1-800 Flowers.com Q3 2006 Earnings Conference Call Transcript (FLWS)

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

1-800 Flowers.com, (NASDAQ:FLWS)

Q1 2006 Earnings Conference Call

April 27, 2006, 11:00 a.m. EST

Executives:

James F. McCann, Chairman and CEO

William E. Shea, Senior Vice President, Finance & Administration and CFO

Christopher G. McCann, President

Analysts:

Anthony Noto, Goldman Sachs

Jeffrey S. Stein, KeyBanc Capital Markets

Casey Fagan, CJS Securities

Eric Beder, Brean Murray & Co

Heath Terry, Credit Suisse

Paul Keung, CIBC

Glenn Krevlin, Glenhill Capital

Operator

Good day ladies and gentlemen, thank you for standing by and welcome to the 1-800-Flowers.com Third Quarter 2006 Earnings Conference Call. My name is Carlo and I’ll be your coordinator for today’s presentation. At this time, all participants are in listen-only mode. We will be facilitating a question and answer session towards the end of today’s prepared remarks, at which time if you’d like to ask a question, please press “*” and “1” on your touchtone telephone. If at any time during this call you require audio assistance, feel free to press “*” and “0” and a conference coordinator would be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s conference, Joseph Pititto, Vice President of Investor Relations.

Joseph Pititto, Vice President of Investor Relations

Thank you Carlo. Good morning and thank you for joining us today to discuss 1-800-Flowers.com’s financial results for our fiscal 2006 third quarter. My name is Joseph Pititto and I’m Vice President, 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 Investor Relations section of our website at 1-800-Flowers.com or you can call Patty Altodama at 516-237-6113 to receive a copy of the release by e-mail or fax. In terms of structure, our call today will begin with brief formal remarks and then we will open up 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 maybe forward looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the applicable statements. For a detailed description of these risks and uncertainties, please refer to our press release issued this morning as well as our SEC filings including the company’s annual report on Form 10-K and quarterly reports on Form 10-Q. In addition, we will discuss this morning certain financial measures that were prepared in accordance with generally accepted accounting principals. Reconciliation of those non-GAAP financial measures to the most directly comparable GAAP measures can be found in 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 recording of today’s call, the press release issued earlier today or in any of its SEC filings, except as maybe otherwise stated by the company. I’ll now turn the call over to Jim McCann.

James F. McCann, Chairman and CEO

Thanks Joe. Good morning everyone. As we announced in this morning’s press release, during our fiscal second quarter we achieved record revenues of $180 million, representing a growth of approximately 15% or $23 million compared with the prior year period. This was driven by more than 20% growth in our online revenues and importantly was achieved despite the shift of the Easter holiday from the third quarter, where it fell last year, into the fourth quarter this year.

Before I turn the call over to Bill for his review of the specific results and metrics for the quarter, I would like to highlight a few key achievements. First on the product front, in our “Call for Gift” category we achieved 12% revenue growth despite the highly competitive nature of the Valentine holiday. This growth, on the larger space in the category, further extended our market leadership position. In our “Food, Wine and Gift Basket” category we saw continued double digit revenue growth, driven largely by Cheryl&Co. bakery gift business; this despite the largely poor nature of the Valentine holiday and the Easter shift out of the quarter.

During the quarter, we also significantly expanded our position in this key gifting category with the announcement of our pending acquisition of Fannie May Confections Brands. The Fannie May, Harry London, and Fanny Farmer names represent premium chocolate brands with a history of very strong customer loyalty. These brands offer a significant opportunity for growth, particularly through the leveraging of our assets and capabilities in the online and direct marketing space. The acquisition also brings an experienced and focused management team that can help us achieve the leadership position that we have targeted in the “Food, Wine and Gift Basket” category.

Second, on the customer front, during the quarter we attracted 824,000 new customers with 73% of them coming to us online. At the same time, we enhanced the relationship we have with our existing customers as evidenced by the 58% weekly order rate achieved during this quarter, which was consistent with the prior year period.

Third, during the quarter, we achieved further growth in our Bloomnet business where we expanded our florist network and developed new products and services designed to help our florist members enhance their growth and profitability. We are already beginning to see contributions from the investments we have made in Bloomnet during the past 12-18 months and we anticipate a ramp up of those contributions in fiscal 2007 and beyond.

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

William E. Shea, Senior Vice President, Finance & Administration, CFO

Thank you Jim. Despite the highly competitive nature of the Valentine holiday, during our fiscal third quarter we continued to drive double digit revenue growth and improved our gross profit margin compared with the prior year period. Importantly, in our current fiscal fourth quarter, our second largest in terms of revenue and profitability, we expect to continue these trends, thereby extending our market leadership in the floral gift category, or concurrently building a leading position in the “Food, Wine and Gift Basket” business.

Regarding specific financial results and key metrics for the third quarter, total net revenues reached $180 million, an increase of 14.6% or $23 million compared with $157 million in the same period last year. This included an organic growth of approximately 10% and 12% growth in our core floral gift category, despite the shift of the Easter holiday. Online revenues grew 20.3% to $110.3 million, compared with $91.6 million in the third quarter last year. These online revenues equaled 68.1% of combined online and telephonic revenues for the quarter, compared with 63.8% in the same period last year, illustrating the continued migration of our customers to our online channels in regards to all of our brands.

Telephonic revenues declined 1.7% to $51.5 million, compared with $52.4 million in the prior year period. Retail fulfillment revenues were $18.2 million, compared with $13 million in the year-ago period. This increase primarily reflects growing revenues from our Bloomnet business as well as revenue from our Cheryl&Co. retail stores.

