1-800-Flowers.Com Inc (FLWS) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2007 1-800-FLOWERS.COM conference call. At this time all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS).

I would now like to turn the presentation over to Mr. Joseph Pititto, Vice President of Investor Relations. Please proceed, sir.

Good morning and thank you all for joining us today to discuss 1-800-FLOWERS.COM financial results for our fiscal 2007 second quarter. My name is Joseph Pititto and I am Vice President of Investor Relations. For those of you who have not received a copy of our press release issued earlier this morning, the release can be accessed at the investor relations section of our web site at 1-800-FLOWERS.COM or you can call [Patty Altadonna] 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 the call to your questions. Presenting today will be Jim McCann, CEO, and Bill Shea, CFO. Also joining us today for the Q&A section of our call is Chris McCann, our President.

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

In addition, this morning we will discuss certain supplemental financial measures that are not prepared in accordance with generally accepted accounting principles. Reconciliations of these non GAAP financial measures to the most directly comparable GAAP measures can be found in the tables accompanying the Company's press release issued this morning.

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

I will now turn the call over to Jim McCann.

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

As a result of these factors we achieved very strong bottom-line performance including EBITDA growth of 54% to approximately $34 million and net income growth of 64% to approximately $17 million or $0.26 a share. These results were driven by double-digit revenue growth and increased profit contributions from our key business categories -- Consumer Floral, BloomNet Wire Service and the Gourmet Food & Gift Basket businesses.

These businesses most effectively leverage our operating platform and our unique collection of assets, including our database of more than 25 million, our strong brands, our service platform, our technology and our unique distribution capabilities.

Importantly, the strong top and bottom-line contributions from these businesses enabled us to more than offset the weaker performance in our Home & Children's Gift businesses. I will discuss the specific steps that we are taking to address this category later in the call.

Before I turn the call over to Bill for his review of the metrics, I would like to highlight a few additional points.

First, in the Floral category. Our Call 1-800-FLOWERS.COM Consumer Floral business grew approximately 11% to $115 million. We believe this growth on the largest base in the category further extends our market leadership position. We also enhanced our gross margin and operating leverage, resulting in a 43% improvement in category EBITDA to more than $13 million in the quarter.

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

Second, in our fast-growing Gourmet Food & Gift Basket category, revenues grew almost 75% to $109 million. Gross margin increased 90 basis points to 48.4%.

Category EBITDA grew almost 140% to more than $25 million. These results include the contribution from Fannie May Confections business, which we acquired in May of last year, as well as strong growth from our Cheryl&Co. bakery gift business. This business is on pace to generate nearly $200 million this fiscal year, positioning us as a leading player in this fast-growing category.

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

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

One other note on the quarter. In December we repurchased 3 million shares of our stock from J.P. Morgan Partners. We saw this as a very attractive investment and it removed a potential overhang from the market.

Looking ahead we believe the strength of our business model, combined with the operating and customer focus programs that I have mentioned position us well to achieve our goals for double-digit revenue growth and enhanced bottom-line results in the second half of this year.

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

Thank you, Jim.

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

Regarding specific financial results and key metrics for the second quarter, total net revenues reached $329.9 million, an increase of 18.7% or $52 million compared with $277.8 million in the same period last year. During the quarter our e-commerce orders totaled 4,375,000 compared with 4,285,000 orders in the year-ago period.

Average order size during the quarter increased to $61.69 compared with $60.33 in the prior year period. This increase primarily reflected a combination of product mix, increased add-on sales and pricing initiatives.

During the quarter, we added 1,246,000 new customers with 780,000 or 63% coming to us online. This was achieved while concurrently stimulating repeat orders from existing customers, who represented approximately 53% of total revenues compared with 50.7% in the prior year period.

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

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

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

GAAP net income for the second quarter increased 63.8% to $16.9 million or $0.26 per share, compared with $10.3 million or $0.16 per share in the prior year period. Pro forma net income was $17.6 million or $0.27 per share compared with $11.2 million or $0.17 per share in the year ago period. For the quarter, non-cash stock-based compensation was approximately $1 million pretax, $700,000 net of tax or approximately $0.01 per share consistent with the prior year period.

