1-800-Flowers.Com Inc (FLWS) 2009 Q2 法說會逐字稿

Good day, everyone, and welcome to the 1-800-FLOWERS.COM Inc. fiscal 2009 second quarter results conference call. This call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Company's Vice President of Investor Relations, Joseph Pititto. Please go ahead, Sir.

Thanks Kim. Good morning and thank you all for joining us today to discuss 1-800-FLOWERS.COM financial results for our fiscal 2009 second quarter. My name is Joe Pititto and I am Vice President of Investor Relations. 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 of our Web site at 1-800-FLOWERS.COM or you can call [Patty Appada] 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 securely from those expressed or implied in the applicable statements. For a detailed description of these risks and uncertainties please refer to our press release issued this morning as well as our SEC filings including the Company's annual report on Form 10-K and quarterly reports on Form 10-Q.

In addition, this morning we will discuss certain supplemental financial measures that were not prepared in accordance with general accounting -- 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 to or obligation to update any of the forward-looking statements made on today's call and in accordance with today's call, the press release issued earlier today or in any of the SEC filings except as may be otherwise stated by the Company.

I will now turn the call over to Jim McCann.

Good morning, everyone. For our fiscal second quarter, total revenues came in below our expectations due to the unprecedented economic weakness that caused consumers to dramatically reduce their spending during the key holiday shopping season. Revenue for the period -- revenues were $329.3 million, down 1.5% compared to the prior year. This included the contribution from DesignPac Gifts which we acquired last April which performed well during the quarter.

Excluding these contributions, revenues declined 14% compared to the second quarter last year. Despite this, we were able to achieve solid profitability, including adjusted net income of approximately $15 million or $0.23 per share and and EBITDA margin of 10% or $33 million during a period in which many retailers were reporting losses.

During the quarter, we improved our operating expense ratio by 210 basis points. This reflects a combination of lower operating costs associated with the DesignPac Gifts business as well as continuation of the programs that we initiated more than two years ago to reduce our operating expense ratio. These programs have enabled us to make more than $25 million of -- $25 million of cost out of our operating platform thereby reducing our annual operating expense ratio by the 290 basis points between fiscal 2006 and 2008.

We accomplished this through a number of initiatives, including consolidating service and supply vendors and the renegotiation of contracts and by optimizing our customer service platform by expanding our Home Agent Network and reducing our fixed facility and labor cost. As a result, I believe we are better positioned to weather the current economic downturn and learn to be a more profitable company when the macro economy begins to improve.

With that said, we expect that there are conditions that will remain very challenging going forward. Therefore we are taking additional actions necessary to scale our operating expenses appropriately. We expect these efforts to provide an additional $50 million of cost savings in our fiscal 2010 year which begins this July.

Among these initiatives are, a 10% reduction in salaried full-time labor force implemented earlier this month as well as reductions in our variable labor costs. We are significantly downsizing our Home and Children's Gifts business segment, including reductions in catalog marketing and resizing the business in accordance with the continuing weakness in the overall home sector.

We are adjusting our marketing spend across all of our brands, scaling appropriately to lower consumer demand and redeploying spending to achieve enhanced returns.

We are revamping our IT infrastructure, consolidating hosting sites and rationalizing maintenance and support applications to reduce costs while maintaining performance and availability. And we are working to further virtualize our customer service platform using technology to expand our Home Agent Network to help further reduce our fixed costs. These initiatives, among others, will be completed this current fiscal year.

Before I turn the call over to Bill for his reviews of specific results and metrics for the quarter, I would like to highlight a few additional areas.

First in terms of our balance sheet. We finished the fiscal second quarter with more than $50 million in cash and no debt outstanding on our revolving credit facility. As we announced earlier this year, we further strengthened our balance sheet and liquidities through a credit agreement with a (inaudible) bank led by JPMorgan.

Consistent with our operating expense reduction programs and our initiatives to scale our business appropriate to the current environment, we are reducing our capital expenditure plans for the remainder of fiscal 2009. And we will target further reductions in fiscal 2010 to maintain maximum flexibility.