During the quarter, our combined online and telephonic orders totaled 2,549,000, compared with 2,432,000 orders in the year-ago period. Average order size during the quarter increased to $63.51 compared with $59.24 in the prior year period. This increase primarily reflects the combination of product mix, increased add-on sales, and pricing initiatives.

During the quarter, we added 824,000 new customers with 602,000 or 73% coming to us online. This was achieved by concurrently stimulating repeat orders from existing customers, who represented approximately 58% of total revenues, consistent with the third quarter last year.

Gross profit margin for the fiscal third quarter increased 140 basis points to 39%, compared with the same period last year, primarily reflecting product mix and pricing initiatives.

Our operating expenses as a percent of revenue was flat at 40.2% compared with the prior year period. When we exclude cost associated with non-anniversary acquisitions, this ratio actually improved to approximately 140 basis points during the third quarter. Going forward, this is a key area of focus and we expect to begin demonstrating enhanced operating leverage in our fiscal fourth quarter and increasingly in fiscal 2006 and beyond.

For the quarter, non-cash stock-based compensation was $1.1 million pretax and $700,000 net of tax, or approximately $0.01 cent per share. As a result of these factors, our GAAP net loss for the third quarter was $1,540,000 or $0.02 per share, an improvement of $506,000 or 24.7% compared with a net loss of $2,046,000 or $0.03 per share in the year ago period.

Pro-forma net loss for the quarter, excluding stock-based compensation expense, was $821,000 or $0.01 per share, representing an improvement of 59.9% or $1,225,000 compared with the prior year.

Turning to our balance sheet, reflecting the seasonality of our business, our cash and investments position at the end of the quarter was approximately $19 million. This includes both a $37 million reduction in accounts payable during the quarter as well as an inventory bill for the upcoming spring holiday season. We expect to generate cash during the current fiscal fourth quarter and anticipate finishing the fiscal year with a cash position of approximately $40 million, excluding the impact of our pending acquisition of Fannie May Confections Brands.

Inventory of approximately $43 million was in line with management’s expectations and reflects the build up of inventories for our spring gifting season, particularly in products for our growing Bloomnet business and for Plow & Hearth garden products.

Regarding guidance; as stated in our press release this morning, we have reaffirmed our revenue growth guidance of 14%-16% for fiscal 2006. In terms of bottom line results, for the full fiscal year excluding the impact of the pending acquisition of Fannie May Confections Brands, we expect to achieve pro-forma earnings growth of approximately 40% compared with fiscal 2005. We expect a combination of operating loses associated with the seasonality of the Fannie May business and interest expense from the debt financing that we’ll use for the acquisition, to reduce fourth quarter EPS by approximately $0.02 to $0.03 per share. As we stated in our earnings, in our earlier press release, we expect the acquisition will be accretive to earnings in fiscal 2007.

In summary, as we enter our fiscal fourth quarter, we are focused on driving double digit revenue growth, growing our gross profit margin, and improving operating leverage. I’ll now turn the call back to Jim.

James F. McCann, Chairman and CEO

So, in summary, we are pleased with the continued positive growth trends that we see in our business during the third quarter, including double digit revenue growth, 15% overall and more than 20% online, driven by our extended marketing programs, both online and off, and despite the impact of the Easter shift. It is also important to note that our organic growth for the quarter was 10% including 12% growth in our core floral gift category. Additionally, we continue to grow our Bloomnet business, further expanding our florist membership in developing new products and services that help them grow their businesses. We are very excited about Bloomnet and we anticipate growing contributions from this business in fiscal 2007 and beyond.

In our “Food, Wine and Gift Basket” category, we continue to see excellent growth opportunities. We’re rapidly becoming a leader in this key gift category with the success of our organic growth initiatives and key acquisitions. With the addition of our latest acquisition of Fannie May Confections Brands, which we expect to close next week, we anticipate revenues in this category will exceed $200 million during fiscal 2007.

Now, looking ahead, as we enter our fiscal fourth quarter which includes the important spring holiday season, we are focused on achieving both solid revenue growth and gross profit margin improvement compared with last year. In our floral gift business, we are excited about the initial success we’ve seen from the innovative outdoor marketing program that we launched with CBS Outdoor for our “Happy Hour Collection,” a new signature floral gift line perfect for everyday gifting occasions. This has been the best new product launch in our company’s history and we plan to build on it with additional new signature gift items and innovative marketing merchandising programs that leverage our successful “Your Florist of Choice Marketing” message. We believe these factors combined with our focus on achieving increased operating leverage will enable us to enhance our results in the current fiscal fourth quarter and beyond, and thereby build long-term shareholder value.

That concludes our formal remarks, and we’ll now ask Carlo to open the call for your questions. Carlo, please restate the instructions for the Q&A.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, at this time, if you ask a question please key “*” and “1” on your touchtone telephone. If that question has been answered or you wish to remove yourself from the queue, you may then press “*” and “2.” Again “*” and “1” at this time for any questions. One moment, please.

Sir, your first question is from the line of Anthony Noto with Goldman Sachs.