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

Gross profit margin for the quarter increased 160 basis points to 39.7%, compared with 38.1% in last year's second quarter. Reflecting the revenue growth as well as the improved gross margin and increased operating leverage, category EBITDA grew 43% or $4 million to $13.3 million compared with $9.3 million in the prior year period. Just a reminder, we define category EBITDA as Earnings Before Interest, Taxes, Depreciation and Amortization and before the allocation of corporate overhead expenses.

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

In our Specialty Brands businesses -- Gourmet Food & Gift Baskets, revenues increased 74.6% or $46.5 million to $108.9 million compared with $62.4 million in the prior year period. Gross margin increased 90 basis points to 48.4% compared with 47.5% in the year ago period.

Category EBITDA grew 139% or $14.7 million to $25.3 million compared with $10.6 million in the prior year period. Results in this category reflects continued strong growth in our Cheryl&Co. brand as well as revenue contribution of $42 million from the Fannie May business which leveraged our operating platform and cross brand marketing opportunities to achieve strong growth during the quarter.

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

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

Turning to our balance sheet. Our cash and investment position at the end of the quarter was approximately $26 million. This reflects $15.7 million used in December to repurchase 3 million shares of our stock. At the end of the quarter we had no outstanding balance on our revolving credit facility.

Capital expenditures during the quarter were $10.5 million compared with $13.1 million in the second quarter last year.

Inventory of approximately $58.8 million was in line with management's expectations and reflects the buildup for the Valentine holiday and our spring gifting season. And includes approximately $18 million related to Fannie May.

It is important to note here that inventories associated with our Home & Children's Gifts brands have been successfully managed, relative to their weaker sales and do not have any significant -- and we do not have any significant excess inventories.

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

In terms of topline, based on the lower revenue contributions from our Home & Children's Gift category we anticipate total revenue growth for the year will be at the low end of our guidance range of approximately 17% to 20%.

Regarding the current fiscal third quarter which includes the Valentine holiday we expect the period will represent 22 to 24% of our full fiscal year revenues.

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

To sum up, we had a strong second quarter. We achieved revenue growth of approximately 19% or more than $50 million. We increased gross profit margin more than 100 basis points. We significantly improved our operating leverage, achieving a 130 basis point improvement in operating expense ratio.

As a result we increased EBITDA 54% to approximately $34 million and improved EPS by more than 60% to $0.26 a share. Our topline and bottom-line performance was driven by double-digit revenue growth and increased profit contributions from our key business categories -- Consumer Floral, the BloomNet Wire Service and Gourmet Food & Gift Baskets, he businesses that best leverage our operating platform and assets.

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

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

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

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

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

Enterprise wide, we expect to drive higher gross profit margins through a combination of sourcing initiatives, process improvements, and focused merchandising programs.

In addition we are seeing some early benefits from our numerous process improvement initiatives and we anticipate growing contributions from these efforts across all of our brands. We believe these factors combined with our focus on achieving increased operating leverage will enable us to enhance our results in the second half of fiscal 2007, and build long-term shareholder value.

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

(OPERATOR INSTRUCTIONS). Anthony Noto with Goldman Sachs.

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

Then secondly, if you can give us any sense of how much EBITDA that Fannie May contributed during the quarter?

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

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

What we are seeing is double digit growth in all of our core categories. 1-800-FLOWERS, the consumer business, BloomNet and the Gourmet Food & Gift Basket arena. All double-digit growth rates organically.

And then just any insight into how much EBITDA Fannie May is contributing?

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

Jeff Stein with KeyBanc Capital Markets.

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

The answer, in summary, is yes. Yes, we are confident that the biggest impact that we would have experienced from Plow & Hearth and those brands occurred in this quarter. It is when they do the lion's share of their business. It is primarily a single quarter business.

As Bill mentioned in his remarks, we have taken steps already with new management at the Plow & Hearth to mitigate any of the impact that could occur in the second half of the year. But keep in mind two-thirds of their business occurs during that -- almost two-thirds of their business occurs during that fourth calendar, our second fiscal quarter.

