenuefrom the Costume Express brand for the second quarter of fiscal 2008 increased45% from the prior year. We added229,000 new customers to our database during the quarter which representsgrowth of 18% from the end of the second quarter of fiscal 2007. This brings our total customer file toapproximately 3.8 million. Fulfillment expenses consisting of costs associatedwith our distribution center and customer service operations decreased 160basis points from the prior year to 10.4% of net sales. We successfully trimmed marginal circulationfor the Birthday Express brand from the prior year by 21% while holding theimpact on net sales to just 14%.

We arepleased to have made progress inthese areas even while somuch of management’s time and attention hasbeen focused on continuing to build theteam and infrastructure necessary for ascalable and successful future. Themajor foundation building projects underway invarious stages during thesecond quarter included anew warehouse management system afirst for the company,a new customerdatabase, a new phonesystem, a new datacenter, TTI and SOXcompliant technologies and processes and theearly planning of anew website that will help us better develop arelationship with our customers and deliver more content, products and servicesin amore relevant manner.

The number of projects we are running concurrently iscertainly a challenge and admittedly creates and opportunity cost related tofocusing solely on the day-to-day managing of the business. We believe that bifurcating management’s timein this way while it pressures short term results will ultimately position usfor greater success than otherwise possible.

Overall, net sales for the second quarter of fiscal 2008were $31.3 million an increase of 10% or $2.8 million from last year’s secondquarter net sales of $28.5 million. Excluding the impact of the closing of our Storey Book Heirlooms brandtotal net sales increased 12.4% from the prior year. The change was largely due to the 45%increase in net sales from the Costume Express brand which was partially offsetby a 14% decrease in Birthday Express brand net sales.

It is important to emphasize that the Birthday Express salescame in essentially in line with our expectations and the 14% decrease from theprior year was driven by a 21% reduction in our catalog mailing as we scaledback circulation in light of significant postage cost increases and recentresponse rate trends for that brand. Theincremental postage expense for catalogs mailed in the second quarter equatedto approximately $435,000. As wementioned on previous calls our ability to manage catalog circulation relativeto our break even points allows us to avoid profitless prosperity. While circulation levels for the BirthdayExpress brand will continue to be down year-over-year over the balance offiscal 2008 the new customers acquired during the second quarter were quicklyprepped to begin supporting Birthday Express mailings starting in January.

Overall, net sales per order for the company decreased by5.8% to $68.41 in the second quarter of fiscal 2008 compared with $72.65 in thesame quarter of fiscal 2007. Thedecrease was due in part to the shift in product mix during the second quarterof fiscal 2008 versus the same time period last year. Our Costume Express brand net sales whichhave a lower net sales per order increased as a percentage of total net salesduring the quarter while our Birthday Express brand which has a slightly highernet sales per order decreased during the same period. Our Birthday Express brand had net sales perorder of $77.13 in the second quarter of fiscal 2008 down 2.9% from $79.43 inthe same period of fiscal 2007. OurCostume Express brand had net sales per order of $62.82 in the second quarterof fiscal 2008 down 3.4% from $65.06 in the same period of fiscal 2007. While we consider the net sales per order tobe an important metric we continue to focus on driving advertising spendingefficiency which is a composite of response rate and average order size.

We have also seen a continued shift of our orders to the webchannel which represented 81% of orders during the second quarter of fiscal2008 compared with 73% of orders in the same period of fiscal 2007. A benefit of this continued shift is that weare able to reduce the overall customer service cost per order as web ordersare less labor intensive.

For the quarter our gross margin was 53.1% of net sales anincrease 290 basis points from the prior year’s second quarter gross margin of50.2%. The year-over-year improvement ingross margin percentage was driven by increases in our merchandise margin dueto improved sourcing opportunities including volume discounts. We remain focused on further sourcingopportunities to continue improving upon margins across all of our brands. We also saw a slight increase in our shippingmargin during the quarter versus the same period in the prior year.

Fulfillment costs decreased to 10.4% of net sales during thesecond quarter of fiscal 2008 compared with 12% during the same quarter lastyear. This quarter-over-quarter decreasewas due to a continued reduction in distribution center and customer servicelabor costs as a percentage of revenue. These reductions were driven by continued operation process improvements,a higher percentage of costume orders as well as the increase in web orders asa percentage of total revenues. Thecompany reduced fulfillment labor and related costs by 5% from the same quarterlast year while shipping 16% more orders.

As mentioned in the earnings release the late season spikein Halloween sales that we and others experienced this year did cause atemporary backlog and led to the disappointment of some customers. We’re developing a number of marketingprograms to reach out to these customers, express our apologies and providethem with more reasons and motivation to shop with us again.

Selling and marketing expenses increased to 31% of net salesduring the quarter just ended compared with 27.2% of net sales in the samequarter last year. The increase wasdriven by multiple factors; our aggressive pursuit of new customers during theHalloween window to support business year round, the increase in online paidsearch fees to retain competitive placement and the $435,000 in incrementalcatalog postage costs for the quarter. It is important to note that we as well as other companies that utilizecatalogs as part of their advertising strategy will continue to showsignificant increases in year-over-year postage expense to the large May, 2007post office rate increase is annualized. This will unavoidably continue to impact our go forward circulationstrategy. While our aggressive marketingduring the Halloween season drove up the ad cost ratio we feel that it helpedposition us for the future as it was an opportunity to maintain market share ina highly competitive season and a prime focused opportunity to acquire newcustomers that represent households with small children which can fuel ourother business year round.

General and administrative costs were $3.3 million in thequarter just ended up from $2.8 million in the same quarter last year dueprimarily to increase bad debt related to our deferred billing program,merchant fees and systems related consulting fees. Due to recent changes in how we manage ourdeferred billing program in accordance with credit card issuers and given thecurrent conditions as they relate to the credit card market place we havedecided to wind down our deferred billing program beginning in January. While we expect this action to potentiallypressure average order size we do not expect it to materially impact totalrevenues.