Anthony Noto, Goldman Sachs

Thank you very much. Jim and Bill, I was wondering if you could comment a little bit more on telephonic year-over-year revenue decline, exactly what you see undergoing that trend, is it ASPs, is it orders? Then separately, could you give us a sense of the organic growth for the overall company or specifically the online revenue, the organic growth excluding acquisitions on a year-over-year basis? Thanks

James F. McCann, Chairman and CEO

In terms of the first part of your questions…telephonic decline is consistent with what we’ve been saying that we expect to have single digit decline, it wasn’t as much as we thought it would be but obviously outpaced by the online growth. I think it will probably stated that we’re probably close to where we expect to be in our most mature brand online, the 1-800 Flowers brand, in terms of the mix between telephonic and online. We expect that it’s going to stay in that 80-20 kind of range, so we’ve gained a couple of points with that now, and that’s frankly because our customers who come to us online sometimes also come to us telephonically. So, it means there’s a customer service occasion that they want to contact us, they order flowers for someone who is in a hospital or had a new baby, and they’ve already been discharged by the time they place the order and they need to contact us, and that contact tends to be done on the telephone. So, I’d expect that in that most mature brand we’re about where we want to be and in the less mature brand like Cheryl&Co., which a year ago had little or no business online, the first year of operating results will probably yield them close to 30% of their business online from essentially zero. So, as to the less mature brands, as we build their online business, we’ll continue to see that trend line move up like it was this quarter, 68% of overall business being online and with our most mature brands being in the 80-20 range.

William E. Shea, Senior Vice President, Finance & Administration, CFO

Anthony, just with regard to organic growth, we stated in the release that the organic growth was approximately 10%…

James F. McCann, Chairman and CEO

…and 12% in the floral category.

Anthony Noto, Goldman Sachs

Thank you very much.

Operator

Sir, our next question is from the line of Jeff Stein with KeyBanc Capital Markets.

Jeffrey S. Stein, KeyBanc Capital Markets

Good morning guys. Couple of questions for you; first of all, one for Bill. I’m wondering Bill if you can help us model Fannie May on a quarter-by-quarter basis, how should we think about dilution and accretion as move into fiscal 2007 by quarter?

William E. Shea, Senior Vice President, Finance & Administration, CFO

Okay. Jeffrey, we’ve provided in the press release regarding the Fannie May transaction and the subsequent following up an AK…Fannie May was about $75 million or so and we anticipated finishing the year ended April 2006 at about $75 million, a little over $12 million in EBITDA. We anticipate being able to grow both those numbers under our ownership as we move forward. It is a seasonal business with a large component of the profits being during the holiday period, the fourth quarter period, and we have to realign their year end quarters into our fiscal year. They make a little bit of money in the quarter after the holiday quarter, in that kind of late winter/early spring quarter, they do lose money during the summer months. So, the impact we indicated on our fourth quarter between the financing course and their operating loss, so we’re losing a little bit, $0.02 to $0.03.

Jeffrey S. Stein, KeyBanc Capital Markets

I was wondering, Bill, if you can talk a little bit about the marketing as a percent of failed. You guys had indicated that you did not see the same customer acquisition cost that FTD did over the Valentine’s Day period, yet your marketing costs were up, can you go into that a little bit?

James F. McCann, Chairman and CEO

I don’t think we did comment on the marketing course during the Valentine’s Day. I think you might be referring to our last quarter where we asked questions about whether or not we saw the irrational pricing at Christmas time, but I’ll ask Chris to comment on what we’ve seen in terms of online strengthening course during this last quarter.

Christopher G. McCann, President

Specifically, it was compared to some of the competitors that had come in the past, that’s really related specifically to search, and we continue search as somewhat rational in our category, as we mentioned during the Christmas holiday season, and again that continues to Valentine’s Day, of course it spikes up at the holiday, but compared to prior year, it’s comparable if not less, so we didn’t see any spike there.

William E. Shea, Senior Vice President, Finance & Administration, CFO

Jeff, one of the comments you made in the formal remarks was that, while we’re showing our operating expense as a percent of revenue being flat year over year, we are absorbing Cheryl&Co., which we acquired in the early part of the fourth quarter last year, this third quarter this year, and then the wind and weather, kind of product line brand, where these are nonseasonal clients for these business, so they’re impacting our leverage ratio in the year-over-year comp…excluding them we would have been…with 140 basis points.

Jeffrey S. Stein, KeyBanc Capital Markets

Got it. One last question guys; now that you’ve purchased or agreed to purchase Fannie May, I’m wondering if you see any additional hope in your non-floral gifting categories that you might still may be on the lookout for?

James F. McCann, Chairman and CEO

I think the way we categorize that is we’ve been pretty successful and demonstrated a core capability here in integrating the different small acquisitions we have made. Frankly the Fannie May acquisition is the largest of those acquisitions and we expect to close that next week. So, I think we’ve demonstrated a pretty good capability integrating where it’s appropriate to integrate them. In terms of other categories, clearly we’ve set out a range of products and services that we want to continue to provide to our customers and deepen our capabilities in each of those categories. In the floral business, clearly we have a lot of assets and the leading position in the marketplace; clearly we’ve not been making acquisitions there. But where it’s appropriate in those adjacent “Food, Wine and Gift” categories in particular, where you can get assets that you can help to leverage and grow more quickly, it will continue to be delivered, studied, and strategic in how we look to flush out those categories.

Jeffrey S. Stein, KeyBanc Capital Markets

Thank you.

Operator

Sir, your next question is from the line of Bob Labick with CJS Securities.

Casey Fagan, CJS Securities

Good morning, this is Casey Fagan filling in for Bob. Can you give us an update on the number of new members in Bloomnet?