So yes. It had a big impact on us in this quarter so we are very pleased that the quarter still came out so good. Yes; we look at what it could've been if we had better performance with those assets, which causes us to say what's the business plan for those assets? What are the investment characteristics for those brands? How do they leverage the assets that we've been fortunate enough to accumulate?

How is their leverage of those assets different from the characteristics of what we identified as the key growth areas and cause us to make capital allocation assumptions and strategic business decisions, which is why we've asked Tim to do the work that he is doing this quarter so that we have all of the right information to make our go-forward plans and assumptions.

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

Right now, what we are focused on are gathering all the information we need to improve the operating performance of that division and to help us define all of our -- help us define all of the options that we have in terms of reviewing all of our assets.

As we have stated in the most recent couple of calls, every asset we have we look at a capital allocation question. We look at a resource allocation beyond our financial capital and bandwidth; and which assets have the best possibility of leveraging the wonderful assets we have been fortunate enough to accumulate. The 25 million customers. Our Web capability; our IT platform, our unique distribution system.

And if we were to determine that someone else could better benefit from our assets or have different leverage, say, than we had two or three, four or five, six years ago in those assets -- that would help us to come to different conclusions about what we do ultimately.

But right now we are in the information-gathering mode and have not made any hard commitments in terms of what we will do there. But clearly as fiduciaries we have a responsibility to make sure we have the best set of leverageable assets.

Great. Two other questions real quickly. Wondering if you could just comment on the increased repeat rate year-over-year. It seems to be pretty significant; and what factors may have driven that.

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

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

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

And each brand looking and -- again, even to the point of leverage, leverageable assets, that is where we are seeing a lot of leverage between the Gourmet Food & Gift basket brands and the Floral brands as well and looking at how we drive customers between those brands and introduce them to the extended product categories.

Other efforts again just like the introduction of the Fresh Rewards Loyalty Program within Flowers really helping to drive significant repeat rates as well. So we are very pleased with our results there.

From a BloomNet perspective, Jim addressed the membership number issue. But again, we look at the results that we are achieving in BloomNet and very pleased with the response we are getting in the marketplace. We continue to add programs into the marketplace. So clearly we have BloomNet products, we have the directory, credit card programs that we've previously introduced. Very recent introductions from BloomNet Technologies is our web site hosting capability for florists. Our florist management, POS, in all the management systems that we have introduced into the community. So very good response that we are receiving in the BloomNet (inaudible).

Thanks.

Paul Keung with CIBC World Markets.

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

One of -- as we look at the advertising for the holiday program, again, we look at the results we achieved from Q2 and thus make adjustments accordingly as we move into Q3 and Q4. So our plans are set. We are ready for the Valentine's Day holiday.

I guess as we look at one component, search is always an important aspect of our marketing plans; and in search this past quarter we had one competitor act very aggressively with their marketing spend overall. And specifically they're bidding on search. With that taking place we are very pleased with how we managed our position in search and the results we achieved which demonstrates the strength of our brands, specifically, the 1-800-FLOWERS brand.

So we believe we are very well positioned for the upcoming holidays in Q3 and Q4. Regarding the customer metrics in Q2, that was primarily driven by the Home & Children's Gifts brands and the declining revenue and now it is scaling back on prospecting that.

So you are saying most of that 10% decline in new customers is largely for the Home & Children's being down?

Yes it is. And on the Flowers brand which obviously is most important to Qs 3 and 4, the new customer metrics are up.

Will you be spending -- how much will you be spending more of for -- on marketing of Valentine's this holiday versus a year ago?

Sorry. What was that question?

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

Our marketing spend that we forecast for the year would be broken down on a quarterly basis. So we are not going to give specific numbers in terms of our marketing spend because it's not finally determined.

Clearly what we saw in the last quarter was we managed our marketing -- particularly our online marketing spend very effectively. There were other competitors who were very, very aggressive in this category. We didn't have to be which as Chris said demonstrates the strength of our brand. So we are very (technical difficulties) forecast for this quarter.