The net income for the second quarter of fiscal 2008 was$430,000 or $0.05 per diluted share compared with a net income of $568,000 or$0.07 per diluted share in the second quarter of fiscal 2007. Weighted average diluted shares outstandingwere approximately 8 million for both the second quarter of fiscal 2008 and thesecond quarter of fiscal 2007.

On the balance sheet as of November 30, 2007 we had $18.7million in cash and cash equivalents. The company’s net cash used in investing activities which representspayment for purchases of fixed assets was $2.2 million for the six months endedNovember 30, 2007. These capitalexpenditures include our new warehouse management system, data centerimprovement and Costume Express related and other website enhancements. In addition, at the end of the second quarterof fiscal 2008 we had shareholders’ equity of $42.4 million and our total liabilitieswere $5 million.

Developing the senior team remains a priority at CelebrateExpress. We are actively recruiting fora new chief financial officer. Thisposition has been open since mid October. We anticipate it to be filled during the third quarter. We are also searching for a vice president ormerchandising. Bet Summers who held thisposition into December will be transitioning into a consulting role. In the nine months since we ended theevaluation of strategic alternatives we have been able to make progress inrecruiting the management talent needed to provide successful thoughtleadership not just at the senior management level but also throughout theorganization. While we still have anumber of key positions to fill as the new team members get their sea legs andwork closely with the more tenured Celebrate Express employees who possesinvaluable institutional knowledge we will become a much stronger organization.

As we’ve expressed previously we remain focused on the majorinitiatives that we laid out for you during our year end fiscal 2007 conferencecall. Reinvigorating the BirthdayExpress Brand including leveraging signature items like our banners, developingmore exclusive products, securing new licenses and enhancing our website toimprove upon the customer experience, developing a strong portfolio of non kidsnon birthday party supplies, building the Celebrate Express name as the parentbrand to give us authority, mind share and wallet share for all familycelebration needs while at the same time erasing the false perception that weare higher priced than our competitors. Developing corollary and seasonal content, products and services thatwill leverage and monetize the growth of our database customers with highincome households and young children. Developing more meaningful relationships with our customers throughbetter service levels, loyalty programs and more relevant contact, messagingand offer strategies. Driving out costswhile preserving appropriate customer service levels. This will help partially offset the impact ofcontinually rising postage and paper expenses on our breakeven points andstabilizing our technology platforms moving from foundation buildingdeployments to revenue building implementations.

As a result of the work we are doing in developing people,processes and systems including our recent capital expenditures we are creatingthe infrastructure that will support future initiatives, provide a broaderrange of products and services thereby allow Celebrate Express to provide thebest possible experience to our customers and to become more a partner to ourcustomers as we help them will all their celebration needs. We believe we are making steady progress and thatwe are continuing to build momentum. Themanagement teams and employees have taken on a considerable amount ofdevelopment projects simultaneously. While the projects mentioned previously in this call and complicatedtasks like our Christmas offering in December will pressure short term resultswe expect these efforts to leave us in a stronger position as it relates to ourinfrastructure and knowledge of the products and offerings to which ourcustomers will respond. Like any goodretailer we are engaged in a program of test and response.

To reiterate what I conveyed during the last conference calland in my letter to the shareholders in the annual report we fully anticipatedthat the beginning of fiscal 2008 would be difficult but that we would end theyear with clear signs we were on our way towards achieving our goals. At this time I’ll turn the call over to theoperator for participant questions.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes from the line of [Mike Regan] of [Hawkshaw CapitalManagement, LLC]

[Mike Regan –Hawkshaw Capital Management, LLC]

In terms of the increase marketing spend is there anyway toquantify just how much was a base for future sales in terms of the crossmarching that’s going to occur I guess in the third quarter and the fourthquarter?

Kevin A. Green

In terms of prospecting and the costume business weincreased the prospecting by 110% prospecting circulation while the house fileor customer circulation increased by about 59%. So, we definitely skewed it towards the new customer acquisition sidewhich as you know has lower response rates but will fuel the business goingforward.

[Mike Regan –Hawkshaw Capital Management, LLC]

Just looking within the quarter and the incremental costmargin on the increased ad spend was about 70% so presumably we should see abenefit going forward if indeed that is just basically spending marketing thatyou would have spent in the future in this quarter. Am I thinking about that correctly?

Kevin A. Green

Partially. It’s anoffset to the Birthday Express circulation that you would see in total andcertainly for Costume Express it positions us better for next year but thosecustomers acquired we’ve been able to attain the birthday information for thechildren in the household through openly available sources and we’ll be able toposition those customers acquired in the appropriate months as we understandthere are birthdays in those households. So, yes you will see it impact the balance of the year but it’s not inone chunk it will be spread out.

[Mike Regan –Hawkshaw Capital Management, LLC]

Have you broken out what the advertising spend was versusthe market spend in the second quarter?

Kevin A. Green

We have not broken that out.

[Mike Regan –Hawkshaw Capital Management, LLC]

Okay. In terms of theinventory that seemed a little higher than expected and I guess it’s because ofthe volume discounts. How much of theincrease in the growth margin is attributable to essentially taking moreinventory risk with the volume discounts and such?

Kevin A. Green

I don’t believe it’s very much in the sense that we’repaying closer attention to the quantities that we order and while volumediscounts we have to order more we do it in the Birthday Express brand wherewe’re able to sell products month after month after month. It allows us to order higher quantities butnot to fill the same kind of inventory you would if you were going for higherminimums for a costume business where you have to carry the inventory the fullyear. So, while some of that is due tominimums it’s mostly the shift in the business where we were left over withsome Costume Express inventory that we’re going to carry to next year and it’sgood inventory. We feel we’re fully reserved for whatever’s going to be put onsale through markdowns and the small amount that would go to a liquidator butwe’re confident in the inventory level. It’s good inventory and we’re properly reserved and I think that themargin reflects the markdowns and reserves that we have in place. So, we’re comfortable with the inventory asit stands today.