Christopher G. McCann, President

As we look at Bloomnet again, Bloomnet is still being in its early stage and for competitive reasons we’re not giving any specific metrics there. I think you’ll see the continued success of Bloomnet on our retail fulfillment line as that continues to grow, driven primarily by the growth of Bloomnet. Other than that, in addition, we continue to enhance the products and services we’ve introduced over the year. So, our directory was the first product and that continues to grow nicely for us, credit card clearings have been introduced, selection guide, and of course product sales through Bloomnet’s purchase net continues to grow. Next year, you’ll see us continue to add other products and services to that base of Bloomnet, and again Bloomnet is not targeted to grow anywhere near the existing numbers that are on the wire services, but it has a much more selective group of florists.

Casey Fagan, CJS Securities

Great, and can you give us an idea of what the competitors response to these products and services have been?

James F. McCann, Chairman and CEO

This is Jim. I would say that it’s difficult for the other players in that category to change. They already have a full breath of services, they already have wonderful cash flow businesses, they’re just mature in the cycle where a classic disruptor coming in with a unique set of assets…our success is of course not dependent on any activity or actions by those two entrenched competitors. It’s just that we have a wonderful set of assets and we intend to continue to leverage them and build a very good, very significant business.

Casey Fagan, CJS Securities

Okay, and can you give us an update on how the revenues for Bloomnet member has been versus your expectations, are they higher or are they lower?

James F. McCann, Chairman and CEO

I think, in fairness, what we’d say is that we’re pretty much on plan with what we anticipate of Bloomnet. It’s still a very contribution when you look at the overall business and I think as we get to the year end at the end of this quarter, when we get to our year end conference call, we’ll obviously get into more specifics in terms of Bloomnet, but this is its first operating year and we’re not going to break out the individual revenue for shop, other than to say that we’re very happy with its performance and it’s right on target.

Casey Fagan, CJS Securities

Great, okay. And how do you view the success of your new customer acquisition method such as Outdoor, and are they ahead or behind your expectations?

James F. McCann, Chairman and CEO

Well, let’s just say…we launched this partnership with CBS Outdoor. Wally Kelly, the CEO of CBS Outdoor, approached us back in the fall and we huddled with them around the holiday season. The holiday season is a good time for us to catch up, because we’re all busy working apparently, all the people at CBS Outdoor are too, and we came up with a really neat campaign here where we were able to introduce…with this being the only media, now of course we had the “Happy Hour Collection” for months on our site, so we had a good sense of what we could do with our own internally generated interest among our own customer base. So, we have a very, very clean test here where we tested in six markets with CBS Outdoor -- New York, Los Angeles, Atlanta, Miami, Denver, and Washington D.C. So, we’re on billboards, we’re on transits, bus shelters, phone kiosks, some mix of all of those in those six markets have been shipped to test, but the results have been frankly phenomenal. I think we had the most successful new product launch for us and probably for the category of it, and what’s unique about this is, is it’s something that speaks to our florist nest. This is a product that can only be made by florists; it’s not practical to ship it by an overnight carrier or anything. We have it available for “Same Day Delivery.” Florists are in love with the product because it’s a good price point, it’s got reasonable margins, its fun, it puts smiles on peoples’ faces, we have quality versions of it, but it’s especially a non-holiday item; a neat way for men and women to express themselves and connect to the important people in their lives. It’s gone so well in its first six-city launch that we’ll tell you now that we’re launching it in nine new markets beginning in May; and that’s Chicago, San Francisco, Philadelphia, Detroit, Cleveland, St. Louis, Baltimore, San Diego, and Seattle. So, this is starting to pick up momentum and now we’re hanging lots of other stuff on it. And what’s nice about this? Yes, we’re an online company; yes, we’ve spent a lot of people and have had a lot successes with online marketing, but now that our brand is so strong, 1-800-Flowers.com, you tell people both ways they come to you; now we have this really disruptive kind of media out of home where anywhere, especially with the population being so wide now and so many of them having high-speed access, that if you’re on a street or in a car in any of the six cities that we launched in, you know who 1-800-Flowers is and you know about this new “Happy Hour Collection.” Those market results have been phenomenal. We’re seeing something in the order of seven-time ratios of sales in those markets of just that product compared to the national audience. So, if that holds up with the other nine markets, we’re going to have a very fun time for us at 1-800-Flowers and for Bloomnet, because its florists are doing well and purchase that because we’re selling them the products. So, it’s an example of what we hope will be a wave of new products that help our florists to help their customers to connect and express themselves and do well in the process.

Casey Fagan, CJS Securities

That’s great, very helpful, thank you.

Operator

Sir, your next question is from the line of Eric Beder with Brean Murray & Co.

Eric Beder, Brean Murray & Co

Good morning. Could you talk about in some respect the ramp up in terms of the new acquisition, in terms of how much presence they have in the Internet, and how quickly do they ramp up to the kind of levels you’d like them to be in terms…maybe like with Cheryl&Co. and some of the ones you bought last year, kind of the ramp to them to move on more on the net?