Second on the [closing] front. Despite the significant economic headwinds, we attracted more than one million new customers during the recent holiday period. We also achieved a repeat order rate of 57% and illustrated the continued success of our efforts to deepen the relationships we have with our customers.

Combined with our database of more than 30 million customers, these metrics illustrate the fact that even during difficult times, our customers still have a need to express themselves and connect with the important people in their lives. With Valentine holiday fast approaching, as well as numerous everyday 15 occasions such as birthdays and anniversaries, we believe we are uniquely will position to help our customers. We are a strong brand that they have come to trust and a broad range of gifts that provide excellent value and convenience. I'll now turn the call over to Bill.

Thank you, Jim. During the fiscal second quarter, significant weakness in the consumer economy impacted our revenues and our gross margins. We were able to somewhat offset this through an improvement in operating expenses by approximately $8 million. This was achieved, despite absorbing the incremental operating expenses associated with our recent acquisitions.

Also during the quarter (inaudible) significant weakness in the Home Decor retail segment in our (technical difficulty) performance, we recorded a onetime non-cash to charge of $20 million for goodwill and other intangible impairment in our home and children gift category. Adjusting for this charge we were able to achieve an EBITDA margin of 10%, $33 million, and adjusted net income of approximately $15 million.

Regarding specific financial results and key metrics for the second quarter total net revenues were $329.3 million, down 1.5% compared with $334.2 million in the same period last year. During the quarter our e-commerce orders totaled [3,762,000] compared with 4,404,000 orders in the year ago period. Average order size during the quarter was $61.16 compared with $62.25 in the prior year period.

During the quarter, we added 1,030,000 new customers. This was achieved while currently stimulating repeat orders from existing customers who represented 57.1% total orders compared with 54.4% in the prior year period.

Gross margin for the quarter was 42%, down 380 basis points. We are talking a combination of product mix associated with our recent acquisitions which operate at lower gross margins, as well as the increased promotional nature of the holiday shopping period.

The lower gross profit margin was somewhat offset by improvement of 210 basis points in our operating expense ratio, 32.1% compared with 34.2% in the prior year period. This primarily affects the lower operating expenses associated with the DesignPac Gifts business model and the benefits of our ongoing cost reduction programs.

In dollar terms, total operating expenses for the period were down $8 million compared with the prior year period. This reflects an ongoing cost reduction program and accelerated effort to reduce costs during the quarter. In addition, this includes a stock-based compensation benefit of $1 million pretax compared with an expense of $800,000 in the prior period.

For the quarter, depreciation and amortization was $5.8 million compared with $5 million in the prior year period. This increase is primarily attributable to our recent acquisitions.

As I mentioned earlier, during the quarter we reported a onetime non-cash charge of $20 million for the write-down of goodwill and other intangibles related to the weak performance in our Home and Children's Gifts category. As a result of the weak conditions in this sector, we have taken steps to downsize this business and planned to significantly reduce our exposure on a go forward basis.

As a result of these factors, our GAAP net loss for the second quarter was $5.1 million or $0.08 per share. Adjusted for the goodwill and intangible impairment, net income for the quarter was up $14.9 million or $0.23 per diluted share compared with $19.3 million or $0.29 per diluted share in the prior year period.

Turn to the category results. In our 1-800-FLOWERS.COM consumer floral business, during the quarter revenues were $97.1 million compared with $114 million in the prior period. The lower revenues reflected a pronounced weakness in the consumer economy during the holiday period.

Gross profit margin for the quarter was 37% compared with 39.4% in the prior year period, primarily reflecting promotional pricing. During the quarter, we've reduced operating expenses in this category by approximately $4 million and by keeping our operating expense ratio essentially flat year over year.

As a result of these factors category contribution (inaudible) was $8.9 million compared with $13.6 million in the prior year period. We define category contribution as earnings before interest taxes, depreciation and amortization and goodwill and intangible impairment and before the allocation of corporate expenses.

In our BloomNet Wire Service business, revenues increased 19% to $15.2 million compared with $12.7 million in the prior year period. This increase primarily reflects the contribution from the small flow of hard goods business that we acquired this past summer.