[Mike Regan –Hawkshaw Capital Management, LLC]

The increase in the gross margin was great to see. I’m just wondering – the DSIs increased Ithink at about 64 versus 45 in the past year. So, is this sort of heightened inventory a thing that we should expectgoing forward? Or, is it just temporaryfor some reason?

Kevin A. Green

It is temporary in the sense that we are working down someBirthday Express inventory. As you knowthe Birthday Express inventory sales have come down because of the circulationcoming down so we’re working through some of that inventory a little moreslowly than we would have back when the initial purchases were made. Then, with Costume Express we do have someadditional inventory that is good inventory that we will resell next year whereit makes sense to carry the inventory. The cost of money is outweighed by the potential loss of margin if wetried to move it now. The inventory as Imentioned, I think is in fairly good shape at this point.

[Mike Regan –Hawkshaw Capital Management, LLC]

You mentioned that the costume backlog. Is there anyway to quantify the lost businessor mistaken orders resulting from those?

Kevin A. Green

It’s difficult in the sense that we’ve reached out to thecustomers. Our customer service team hascalled them so we’re trying to do as much as we can to save anyone who’sdisappointed. It was the number ofcustomers affected were probably around 10,000 or less and we have reached outto them and we will continue to reach out to them to retain them as goodcustomers.

[Mike Regan –Hawkshaw Capital Management, LLC]

So in terms of the amount it would be I guess $640,000 inrevenue? Based upon the average costumeticket was about $64.

Kevin A. Green

Well, some of those customers have actually taken the goodsand when we mentioned that we had a backlog that created a suboptimalexperience if you will. Some of thatmeans that they did receive the order in time for Halloween for the event it isjust that it took much longer to get it there and so they did end up using theproduct, they have not returned it. So,it’s not really an impact on sales it’s just an impact on how they feel aboutus which ultimately is where the rubber hits the road and why we’re addressingit.

[Mike Regan –Hawkshaw Capital Management, LLC]

That’s very helpful clarifying that. In terms of the fulfillment, sales andmarketing or SG&A were there any what you would term one time expensesassociated with ahead of the launch of the new warehouse system in December orany non recurring costs that occurred in the second quarter?

Kevin A. Green

Not to my knowledge. Itspart of the cap ex expenditure but no one time costs.

[Mike Regan –Hawkshaw Capital Management, LLC]

Okay so it’s all in the cap ex. How did the Christmas test go? Where there any Christmas revenues in thesecond quarter?

Kevin A. Green

Within the second quarter was kind of a slow ramp we didn’tstart – we went with soft launch at the end of October and so it was a slowbuild through November. The revenueswere about $250,000 in the second quarter most of it coming in December. And, I’d like to really stress as I mentionedin the call that we are testing a lot of different things to learn about ourcustomers and where they see we have brand authority. The holiday test, the Christmas test inparticular is one in which we were after information much more so than salesand profits this time around. So, wetested a lot of different product categories and price points as well as a lotof different segments of our customer file and prospect list. So, it is not something that will beaccretive to income this year but it is something that we felt is veryimportant to learn more about our customers and where we can expand into gifts,personalized products as well as the Christmas seasonal holiday.

I would also add that some of the work we put in, in termsof changes to our website for instance with the holiday launch one of the firstthings that we’ve had available to the company is the ability to drop shipproducts and drop shipping is really where we have a systems integration toanother vendor who maintains the inventory and ships directly to our customer. It allows us to be able to offer products toour customers without taking on an inventory risk. Before we ran the holiday test we didn’t havethat capability so that opens up a wide range of opportunities to test othertypes of products. Things that areeither perishables that we don’t have the ability to house in our current DC orthings that are oversized or things that frankly we think may be risky and wedon’t want to take on the inventory but we’ll be able to seamlessly offer themto our customer, have them part of our checkout process but shipped from athird party. That’s something wecouldn’t do prior to setting up the test for the Christmas season.

[Mike Regan –Hawkshaw Capital Management, LLC]

I take it that came with the new December warehousing andthe Christmas tests?

Kevin A. Green

No, it was actually more of the website piece of it but itdid have to be tied in and integrated with the warehouse management system.

[Mike Regan –Hawkshaw Capital Management, LLC]

That’d be great if you could sell without taking theinventory risk. Finally, on the cap exis there any cap ex guidance for the balance of 2008?

Kevin A. Green

As we mentioned in the 10Q for the first quarter we expectedcap ex to range between $4 to $5.5 million for the year and we think we’restill trending in that direction. Someof that will depend on the work on our next generation website which dependingon how much gets done before the end of the year what will influence where thatcap ex expenditure will ultimately land.

[Mike Regan – HawkshawCapital Management, LLC]

What was the advertising revenue in the second quarter?

Kevin A. Green

It was $335,000. Again, that’s one of the things mostly coming from the program we callweb loyalty which is at the end of an online order we have a pop up windowwhere our customers are then presented with an opportunity to purchase adiscount program that is valuable to families with young children. This is something that is really just thestart of what we can do to monetize the growth of our customer file andcontacts with our customers. I’m sureyou’ve seen and are aware that local advertising is over an $8 billion industrythis year and growing with everything from Craigs List to others. People are willing to pay contact to acustomer who has their wallet open in a relevant time period where they need tospend. So, whether it’s a web loyaltyprogram at the end of an online order or it’s a website that can support localadvertising we think there’s a lot of ground to develop this ancillary sourceof revenue.

[Mike Regan –Hawkshaw Capital Management, LLC]

Can you give us the gross margins by Birthday Express versusCostume Express?