James F. McCann, Chairman and CEO

I’ll let Chris speak to the second half of your question, Eric, this is Jim. I’ll tell you on the front end of it, the management team is delighted to be partnering…standing on to run these three brands for us. That’s a very aggressive plan to go directly out to the consumer. In the first couple of years of operating this business, this management team had to be focussed on stabilizing the business, reintroducing the brands, orchestrating their backend manufacturing, and reintroducing the products to the markets that had disappeared. They’ve done a great job with that. Now, phase two for them is, in order to have all these other direct-to-consumer assets to play with, is to really focus on the business model they already have but especially on the new part of the business model, which is direct-to-consumer business. There’s a third aspect too, which is the second most important product for us is the florist to be able to bring our customers, uniform and across the country, is candy. People expect that their florists would carry candy. They’d expect it as an add-on product that they could send with flowers or in gift baskets, but also a product that might be a standalone product. So, that’s why we went looking for this product line and for these brands, and we’re lucky enough to find them and hand them to the management team that we felt a very strong relationship with that can help us grow it now through our florist network, specifically through Bloomnet, where we’ll be able to have a really good mid price point nationally known brands of candy in our stores that we can promote now; the first time ever in the florist category, promote on a national basis. So, the three aspects are: a) continue their core business which they already have, which is retail and some wholesale manufacturing, this is for wholesale markets; b) direct-to-consumer business; and c) the direct-to-consumer business aided by the Bloomnet capability. In terms of direct-to-consumer business, I’ll ask Chris to speak to that, but it’s a nascent business, we earned just a few million dollars now and we expect that we can help that management team grow that part of it with the addition of our assets.

Christopher G. McCann, President

We’ve mentioned earlier we’re really happy with the success we’ve had with the Popcorn Factory growing their online business from relatively a zero to one-third of their business right now, 35% plus of their business coming online…in approximately let’s say three years on the Popcorn Factory. Cheryl&Co. we went from a single digit percent of their business coming online to 35% probably within the first year of us owing that business, so we’ve had success. And as Jim pointed out with the Fannie May, Harry London brand, a little bit different there, because our focus will be really on growing over all directions in the marketing business, whether it be through the telephonic or the online channel, but of course the focus will be on the online channel.

William E. Shea, Senior Vice President, Finance & Administration, CFO

Yeah, the one difference with Fannie May with this acquisition is the other brands we speak about were direct-to-consumer businesses and it was a matter of changing some of the channels, probably how they order from us, but it was a direct marketing business. Now, here it really is a retail wholesale business with a very small direct-to-consumer business that we think we have a great opportunity with, but the size of that and the ramp will take longer to do.

Eric Beder, Brean Murray & Co

Okay, in terms of Bloomnet, when do you believe that you’ll have the same suite…what’s the target of the same kind of suite of all frames that your competitors have, which will enable someone to do basically the soup-to-nuts that they do with another competitor now?

James F. McCann, Chairman and CEO

Well, I think we have every service that a florist needs to interact with us, so florists chose to apply their Bloomnet membership and it was accepted in our membership program. They don’t need to belong to any other wire service. The suite of services that we’ll continue to offer and introduce, I would say that the bulk of them will take the next couple of years to introduce, but we will always be introducing new products and services. Chris mentioned half a dozen or so that we’re planning to introduce in the next 24 months, different service each quarter, but right now a florist who belongs to Bloomnet need not belong to another wire service.

Eric Beder, Brean Murray & Co

Okay, beyond the things like candy what other products do you want to sell through the Bloomnet network to the florists that are unique or different than other players on offering?

James F. McCann, Chairman and CEO

Frozen pizzas…I think we’ve set out a planogram, Eric, of the range of products and services that we want to have as “Your Florists of Choice,” that we want to continue to flush out, and that’s all flowers and plants, all of the giftware related to those products -- the greetings products, the balloons, the stuffed down old products, candy…we’ve always known that candy was the single most important next category, and then all of the “Food, Wine and Gift Basket” categories. So, I’d say in order of importance; candy is important in the next 24 months to make that just a great national multi-branded, great positional brand. We already had the very high end of candy coverage with our Godiva relationship. Now, we have some mid price points as well. We’ve always had some novelty price points, but now we have mid price points with brands. So, we have a really great suite of the chocolate products to bring to our customers and to partner with Bloomnet on. I think the biggest growth opportunity is an organic effort which we just launched, which is 1-800-Baskets, launched as a soft launch in the last quarters. I think that has the potential to be the biggest category. And what’s good about that is, it’s clearly a gift product that leverages all other brands, the items that we include in those baskets. This is great opportunity to do interesting promotions and partnerships where we build our brand by doing great partnerships and great promotions and finding unique marketing opportunities like the marketing opportunity with CBS Outdoor. So, I think 1-800-Baskets in an organic effort, leveraging brands…and I just happen to think that all of those gift baskets are going to have a lot of Fannie May candy products in them, just something tells me that, but there are good opportunities there. So that’s the planogram we’ve laid out and we just see ourselves deepening those opportunities.

Eric Beder, Brean Murray & Co

Okay, a followup question on Bloomnet. In terms of pure order flow to the Bloomnet florist, when you talk about competitors, how many more orders they can get…I mean, the florist takes this product to have these innovative items, they also obviously take it to get orders, how much advantage do you see with competitors in terms of order flows you can give to a florist where they can’t get in other networks?

William E. Shea, Senior Vice President, Finance & Administration, CFO

Eric, we said in the past, we had more than twice as many directable orders to our next closest competitor. So, we have significantly higher number of orders and we can help deliver to a much more network. So, we can always be a more important part of our florist members’ business than our competitors can be.

Eric Beder, Brean Murray & Co

Okay, and is there anything new going on in terms of how the franchising is doing, in terms of that effort?