I think I got that. Then on the free cash flow let's try to get the numbers to work out again. I noticed the last two quarters your free cash flow is -- [doing less than] last year I think some of it has to do with -- you guys explained before -- with the mix of the business changing somewhat. What should we expect the next couple quarters from a [field] standpoint since we don't really have the benefit of making the [form] adjustments? Are you on track to (indiscernible) $25 million free cash flow this year in fiscal '07?

Bill.

As you know with free cash flow basically the components of free cash flow -- we have given guidance on EBITDA that we would be doubling our EBITDA interest with the Fannie May acquisition and us taking on debt, you can compute what the interest is. We've given guidance on CapEx to be about 2% of revenues or in that $18 to $20 million range. And then the only other component really is the change in working capital.

With the businesses that we have acquired, having some inventory investments in those businesses doing well and growing, there is increases in working capital. So that does -- so there is an investment in working capital this year in that kind of $5 to $10 million range.

So you can kind of work through those numbers and it still generates a north of $20 million free cash flow number.

So what I saw in the AR/AP this quarter is really it's an assumption that working capital increase [on] $10 million, but you still hit 20, 25 there.

Yes for the year and what you saw this quarter, the really one that jumped out is receivables jumped up. That is due (technical difficulties) Fannie May business; they have a wholesale component to their business and they therefore have receivables. That all gets paid down in this quarter.

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

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

I got that. Thanks a lot.

Eric Beder with Brean Murray.

Your guys are in the midst of your looking at all your costs and the benefits from processes and stuff. What kind of -- what's your initial impression of what you are seeing and how quickly you can implement this and where you are in the process?

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

So that gives us a great deal of hope even in its earliest couple of quarters now of activity there, that our -- the future quarters will be even more effective in terms of [taking] a yield from those. Chris, anything you want to add there?

(technical difficulties) as you are seeing reflected in our operating leverage and in our gross margin improvements (inaudible) this past quarter. (technical difficulties) more of the low-hanging fruit short-term benefits, and you are seeing those flow through our performance. Then on a longer-term basis how we structure the Company (inaudible). Those things will take more time (inaudible) demonstrate short-term benefits (inaudible).

And for BloomNet I see you guys started web hosting in January. What's kind of the next thoughts in terms of services that you still need to fill in and kind of what has the response been to -- it only has been a week or two -- to the web hosting?

I kind of referenced that earlier (technical difficulties) web hosting and the introduction of our floral management system. Florist auto-management system, the POS system (inaudible). Very strong results so far. Very good responses. We have just basically been in the marketplace about a week. So it is -- we are very pleased with the results.

But again even leading up to that, how we dialogue with our customers about what is important to (technical difficulties) and what to introduce andwhen. We are focused on delivering what they need and so we are not surprised by the response.

Thank you.

Kristine Koerber with JMP Securities.

Couple questions. First of all, you mentioned in your introduction cost to expand the Home & Children's Gift category. Can you elaborate on that? What the costs are related to? And why you would be expanding it?

Yes. Our plan called for us till this year to try to go after some successes that we had seen in a couple of product categories. So we had product expansion -- product category expansion plans and moving them out under a couple of sub-brands. So therefore there was prospecting, catalog development costs associated with that. So ultimately showing up in the marketing expense line. Those are in the Problem Solvers category line and in more of the Home Furnishing line.

We did not see the success that we were looking -- that we anticipated there and therefore are curtailing back on those spends.

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

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

Right. But not your -- you are not promoting it.

Now we are promoting it and we've retooled it to better focus its efforts on our e-commerce customers. So it's a retooled program. We reintroduced our program this summer. We are very happy with the results. At the end of the year we will probably give you some more specific number color on it. But what we're seeing is a couple of things I will give you some anecdotal information on.

One is, the interest rate on the customers is very high. It's a platform that helps us with ECV. What I mean by that, the Enterprise Customer Value creation because there is an opportunity for us to expose very cost effectively our new Gourmet Food & Gift Basket brands to our customers in a very cost-effective way and a fun kind of way, using those brands as rewards and incentives within our Fresh Rewards program. So we will continue to do that this year.