Kevin A. Green

I believe we can. Birthday Express gross margin 53.7% and Costume 51.9%.

[Mike Regan –Hawkshaw Capital Management, LLC]

Then on those – because those are pretty impressiveincreases how much more opportunity do you see from improved sourcing on thegross margin line?

Kevin A. Green

I think there will be continued opportunity. When Bet Summers joined the company lastFebruary we were able to review how we negotiate and how we buy and that led tothe start of better gross margins and that practice has beeninstitutionalized. Once we anniversaryher arrival and frankly her having impact probably didn’t really hit until thefirst quarter of this year so we will see – we should see year-over-yearimprovements continue. But, we thinkeven beyond that. I think we’ve got thelow hanging fruit now whether it’s our own print production or it’s being ableto manage sourcing overseas in a better way through continual processimprovement. We think there’s room. We also think there’s room in terms ofproduct mix. As we improve our abilityto understand the profitability as a skew level we will more naturally shifttowards the items that customers like and buy lots of that have the highermargins. So, we anticipate that there’sstill a bit of a runway in this area.

[Mike Regan –Hawkshaw Capital Management, LLC]

To say the 55% then?

Kevin A. Green

Well yeah. Certainly,I wouldn’t commit to a date. Do I thinkthat’s reasonable? Yeah, I do.

[Mike Regan –Hawkshaw Capital Management, LLC]

How do you balance keeping the improved margin versusreducing prices to drive additional sales?

Kevin A. Green

That’s the $66,000 question and it’s something that westudy. We have different ways of lookingat it. It’s the product price that’spresented, it’s our shipping and handling rates that is also part of pricingand then we have promotions on top of it whether it’s a percent off or a freeshipping offer with a minimum order amount. So, what we try to do is balance all of those factors to create a betterprice value relationship for the customer. One of the things that we’re doing in January, as a matter of fact,we’re going out with a new entry level party pack. It’s a basic pack for $19.99. We think it’s a great value, has goodmargins. Because the company’s legacywas really the larger party packs that cost over $100 I think we got taggedwith a wide brush that made us seem a little bit higher priced than we reallyare because when we go down to the skewed level we’re actually very competitiveand what we can do is a better job of packaging our products and also pullingout in many cases where we may seem to be offering the same product for alittle more that in fact the quality and the number of components to thatproduct are much greater. So, that’sanother initiative to strike a better price value relationship. I think if we do that and we continue to improveour service and use that as a tool we’ll be able to actually get more marginand provide the customer with a better experience at the same time.

[Mike Regan –Hawkshaw Capital Management, LLC]

That raises one other question that I had. I think in the past, as you know, you’ve sortof been thought of as more of a higher end retailer and I think in the past hada strategy to more down the market. But,in looking at the average tickets of the new customers versus the repeatorders, the new customers have a higher average ticket than the repeatcustomers. Is that something that justnaturally happens with this business or is that a sign that you’re going aftermore the higher end customers?

Kevin A. Green

I think its part of the nature of the beast in that newcustomers everything you offer is new to them. So, historically in my past experience and I think in the industryyou’ll sometime see a higher average order size from a prospect because all theproduct is in fact new to them. However,when you look at that relative to catalog circulation or ad spending you get amuch lower response rate because obviously it’s prospecting and inherentlythat’s what happens. So, they’re not ascost effective in terms of an ad cost ration but they will often put out ahigher average order size.

[Mike Regan –Hawkshaw Capital Management, LLC]

So, that’s not a sign that you’re going after higher endcustomers. It’s just something thathappens in catalogs?

Kevin A. Green

Yeah. And, in my experience, I was atLillian Vernon for 16 years, we saw the same phenomenon. But, hopefully what then happens is thatthose customers come back to us and while some of their initial purchases arethings that they’ll still have an continue to use over time they’ll continue toaugment through the new products that we offer. So, what you hope to do then is to get a repeat customer that ordersfrequently although perhaps at a slightly lower net average order size.

Operator

Your next question comes from the line of Bill Lauber ofSterling Capital Management. Pleaseproceed.

Bill Lauber –Sterling Capital Management

On your customers do you guys keep track of the repeat orderrates by I guess the word would be different co-horts. So, if you first got a customer the summer of2000 what that repeat rate is versus someone from year 2005?

Kevin A. Green

It’s a great question. It’s one of the main objectives of the new customer database and we’renot there yet but, it’s certainly very important. And, what you’ve suggested is that at certainpoints in time and certainly one of the things we’re key to look at is in theJanuary through June, 2006 time period where we put a lot of customers throughthe [pick to light] issues that we had at that time are they going to have ahigher or lower lifetime value than other customers acquired at different timesthrough better service windows that we’ve provided. Also, by source – do you acquire someonethrough paid search? Do you acquiresomeone by a catalog mailing? And, howdo those people do? And, same thing bybrand – someone acquired through the Birthday Express brand versus CostumeExpress brand. Unfortunately, we don’tknow that right now but, we’re going to gain that knowledge. It’s a key initiative over the second half ofthis fiscal year to learn that and what that will help us do is be able toprioritize ad spending to those areas, those sources, particular prospectlists, different advertising channels that will provide the customers with thegreatest lifetime value. But, I’m sad tosay today we cannot do that.

Bill Lauber –Sterling Capital Management

But somewhere that information is there it’s just that youcan’t query it?

Kevin A. Green

Correct. It’s all inthere. We have a tremendous amount ofdata. Unfortunately, it was not a waythat was structured for access and that’s what we’ve been changing.

Bill Lauber –Sterling Capital Management

Do you have outside consultants getting a database togetheror is that an internal project?