James F. McCann, Chairman and CEO

Nothing new there. Franchising for us is, as we’ve mentioned in a couple of prior calls, is super-Bloomnet for us. We have a couple of experiments that we’ve talked about in the past. One is a co-branding experiment in Denver with a very good, well established, terrific family that runs flowers in Denver, Colorado, now Belcamps_ 1-800-Flowers. We’re doing lots of fun and interesting experimental things. It’s not an accident that Denver was on the list of the first markets. We’ve tested with CBS Outdoor our “Happy Hour Collection.” Doing it in Denver gave us an opportunity to really drive traffic into Belcamps_ 1-800-Flowers retail business and into their retail brands locally. So, franchising is not a growth opportunity for us right now. It grows because we’re selling company owned stores to some of our franchisees, and of course our franchisees are doing well and they’re looking to expand the number of shops that they operate. And the most recent thing is that our design centers, formerly called local performing centers, are converting their contracts to come up with the franchises. So, that’s the only growth in that network. Our primary emphasis is clearly on Bloomnet. How do we attract the right florist to apply for membership in our network, which we’ve already done; how do we ramp them up, how do we introduce the programs to them and help them be successful, how do we make that exclusive very elite network which has the most orders in the industry over the fewest number of shops, being disproportionately important to them, how do we help them be profitable and successful while there’s still some trouble in the overall floral category, and we still can see in the information available to the industry that retail florists other than those that part of Bloomnet are struggling.

Eric Beder, Brean Murray & Co

Okay, thank you.

Operator

Sir our next question is from the line of Heath Terry with Credit Suisse.

Heath Terry, Credit Suisse

Great, thank you. I was wondering if you could just talk a little bit more about what you’re seeing in marketing and customer cost, particularly on a unit basis, you guys obviously do a lot of sponsored search, can you talk about the trends in pricing there as well as the ROI that you’re seeing or been able to realize?

Christopher G. McCann, President

Heath, this is Chris. From an ROI point of view, I’ve kind of touched on this area. We’re comfortable with the marketing spend and the return that we’re getting from a pure customer metric, new customer acquisition cost point of view, we give that metric at the end of the year and annual basis simply because it’s fluctuating for so much during a quarter. You got to search specifically…nothing special continues to be very productive for us, especially as we are able to leverage our multiple brands throughout the seasons. So, when one brand is getting extremely expensive other brands are able to really cost effectively mind the customers and that works very nicely for us. The other great thing in that, as we look at our marketing mix and the ability to constantly manage that mix, and that’s one of the things that I think we’ve proven very adept at, is keeping our cost in check to mind this channel for the best part ROI. So, if that gets too high, we’re able to pull back in that area and we’ll move that business to offline, whether it be a new program like Jim speaks with the on-hold program as an example, and that’s something from an overall point of view we’ve consciously and strategically made sure our marketing plans always has that flexibility so that we are never held prisoner by rising costs in one specific channel.

Heath Terry, Credit Suisse

Okay, thanks.

Operator

Again, ladies and gentlemen, as a reminder “*” and “1” for any questions. Sir, our next question is from the line of Paul Keung with CIBC.

Paul Keung, CIBC

Good morning. Couple of questions, I might have missed it, one was on the free cash flow, can you give us some parameters about how to determine free cash flow generation given some of the items coming online, and specifically I’m just trying to figure out what your sort of normalized inventory bill working capital is going to be, as well as it looks like your CAPEX also might be ticked up as well given some of the necessary spend on some of these acquisitions?

William E. Shea, Senior Vice President, Finance & Administration, CFO

Yeah, I think with regard to…we anticipate CAPEX somewhere on a normalized basis, around 2% of revenues, going up maybe with the growth that we have, but not necessarily at any extraordinary pickup on CAPEX. With regard to free cash flow, we do have some fluctuations with seasonality and working capital that works into it, but it is a traditional complication of working back from an EBITDA basis…we will as we move into next year…we’ve had some growth this year with some of the balance sheet items including inventory as we’re looking to drive greater margins. So, we’ve had some uptake on inventory, some of that is seasonality with the shift in Easter as well as we’re preparing for the upcoming spring season, but we should be normalized more in the high 30s or so in revenues.

Christopher G. McCann, President

I think we’ve seen it early that we’ve been focussing on cautiously…taking a little bit more in because we’re doing some foreign sourcing that gives us better gross margin, one of our targets is to driving gross margins and that enables us to do it.

Paul Keung, CIBC

So, we shouldn’t see inventory bills in CAPEX grow faster than revenues next year?

James F. McCann, Chairman and CEO

No we won’t, in fact Bill just gave you a way to average it out as we become a larger company, he’s expecting CAPEX to average out around 2%.

Paul Keung, CIBC

Okay, and then on your stock compensation, I know you expelled your stock option plan this year. So, now that you’ve done that, what sort of stock compensation should we expect going to next year?

James F. McCann, Chairman and CEO

I’m sorry I didn’t hear the first part.

Paul Keung, CIBC

I believe you expelled your stock option this year to reduce the effect it may have on your earnings going into fiscal 2007. I was wondering what the use of that is?

James F. McCann, Chairman and CEO

We just did that on some of the money options…

William E. Shea, Senior Vice President, Finance & Administration, CFO

But Paul, that was over a year out that we did that. We do still have some options that are coming due. We have migrated our long-term compensation plan from straight stock options of a few years ago through a combination of stock options and restricted stock, etc., accounting treatment on the FAS 12R, we’re showing this year at about $3 million on an annual basis or about a penny a quarter hit to EPS, which will actually reduce over time.

Paul Keung, CIBC

So, it will go down in fiscal 2007?

James F. McCann, Chairman and CEO

Yes. It’s been a penny a quarter this year, no more than that next year.

Paul Keung, CIBC

Got it. Then, the last question is on Plow & Hearth, and would you consider selling any of the brands you have in the portfolio to the extent that you may not see the signs that you thought you would see when you originally acquired these brands?