Gross profit margin was 57.9% compared with 57.1% in the prior year period. As a result, category contribution was $4.8 million compared with $4.5 million in the prior year period. It is worth noting the contribution margin in this category remains strong at 31.6% despite an increase in operating expenses related primarily to the seasonality of the aforementioned acquisitions.

In our gift category, home and children gift segment, revenues reflected the overall weakness in the consumer economy as well as the continued decline in demand within the home decor segment. As a result, revenues for the quarter were $77.8 million compared with $98 million in the prior year period.

Gross margin in this area improved 80 basis points to 48.3% compared with 47.5% in the prior year period reflecting continued enhancements in product sourcing.

Due to the significant decline in year-over-year revenues, category contribution was $2.8 million compared with $8.7 million in the prior year period.

As noted in today's press release and my earlier remarks, we are implementing plans to significantly downsize this business and reduce our exposure in this segment. This includes a labor force reduction affected earlier this month as well as reductions in catalog marketing.

As part of this process during the quarter, we incurred a non-cash charge of $20 million for goodwill and intangible impairment related to this business.

In our gourmet food and gift basket category, revenues increased 28.3% to $141.9 million compared with $110.6 million in the prior year period. This growth reflects -- reflected contributions from DesignPac Gifts which we acquired at the end of April last year. Gross margin for the period was 39.7% compared with 49.1% in the year ago period. The lower gross margin reflected the review contributions from DesignPac Gifts which has a lower margin business model as well as the increased promotional pricing during this period. This was somewhat offset by lower operating costs.

As a result, category contribution margin improved 4.8% to $26.1 million compared with $24.9 million in the prior period. As I stated earlier, category contribution margin results (inaudible) associated with the company enterprise services platform which includes among other services IT, HR, finance, legal and executive. These functions are operated under a centralized management platform providing support services to the entire organization.

For the fiscal second quarter, corporate expense including stock-based compensation was $10 million compared with $13.1 million in the prior year period.

Turning to our balance sheet. Our cash and investment position at the end of the quarter was $[51.1] million and we had no borrowings outstanding under our $155 million revolving credit facility. We do not anticipate any borrowings, any need to use borrowings under the revolving credit line until the first quarter of fiscal 2010 when we begin to build inventories for the year-end holiday season.

Inventory of approximately $80 million reflects the lower than anticipated sales achieved during the holiday period and while inventory is higher than we would like, we have conducted a thorough review and we are confident that we will be able to sell through the inventory in its normal channels without any dramatic impact on margins. The increase in materials position to approximately 44 million compared with 27 million at the end of the second quarter last year is primarily reflected through the DesignPac Gifts business. These receivables have already begun] converting to cash and will completely convert during the current quarter.

Lastly, total long-term debt at the end of the second quarter was approximately $119 million.

Regarding guidance. As we stated in this morning's press release, we expect economic conditions for the consumers will continue to be very challenging during the second half of our fiscal year. Based on this outlook and combined with our first-half results, we anticipate that revenues for the full fiscal year will be down approximately 5 to 10% compared with the prior year period. As such we are moving quickly to scale our operating (technical difficulties) appropriately to the lower revenue expectations.

The new actions in this area, described by Jim earlier, will be completed this current fiscal year. And we expect to reap the full $50 million in additional cost benefits in fiscal 2010 which begins in July.

In terms of bottom-line results, we expect to generate positive adjusted EPS, EBITDA and free cash flow during the second half of 2009 and for the full year albeit at low levels compared with the prior fiscal year.

In summary, while we anticipate continued weakness in the consumer economy, we are confident in our ability to leverage our unique business model, to reduce operating costs and position our Company for stronger results in the future. I will now turn the call back to Jim.

Clearly, this was a tough quarter. I think that you can see that we have been responding to the changed environment (inaudible) within the second fiscal quarter but especially at the beginning of this third fiscal quarter.

Total revenues were $329 million, down 1.5% during a period of unprecedented weakness in the consumer economy. We benefited from the continued strength of our BloomNet business as well as the contributions from DesignPac Gifts and our gourmet food and gift basket category.

This illustrates our strategy to grow our business through a combination of organic initiatives, strategic acquisitions and help positions for future growth opportunities.