Kevin A. Green

Yeah. We’ve used acompany here on the technology side called [Ramp] and they’ve been able toconvert our database from what was on old FoxPro technology to a SQL serverdatabase. We’re also using outsidemarketing consultants at this point now to start going through the informationto get a leg up on starting to understand how we can mine it and begin toimplement it. And, some of this as youknow in our industry test and respond means we’re going to go through ourdatabase in the coming months, we’re going to create a number of hypothesis andsimulations and then we will test those. So, the actual impact of any kind of magnitude will happen at some pointin the fiscal year ending May, 2009.

Bill Lauber –Sterling Capital Management

On the costume inventory build up would it be safe to say –and I guess on the last call I asked you guys this. It looked like you guys were making a prettybig bet on sales. Would it be safe tosay that the sales were disappointing compared to what you were expecting withfilling up the inventory that much?

Kevin A. Green

The early season sales – we started in August and then thefirst half of September were soft and I think they were soft not only for usbut, as we understand it was within the industry. So, that portion of the inventory wasdisappointing in that it is leftover. Onthe other hand, we had a great surge the second half of September and intoOctober and so the inventory that we have primarily is good inventory. We just had a little too much of it figuringmore of it would sell throughout a three month period instead of a month and ahalf. So, while there’s some liquidationand some discounting right now still on our website, most of its still goodinventory that we’ll be able to offer successfully next year.

Bill Lauber –Sterling Capital Management

When you say good inventory is it costumes that are year inyear out? I know you can’t predictwhether Hannah Montana is going to be popular next year and stuff like thatbut, what do you mean by good inventory?

Kevin A. Green

It’s actually the proven inventory things like Star Warsthat sell year-over-year and just don’t go away is what comprises most of whatwe’re holding. Is there a little bit ofthe baddish Hannah Montana in there? Probably however, that represents less of what we’re carrying becausefrankly it wasn’t very, very hot this year and as you know a third of yourproducts run away. You’ve got the middlethird and then you’ve got dogs and Hannah Montana certainly wasn’t in the lowertwo thirds.

Bill Lauber –Sterling Capital Management

The Birthday Express business I guess you’re saying thebiggest driver there of the drop in sales was sending out less catalogs thanbefore. I’m just trying to get a graspon going forward looking at 2009, 2010. Is that going to be a growth business again? And, how do you get there?

Kevin A. Green

We believe it is and there are a number of things that wethink are going to jump start it. One isimproving the customer experience consistently over time that will become arecruiting tool through positive word of mouth advertising and increasecustomer loyalty and repeat buying. And,as you know, over the last several years as the company reached the scale wherethe infrastructure couldn’t support it adequately we haven’t been the leader interms of providing the best experience to our customers. That is going to change. From the warehouse management system thatwe’re putting in that will allow us to replenish picking bins to manage orderdeployments and prioritize orders to get picked so that customers get them in amore timely fashion and more accurately. Having a data center that we’re working on that’s going to mean a fastwebsite and a stable website. A phonesystem that will allow us to manage the customer relationship better andprevent dropped calls. Having a betterfocus on customer service. These arethings that we think not unlike companies like [Zappos] and others that actuallyuse good service as a tool for recruiting, I think we’re going to be able to dothat. Positive word of mouth advertisinghas been one of the legacy tools that this company has used and we need to getback there.

The other thing is in terms of Birthday Express thecontent. We need to find a way to getinto the lives of our customers and make ourselves relevant everyday and thenwe’ll be able to monetize those contacts as I mentioned earlier throughproducts and services that we don’t currently offer. This is something that until we have our nextgeneration website in place we’ve been basically doing I think good work interms of the interfaces that we can for our customers but, you think about aBirthday Express business and creating loyalty right now I have to admit on ourcurrent website customers can’t even register. We don’t have a registration and so when they come back to usunfortunately, each and every time it’s as if they are a new customer. They have to enter their billing address,their shipping address, their credit card information and not having that onour site means we cannot serve content to them in a relative way. So, without the belaboring the point we’vebeen operating solely on the fact that we’ve had tons of themes, a broadportfolio of themes and licenses and exclusive products but we’ve really lostground over the last five years or so and especially in the Internet space interms of being able to provide a good shopping experience and to have arelationship with our customer. I thinkthat’s going to be a gain changer for us in being able to provide the kind ofcontent whether it’s local resources for magicians or pizza parlor, you nameit, like a party planning wizard where people can come in whether it’s forbirthdays or even Halloween or for an anniversary to be able to have us helpthem make it easier to be the hero in the eyes of their family is somethingthat I think will be a game changer.

Then the products; we’ve been focusing on a number of newinitiatives with costume and with holiday but I think as we build out ourmerchandising team which we’re looking to do and augment it. Some of the themes like Pokemon and SesameWorkshop and Bindy. We have Candy Land,we have Full House. These things may notresonate with you right now but in the five to eight year old little girllittle boy world they are better important. Those are new things that we’re going to bring to the market and I thinkwe’ll be able to accelerate that and establish the leadership position that thecompany has had.

Then, on the marketing side whether it’s new ways of public relations orgetting the word out and building the brand, grassroots through onlineadvertising, doing more with press releases but, being able to make us more ambiguousin terms of the customer, I think that’s going to go along way. The business intelligence that will come outof our new database to allow us to market what products should be on the coversof which catalogs to which customers at what time. This customer has only fairly in arudimentary way circulated catalogs and while we’ve made some improvements thusfar, we really haven’t had the information to support it on a consistentbasis. That’s going to be very helpfulgoing forward.

One of the things to remember is that this company did havehigh growth rates in the past until it kind of out ran it’s infrastructure andwhat we’re trying to do now is play catch up and put that infrastructure inplace. Then, while certainly the marketis different now and there’s different competitors and there’s certainly morecompetition for the keywords in the costume business we think once we catch upand we’re close to getting there, that there is growth ahead for BirthdayExpress and the gross pollination between – we have a portal website now whichcombines Birthday Express as well as Costume Express and that kind of crossmarketing in an environment that is very useful to the customer we believe willadd a lot of growth opportunity for us.