James F. McCann, Chairman and CEO

The Plow & Hearth brand is fortunately doing what we forecasted it to do. We’re finishing up a two-year term in that business. It’s growing in good high single digits, contributing nicely. We’re leveraging its backend assets, in terms of what we call our shared services platform of IT and service center, etc. So it’s contributing as nicely as we said it would and providing us good cash flow generation at the same time.

Paul Keung, CIBC

So, where are you having challenges among the brands? If you kind go across a lot of brands that are doing well, very decent numbers overall, there’s obviously something that’s still not adding up, so there’s obviously something that’s not doing well.

James F. McCann, Chairman and CEO

No, I think they’re all doing about what we said they would, and as we give our guidance for next year, at the end of this quarter, I think you’ll get a deep appreciation for the performance of each of the brands. Some are very…Fannie May is not in our hold yet, but as you see the layout of our forecast and next year, I think you’ll see they’re all doing well.

William E. Shea, Senior Vice President, Finance & Administration, CFO

And Paul just to get specifically on the third quarter when you’re looking a year-over-year compensation on the third quarter, there would be have been 140 basis points improvement in operating leverage. Again, a number of our businesses have seasonal periods that are very strong in the calendar fourth year, but during this timeframe our weakest with the year-over-year compensation is we’re absorbing a Cheryl&Co., which is a non-seasonal time for them.

Paul Keung, CIBC

Got it, great, thanks a lot.

Operator

Sir, we have a question from the line of Glenn J. Krevlin with Glenhill Capital.

Glenn Krevlin, Glenhill Capital

Good morning. I was wondering if you could elaborate on your success of shifting some of these offline, online businesses, specifically with Cheryl&Co., you talked about 35% online. Can you talk about what kind of sales growth you’ve seen in that business, and why you’ve been able to get to 35% in one year versus…in prior it’s taken you a little bit longer, what are you doing there to accelerate the growth of online? And then in terms of Fannie May, can you talk about what kind of growth you’re looking for in that asset, in terms of topline?

William E. Shea, Senior Vice President, Finance & Administration, CFO

In terms of the first question, the reason why we’ve been able to do so well at introducing Cheryl&Co. online business, I think it took us three years to get there in terms of the Popcorn Factory, but there were a smaller company and had other issues that we had to address -- the technology issues, build of website. Cheryl&Co. already had a website. It wasn’t doing a lot of business on a single PC; what we were able to do is come in and not change the website but now give the horsepower behind it so that it didn’t lock up with more than four people active. So, we put them on top of our server form of hundreds of servers and it allowed its existing website to have the horsepower. In addition, they were able to prospect in the 1-800-Flowers corporate database, the names, increase their marketing in terms of catalogue efforts, which has a nice split between telephone and online respondents. In addition, probably most importantly, we have a very talented team here, Glenn, that really know how to do online marketing. And when you take these smaller brands, these smaller giftable brands which have not exposure to search and other online marketing methodologies, and now have a team of professionals who can now guide that and in fact takeover as an agency, sort of an internal agency, directed in the online marketing world, we’ve become more sophisticated over those last three years. So when Cheryl&Co. joined the fold almost a year ago now we were able to immediately help them with the online world, increase their prospecting capabilities very cost effectively through catalogues as a result of their access to our database, and what you’ll see is a force in addition to the robust backend on their existing website. And the fourth element you’ll see for them this summer, is that we’ll actually redo the front-end of their website too, to give it all the whistles and bangs and customer functionality that the 1-800-Flowers customers and other brands enjoy, because now they’re in their off season and we can do that and put that on the front end. So I think that growth has been good. We said that they were growing, Cheryl&Co. was growing at a single digit rate when we acquired them, and I think we’ve said in our last call that they were growing more than a good solid double digit rate now without the proportionate increase in marketing, showing the leverage of the assets we brought to the table.

Glenn Krevlin, Glenhill Capital

And in terms of Fannie May, Jim, what kind of growth you’re looking for there?

Christopher G. McCann, President

I think just was regard to Fannie May without giving specific numbers, I think we’ve stated that we believe it will be accretive both to our topline growth rate as well as to second quarter earnings.

James F. McCann, Chairman and CEO

So, we can’t give specific guidance on that beyond what we’ve done in the press release. What we did state to you is the different areas that we expect to grow in without being able to quantify that until the end of this quarter, and their primary business, which is a split of retail and the wholesale manufacturing operations, will continue to grow. They’ve been growing at a nice single digit rate on their own. We expect that we could jazz that. If you look at the retail piece, that’s not going to grow a lot. But if you look at the retail direct-to-consumer piece on the catalogue and especially on the website, that’s only been a few million dollar business, so we’re going to put the lion share of our focus in terms of their growth efforts.

Glenn Krevlin, Glenhill Capital

And in terms of Plow & Hearth, just to complete that, in addition to the good revenue growth you cited, what are you seeing on the margin, sort of the operating margin?

William E. Shea, Senior Vice President, Finance & Administration, CFO

With gross margins, we’ll continue to move in our efforts to bring in and import more of that product line to drive their gross margin dollars and move it down to the bottomline, and we’re seeing improvement. We have specified the margins by brand, but we’ve certainly seen improvement in the operating margin.

James F. McCann, Chairman and CEO

I think the focus there clearly is, we’ve set out some longer range guidance for the whole company, and our expectations and emphasis of Plow & Hearth is a good solid single growth rate on the topline and growth rate in terms of their operating margins as result primarily of gross margin enhancement on pace with the whole company.