The surprise thing that I tell you is that many more of our customers who have enrolled in Fresh Rewards are new customers which, frankly, is surprising us. I hope at the end of year when we report more specific metrics on that that we give you even more information and that it holds up. But right now it's nearly one-fifth of the customers who are enrolling in Fresh Rewards are new to the program. New to our customer list. So that is very exciting for us.

So a that is program solid, growing well for us and we think long-term has a tremendous benefit especially in that ECV environment.

Okay. That's what I wanted to know. How many new customers you have adopted. Then lastly, inventory up 51%. How much of that is related to the Home & Children's category?

Then is J.P. Morgan -- are they completely out of the stock at this point?

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

With regards to inventory the big increase, year-over-year really relates to Fannie May. About $18 million of the increase relates to Fannie May. With respect to the Home & Children's Gift category we don't break out the inventory by each of the areas; but we did manage -- with the weaker sales in there we did a very good job of managing the inventory. And we are very comfortable where that inventory is that we've not had -- we didn't have any issues with regard to write downs of inventory in the second quarter or it is going to impact the future.

Thank you.

Anthony with Sidoti & Co.

Good morning.

Are you going by one name now like Madonna or is that -- ?

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

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

Well as Chris mentioned, with our performance improvement initiatives and that we referenced on the last couple of quarters, what we've done is we've hired a team of people that is fleshed out and really developed now and they are gelling well.

So the fact that we had such good performance this quarter in spite of the poor performance in the one category of the Home & Children's Gifts is partially a testament to the strength of those brands, the marketing successes we had in those other three categories and the performance improvement programs we've initiated.

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

So yes we had done some things that have been beneficial to us, but as we have assembled this terrific collection of assets, now it's how to get the most leverage out of them; how to get them to work together. And one of those critical areas is sourcing and one that they are focused on.

In fact we just hired a specialist (technical difficulties) past quarter just to focus on the sourcing initiatives. Someone who has done this professionally for years and that is his primary focus, working that whole process improvement team. He is singly focused on the sourcing initiatives.

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

What we did during this quarter was we finalized the valuation of the intangibles related to the Fannie May transaction. We had estimated -- as GAAP allows you to do, we had estimated what that value was. So we were amortizing at a higher value and we had a slight pick-up this quarter.

That is why I mentioned that it will go back up next quarter. So it will be up let's say, $0.5 million or so next quarter.

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

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

But for the full year you (MULTIPLE SPEAKERS).

For the full year that 40.7% is an accurate number for us.

Thank you.

(OPERATOR INSTRUCTIONS). Heath Terry with Credit Suisse.

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

As we've mentioned several times in the past we feel that our 1-800-FLOWERS stores, other than the few that we have hanging off of our Design Center here in the New York area, are best owned and operated by our franchisees. These are good family-run businesses. They have advantages, frankly, that in a corporate environment we can't replicate.

So our plan is to slowly migrate from Company ownership there to franchisee ownership and you'll see several stores moved in the last quarter from Company ownership to franchise ownership.

That would be true, too, of the Design Centers where there's a good franchise operator who will take over the staffing in those stores, who will be able to grow them more effectively, and be able to leverage their capability to expand their own retail franchise footprint -- will allow that to happen too.

So 1-800-FLOWERS store counts coming down. We are up a couple of stores now in the Fannie May arena. We started just seven months ago with the 50 stores that came with the acquisition. They had in their plan a couple of store increase and that has happened.

We have a few stores that came with Cheryl&Co. and we continue to look at those models and expand them; but there is no expansion plan to speak of there.

Thank you.

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

Thank you all for your questions and your interest. If you have any additional questions please don't hesitate to contact us. In closing it is a custom I would like to give you a little public service reminder and that is, the Valentine holiday is fast approaching. It is never too early to call, click or come in to 1-800-FLOWERS.COM. Your florist of choice for all the great gifts, for all the sweethearts in your life. Thanks for your time and attention today and we look forward to chatting with you more in the future.

This concludes the presentation. You may now all disconnect. Good day.