Bill Lauber –Sterling Capital Management

On that point doyou see youradvertising model moving more away from thecatalogs to theweb? I mean my daughter will bethree here in acouple of months and just from watching thePBS kids programs I took her to theCurious George website one time and she’s always asking meto go on the computerand go to the CuriousGeorge website to play thegames or something like that. Itseems like if you can advertising on something like those, and I know thatbasically all of thosecharacters that are onPBS have basically their own website for thewww.PBSKids.org, itwould seem like that might bemore cost effective –something like that because looking forward I’m sure these shipping rates areprobably going to go up and it’s probably going to become more uneconomical aswe go along.

Kevin A. Green

Yeah. I think you’reabsolutely right and that is part of our test and respond program. We want to spend our advertising dollars asdeeply across each channel as makes sense and acquiring customers that have apositive lifetime value. So, we will seta certain level, a natural level for catalog circulation as well as paid searchas well as online advertising and it will find its natural level and the newdatabase will allow us to better evaluate the success of the program. And, you will see it move in a way thatfrankly the customer respond and that’s the beauty of this business is that thecustomer will tell you what’s the best way to acquire them if you will listento them. Up until now we really haven’thad but except for very rudimentary ways of listening to the customer.

Bill Lauber –Sterling Capital Management

Going back to the Costume Express you mentioned that theones that had a bad experience was 10,000 or less. How many costume orders were taken in thatquarter?

Kevin A. Green

271,000.

Bill Lauber –Sterling Capital Management

What’s kind of the industry standard or guideline? You touched with Birthday Express gettingback to the positive word of mouth but, the negative word of mouth for everydisappointed customer how does that affect your future sales? How much does that person tell otherpeople? Is there any kind of industryguideline on that?

Kevin A. Green

Yeah and unfortunately a good experience will lead to threepeople being told. A bad experience willlead to 10 people being told so we understand how important it is to providegood service and that is a clear, clear priority within the organization. In terms of being able to quantify that,that’s difficult.

Bill Lauber –Sterling Capital Management

I knew there were some numbers out there whether it was allthat scientifical I didn’t have that with me so I just wanted to get thatagain. Then, the deferred billingprogram you’re winding that down?

Kevin A. Green

Yeah. It’s somethingthat we started testing in August of 2006 and then fully rolled out by January,2007 and it’s really buy now pay later and the notation was that we wouldauthorize the customer’s credit card for the full amount of the order at thetime that they placed the order but not send it through to the credit cardcompany until about 90 days later. Thenotation there is obviously if someone’s throwing a lavish birthday party theycould spend more perhaps on the party itself and pay off the party supplieslater. It seemed to work and we wereabout 5 to 6% of our total orders were coming in over the deferred billingchannel. The deferred billing orderswere about $105 per order. The key toremember though is not all that is incremental it’s just natural for thecustomers who are spending more to kind of just check off the box. So, the incremental portion is smaller thanwhat those numbers might suggest.

But, one of the keys to the program is that when you go toactually bill the customer is that you submit that same credit card forreauthorization and there’s a certain amount that don’t reauthorize forwhatever reason and there’s a process called – there’s different names withinthe industry whether it’s force payment or soft declines but even if you don’tget a second authorization you can send it through and more often than not muchmore often than not it’s just a matter of timing and the customer ends uppaying and it’s something that I think is fairly widespread in theindustry. However, the credit cardissuers and the banks that support them has over the last four months or fivemonths have changed their position and they’re actually starting to issue finesfor sending through soft declines. So,the risk of those fines relevant to what we felt was the incremental value ofthe program made it more of a breakeven proposition for us rather thangenerating accretive earnings. So,because we’re obviously a for profit business and this program does take timeaway from management attention we decided that we would wind it down startingin January.

Bill Lauber –Sterling Capital Management

It was more of the credit card companies changing theirpolicies?

Kevin A. Green

Yeah. That was thedriver.

Bill Lauber –Sterling Capital Management

My last question is I know you’ve talked in the past that2009 is kind of when we can start judging you as you turn around thebusiness. Are you happy with yourprogress so far? And, in addition tothat, is the board happy?

Kevin A. Green

Well yeah, I think we’re moving according to plan. There’s nobody more eager to show resultsthan myself and the management team and everyone here as well as the boardwhich I think has great representation of the shareholder base. But, we know there’s a lot of non sexy hardwork that has to get done and we’re pounding through it and we’re doing it andwe’re also showing other signs of improvement as we’re going forward. So, while certainly we would hope to be ableto show improved results sooner rather than later we are making good solidprogress. The statement that in fiscal09 and again, fiscal 09 starts for us June 1, 2008 is the put up or shut upyear and I think that the board’s been very supportive of the work that’sneeded to get done in order to create the infrastructure to run the business;it’s that simple. It’s not great, it’snot exciting but it’s what needs to get done.

Will

Have you seen any effect from the economy slowing down? Has that affected the business at all?

Kevin A. Green

It would be hard to think that we wouldn’t experience it aswell. Certainly on the Birthday Expressside there’s the notion that kids are usually the last ones to suffer a tougheconomy so we understand that. We areprobably less effected by it than others but with high energy costs, gas justhitting $100, volatility in the stock market, credit cards being maxed out inmany cases, it’s hard to believe that some portion of our results aren’trelated to that.

Operator

Your next question comes from the line of Kian Ghazi ofHawkshaw Capital. Please proceed.

Kian Ghazi – HawkshawCapital Management, LLC

I think if I remember the history correctly the fulfillmentproblem or challenges pretty much finished in the early summer of 2006 and so Iwould think that your repeat order rate would be impacted, you know, at a tightwould have the worst impact a year after those fulfillment challenges werefixed because you wouldn’t have as many repeat orders from that group ofconsumers who had a bad experience. But,I would expect also that your repeat order rate would improve as youanniversary that and certainly this quarter was a full quarter were I believewe anniversaried those problems and yet we’re still not seeing a pick up in therepeat order rate. Do you have a thoughtas to why that might be the case?