Glenn Krevlin, Glenhill Capital

And any comments on their retail endeavors?

James F. McCann, Chairman and CEO

No, their retail efforts are minor. We haven’t had any new stores in a while there. We’re testing the waters there to find out what models work best. It’s primarily a direct-to-consumer business, not through a retail channel but through these virtual channels, and that will continue to be the case.

Glenn Krevlin, Glenhill Capital

So, it’s fair to say that you’re pleased with or comfortable with the process the new team is making there?

James F. McCann, Chairman and CEO

Very much so.

Glenn Krevlin, Glenhill Capital

Thank you very much. I’ll let someone else jump in.

Operator

Again, ladies and gentlemen, as a final reminder “*” and “1” for any questions. Sir we have a question from the line of Jeff Stein with KeyBanc Capital Markets.

Jeffrey S. Stein, KeyBanc Capital Markets

I just wonder, guys, for the record, did you make money at Bloomnet during the current quarter, and beyond that would it be fair to say that the investment period is now behind you and that we should begin to kind of move into a harvest mode?

James F. McCann, Chairman and CEO

Jeff, I would certainly yes to the first question, because the return was profitable this quarter. We expect it to be profitable on an ongoing basis. Harvest might imply that we’re going to just strip our profits from it and not grow it. It will do both. It will grow at a very good healthy pace, outstripping the growth of the rest of the company and it will disproportionately contribute in terms of operating margins as we forecasted. So, when I say Harvest I don’t want you to think that we’re going to slow down its topline growth. It will grow nicely on both fronts.

Jeffrey S. Stein, KeyBanc Capital Markets

You did indicate that on your retail and fulfillment line that it was, I guess, the strongest contributor to dollar growth, can you be anymore specific in terms of how much of that dollar increase was attributable to B2B?

James F. McCann, Chairman and CEO

We wouldn’t go beyond what we’ve already said. It’s the significant contributor on that line and I’m not sure we’ll get into more specifics in the future.

Jeffrey S. Stein, KeyBanc Capital Markets

One final question; by the end of this fiscal year, once the deal closes for Fannie May, you guys have historically been in a net cash position, it seems that now you’re going to be taking on a little bit of leverage. Longer term, is there any type of capital structure that you feel comfortable with; in other words, would you be willing to take on considerably more leverage if the right opportunity came along?

James F. McCann, Chairman and CEO

Well, I’ll give you what the top lines will look at. Without the Fannie May acquisition, Bill said that we would end this quarter with $40 million in cash. With the acquisition, we’ll end this quarter with about $30 million in cash. We’re taking on a very prudent amount of debt to do this acquisition, which we after our capital announcement is the best way to manage this very conservative balance sheet, this very strong balance sheet with a properly priced bank debt. We’ll still have $30 million in cash at the end of this, so obviously we’re spending cash on all the deal-related costs and the working capital adjustments that will go into that. So, you see prudence and you see a very strong balance sheet, but you see that when the right opportunity comes that we think we can bring real asset benefit too, that we can have a great earnings routine, great trends, and really grow it in three to almost four different places that we described, and we’re certainly willing to do that, and that gives us the best opportunity in a very good environment for good shareholder appreciation.

Jeffrey S. Stein, KeyBanc Capital Markets

Thank you.

Operator

Sir, we have a question from the line of Peter Treadway with TracerCapital.

Peter Treadway, TracerCapital

Good morning guys, how are you…I have one question and it is again on the cash perspective. You guys talked in the beginning of the year about generating about $25 million of free cash flow. It looks like you’re going to come in about neutral this year, and you’ve reiterated your long-term targets throughout the year. What’s changed a little bit just from the free cash flow generation perspective? You’re in line with revenues, in line on the EPS, but free cash flow has been a little bit weaker, and when can we expect that to turn around?

William E. Shea, Senior Vice President, Finance & Administration, CFO

We certainly anticipate next year to be a strong period for us in terms of not only top line growth but accelerated bottom line growth. With regard to some of the numbers with the free cash flow that we talked a little bit about, CAPEX being a little bit higher and some of the working capital that we had, we said as we’re looking at enhanced gross margins, bringing in a little more inventory, we’ll get into a level that we think we’re comfortable with, and going forward it will not grow at the same rate as our top line growth. But for next year, we’ll be generating significant free cash flow.

Peter Treadway, TracerCapital

You guys talked about adding debt to make acquisition, would you do that in order to buyback some of your own shares?

James F. McCann, Chairman and CEO

I’m sorry, Peter, could you repeat that one.

Peter Treadway, TracerCapital

To buy back some of your own stock, would you take on debt?

James F. McCann, Chairman and CEO

We’re not making any forecasts to doing that, but it’s certainly an option that’s available to any management team that has a strong balance sheet that we have.

Peter Treadway, TracerCapital

Great, thank you.

Operator

Sir, we have no further questions at this time.

James F. McCann, Chairman and CEO

Thank you Carlo, and thank you all. Thank you for your questions and your interest, and if you have any additional questions, please get in touch with us. In closing, I’d like to offer a public service announcement. There are only two days left in Administrative Professionals Week, with our “Same Day, Any Day” delivery capabilities, it’s not too late to recognize that special professional in your office that keeps your business life in order. Also, Mother’s Day week begins next week, only a week more, and it’s never too early to visit your Florist of Choice, 1-800-Flower.com. So thanks for your time and your attention today and for any further questions please give us a call. Thanks.

Operator

Ladies and gentlemen, we thank you for participation in today’s conference. This concludes your presentation and you may now disconnect.

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