Kevin A. Green

Well two things. Oneis we did push as we mentioned the prospecting circulation for Costume Expresswas up 110% this year versus on the customer file it went up 59%. So, be design we did push for more newcustomers to be acquired during the Halloween window so that itself would drivedown the percentage of revenues coming from prior customers. The other piece of it is that not everycustomer orders every year so there is unfortunately kind of a laddered effectof customers coming back. I think Will hadasked the question earlier in terms of understanding repeat buying rates forpeople that had purchased at different points in the past and so the peoplethat shop with us in the January through June, 2006 time period where we weregoing through the [pick to light] issues that portion would have been animportant portion because they are still fairly recent to generate businessthis year and certainly my instinct is that they as a chunk of our businesswould have pressured repeat buying down a bit. So, mainly there were those two factors.

Kian Ghazi – HawkshawCapital Management, LLC

When do you think it would be reasonable – I presume you’renot going to be as aggressive on the prospecting in the current quarter becauseI think that was a Halloween specific issue, correct me if I’m wrong and ifthat’s the case when do you think we’ll start to see an improvement in therepeat order rate?

Kevin A. Green

That’s a very good point and I think that we did do muchmore prospecting certainly with our holiday test so I would say by the thirdquarter will be a little bit but, by the fourth quarter I would think yourassumption would be correct.

Kian Ghazi – HawkshawCapital Management, LLC

With regards to the fact that you did more prospecting forthe costume business is there a readily available repeat order rate for thebirthday business that we could segregate out so we can kind of see whathappened without that increased prospects.

Kevin A. Green

No there really isn’t. Again, it’s something that at some point hopefully soon in the comingmonths we’ll have handy but breaking it out by business segment right now issomething that we’re going to need to leverage our new database to provide.

Kian Ghazi – HawkshawCapital Management, LLC

So it’s not a matter of you don’t want to provide thatinformation it’s you don’t have that information.

Kevin A. Green

Yeah. I wince when Isay that but, yeah.

Kian Ghazi – HawkshawCapital Management, LLC

Fair enough. Now,with regards to the – I know circulation was down 20% for the birthday businessand you showed I think it was a 14% decline in revenues so net/net it lookslike you’re getting rid of less productive orders. But, having said that were you expecting adouble digit decline in your order rates?

Kevin A. Green

It’s a good question and the answer is relative to thecirculation decrease yes we were expecting that. We were anticipating perhaps being able tospend more cost effectively on paid search to make up the difference but thatdidn’t happen to the degree we had hoped.

Kian Ghazi – HawkshawCapital Management, LLC

So, there was a 20% decline in birthday circulation catalogswhat was the change in online spend for the birthday business? Ballpark would be fine. Was it up? Down? Or, flat?

Kevin A. Green

It would have been down about 17 to 18% I would presumeballpark just because of the circulation certainly was the lion’s share of thespending and paid search having gone up would have offset that.

Kian Ghazi – HawkshawCapital Management, LLC

Let me just make sure that I understand the 17 to 18%. What I was asking was what was the change inyour online advertising spend for your birthday business? Was that what was down 17 to 18%?

Kevin A. Green

Oh, I’m saying that the total ad spend – the online spend intotal dollars was up about $300,000 versus the second quarter prior year and sowe don’t have the percentage handy but where I was headed was if the catalogcirc was down 21% and that drives the lion’s share of the spending. But, the online spending would have been upand up by $300,000 versus the prior year so that’s a net change in onlinespending would have been down say 17 to 18%.

Kian Ghazi – HawkshawCapital Management, LLC

Should we expect continued kind of 20% decline in circ for theremainder of this year and therefore continued double digit declines in thebirthday business for the rest of this year?

Kevin A. Green

I think until we anniversary the May, 2007 postage increase we would see thatand so it wouldn’t be unexpected for the balance of this fiscal year ending Mayof 2008. But, we would anticipate beingable to go back and revise our circulation. As Will had mentioned earlier yeah there is going to be a reallocationof dollars that’s going to come naturally between online and catalog as costsgo up however, our feeling is that with our new database we’ll be able totarget catalogs much more effectively. We’ll have a better understanding of the online revenues that catalogmailings generate and so we think we’ll definitely be able to drive catalogexpense down as a percentage of revenues. But, we may also be able to increase circulation if in fact we find thatwe can tie more online spending back to the catalog mailings themselves.

Kian Ghazi – HawkshawCapital Management, LLC

Lastly, we saw a spike in selling and marketing this quarteris that entirely or largely because of Halloween? Or, is this an all season change in yourmarketing strategy?

Kevin A. Green

It was primarily Halloween. We were very, very aggressive but, one of the things that you will seeaffecting the third quarter is that we did do a test for the Christmas seasonand it’s a test that we label as the Christmas season because we didpositioning of the products for Christmas. However, it’s a broader test in that some of the spending around it wasas I mentioned earlier to enable us to work with drop shippers, third partyproviders of products, also some different options in terms of gift messagingfor our customers, being able to provide gifts to support the birthday businessas well as Christmas, linking to personalized product offerings. So, some of the things that we did with theholiday test will be leveraged going forward but I think because of the holidaytest was kind of a concentrated effort you will see some higher marketing spendin the third quarter related to that.

Kian Ghazi – HawkshawCapital Management, LLC

Just bigger picture as you kind of step back and review yourimplementation of the strategy and vision and direction you brought to thecompany what’s been your greatest disappointment relative to the expectationsyou had when you established your strategy?

Kevin A. Green

Well I think it’s really just been the amount of worknecessary to execute. When I joined thecompany in May of 2006 as you know we went through a process of a little bit ofturmoil during the summer we explored strategical alternatives for about ninemonths and that didn’t end until March of 2007. And, during that time it was really hard to bring on the managementtalent that we needed to augment the people who were already here. So, in some respects it’s only been ninemonths since that process ended and you know that doesn’t turn off immediatelylike a water valve. So, it’s just been alittle bit more difficult. I think alsosome of the legacy systems that were here were perhaps a little morerudimentary and patchwork than I had anticipated coming in. So, doing certain things that may seem kindof common and frankly are common are difficult here. So, it’s really been the speed with whichwe’ve been able to execute while trying to protect the customer along the wayand you know we’ve had some bumps and bruises for the customer in terms ofbring up WMS and driving a Halloween business while the infrastructure is stillnot where it needs to be to support the things that we’re doing. But, we’re trying to learn and build at thesame time and hopefully it will start coming together towards the end of thiscurrent fiscal year and that’s why we still stand by the fact that the fiscalyear 2009 that begins in June of 2008 is really the year where we think we’llbe able to show the difference.

Kian Ghazi – HawkshawCapital Management, LLC

When do you think you’ll have the key systems in place to nolonger feel like you’re handcuffed and fighting with one arm tied behind yourback?

Kevin A. Green

It’s going to be as we enter fiscal 2009. That’s when what we describe internally as our next generation websitewill go up. But, we’ve slowly beenreplacing systems and I’ll give you a for instance – our warehouse managementsystem which allows us to be able to know where our inventory is in differentlocations in our DC it also triggers replenishment to pick bins on a timelybasis and for the first time we’ll know where stuff is. I can’t put it any more simply thanthat. So, that system had to be tiedinto our enterprise system and we had upgraded from Great Plains 5.5 to Great Plains 9.0 during last spring and I believe it went in April of2007. So, that aspect of integrating anew warehouse management system within Great Plains wascertainly easier because we had updated that piece. But, the other pieces that the warehousemanagement system needs to be integrated to is a banner printing system, ascroll printing system, a old manifest system and all those things are – andagain, I don’t want to denigrate any of the work that we’ve done before myarrival because before the company went public everything had to be done on thecheap and some of the systems are frankly old and unsupported and we can’t evenfind expertise today to help us with those systems so you can’t even throwmoney at it. But, we have to piece thosethings together and as we replace them piece-by-piece each subsequentimplementation will become easier. Westill have a lot of work to do on the back half of this current fiscal year andthen as we implement the next generation website in phases in fiscal 09 I thinkthat’s when we’ll start to really be able to operate focus on marketing andmerchandising.

Kian Ghazi – HawkshawCapital Management, LLC

Is there anything in the next generation website that is“innovative”? Or, is this just catchingup, stuff you see on a lot of websites, stuff your competitors are doing, youjust haven’t done it yet?

Kevin A. Green

Unfortunately a lot of it could fall into that category but,there are things like being able to tie in our customers to other resources ina way that very few others do. Forinstance most of it relates to things that are being done but not necessarilyin our space in terms of birthday parties or costumes. While I could point to a number of websitesthat’ll have the features we’re contemplating for the next generation websiteother competitors and certainly you know who they are in the party favor space,birthday space, costume don’t have those features. So, we think we will be able to establish anindustry leading relationship in our corner of the world.

Kian Ghazi – HawkshawCapital Management, LLC

As far as your competition goes can you describe who youfound to be the most aggressive with regard to what they would spend on paidsearch or whatever the modes might be in both sides of your business thecostume business and the birthday business?

Kevin A. Green

Sure. Incostumes certainly www.BuyCostumes.comhas amodel where I think they mail maybe less than amillion catalogs ayear and rely almost entirely on paid search. But, there areother companies like www.Spirit.com,Halloween Express and then there area whole bunch – whatwe noticed this year is there were awhole bunch of small online retailers that were chewing up paid search. They allincrease market share from theuniverse that we look atby half a percentagehere and half apercentage there but, there were somany of them that itreally added up. So, one of thereasons why we were soaggressive with Halloween was anunderstanding that we wanted to beable to fend them off and maintain our customer file and build our customerfile for thefuture. So, inthat regard we saw paid search costs go up fairly significantly.

On the Birthday Express side it’s less competitive on thepaid search for the types of party supplies that we offer and while paid searchhas been notched up it hasn’t been certainly to the degree it has been forHalloween.

Kian Ghazi – HawkshawCapital Management, LLC

So it would be the most [inaudible]?

Kevin A. Green

Birthday Express is very competitive. Birthday Direct, Oriental Trading, Shindighas their birthdays products and there’s a whole host of them but there’s notas many as seem to come out of the woodwork as Halloween this year.

Kian Ghazi – HawkshawCapital Management, LLC

What are you seeing from Oriental Trading as far as changesin strategy and how aggressive or non aggressive they’re being?

Kevin A. Green

One of the things that we’ve found with our birthdaybusiness is that there is a barrier to entry even for a company as powerful asOriental Trading is and that is that the prepackaged party supplies thatrequired 15 lines per order and multiple units per line is something that wehave now expertise in terms to our [pick to light] module that services theBirthday Express business and what we’ve found is that other companies arestruggling with that. So, we haven’tseen the kind of special memories that we can create in a packaged way to allowa mom to save money and to be the hero more easily to their family. So, other companies tend to say, “Hey we’vegot 25,000 products we’ll dump them out on the table and you go pick.” On the other hand we’re trying to develop arelationship and an editorial perspective of what we put in our party packs toreally create that special memory we think is important to our customer base.

Operator

(Operator Instructions) We have no further questions at this time.

Kevin A. Green

Great. I’d like tothank everybody for spending this time with us today. We appreciate it and we look forward toupdating you on our progress during our third quarter conference call. Thank you everyone.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

This Transcript
All Transcripts