The combination of DesignPac Gifts' strong performance and our ongoing programs to leverage our business platform enabled us to achieve a 210 basis point improvement in our operating expense ratio. This sum might offset the revenues and gross margin pressures during the period. As a result, we were able to achieve adjusted EPS of $0.23 per share and EBITDA of approximately $33 million.

Importantly, unlike many other retail companies, we have two solid revenue quarters ahead of us including this Valentine holiday in this current fiscal third quarter, as well as Easter, Professional Secretaries Week, Father's Day and the key Mother's Day holiday in our fiscal fourth quarter.

As a result, we expect to continue to be profitable in the second half of our fiscal 2009 and for the full fiscal year.

Looking ahead, we believe the consumer environment remains challenging. And we are moving quickly to scale our operating expenses appropriately. We expect that these initiatives will provide $50 million in cost savings in addition to the more than $25 million in operating expense reductions that we have removed from our business platform during the past two years.

However, we will continue to invest in the innovations that position us for the future. Among such initiatives are the Fresh Digital e-commerce platform where we have begun to move our gourmet food gift brands and are already seeing improved conversion as well as enhanced shopping experience for our customers. This platform will also enable us to expand our Fresh Rewards Loyalty program and roll out an enterprisewide gift card program as part of our plans to increase crossbrand promotional efforts.

We will also continue to invest in new product divisions such as the successful Everything Cupcake gift line in both our floral business and our bakery gifts business, as well as new shelf stable cookies and candy products from our Cheryl&Co and Fannie Mae brands.

We continue to see significant future growth opportunities in our Gourmet Food and Gift Baskets category, particularly with our new 1-800-BASKETS.COM brand, which will leverage DesignPac Gifts' unique product design and cost-efficient confection capabilities.

In conclusion as we plan our business for the future, [we do not] view the economic landscape as a short-term cycle. As a result we are taking the necessary actions to adjust our business infrastructure and operating [experienced] platform in accordance with the lower consumer demand environment.

We are confident that we can scale our cost appropriately, position our business with stronger results going forward and thereby build long-term (inaudible).

That concludes our formal remarks and we will now open the call to your questions. Kim, would you please restate the instructions for the Q&A?

(Operator Instructions). Jennifer Watson from Goldman Sachs.

Thank you. Two questions. First when we look at the $50 million in cost saves that you are planning to implement in fiscal year 2010, it seems without a rebound or a significant rebound in fiscal year 2010 revenue growth, would you anticipate margins to be below levels of fiscal year '08 or do you think you can get them back up to the levels that you saw then?

Do we anticipate what?

We didn't hear --.

With the cost saves of the $50 million, do you anticipate that you can get margins back up to the levels that they were in fiscal year 2008 with or without a rebound in the revenue growth in 2010?

We are clearly sizing the business and taking the operating costs appropriately out. We think we have identified significant cost cuts that will certainly improve our operating margins over our fiscal '09 levels. I think the upside is when the economy turns and we start getting some revenue growth, we think we can be significantly more profitable than we were in fiscal '08.

Okay. Got it. Then also just what marketing channel did you find to be the most and or least successful in the December quarter? And which are you depending on heading into the Valentine's Day's period? And if you could comment on any changes in the rates of that different advertising medium, that would be helpful as well.

I think on the marketing channels, the least productive channel we had was catalog marketing especially on the prospecting side and you see that's where most of the reductions are coming from on a go-forward basis. Especially as we resize the home in children's group category.

So as we look into the Valentine holiday, clearly the best marketing efforts that are producing the ROI for us right now are any marketing efforts aimed at our existing customer base. So while we are still able to attract new customers (technical difficulties) at a higher acquisition rate so you see us (technical difficulties) increased repeat rate that you saw (technical difficulties) on the things you could expect to see as we go forward into the Valentine's holiday as well.

So a lot of e-mail marketing and targeting of that nature?

Correct.

All the kinds of things that are correct for the consumer and the worst of course is, as you can see in the home and children's group which was (inaudible) dramatically dependent on our catalog marketing. There we just don't see the return any longer and, there, we are really scaling back our marketing efforts, focusing on our increased marketing spend in that category within the overall reduction on things that we -- where we are going direct to our existing customer base, but not necessarily with the catalog. Almost totally not through catalog marketing.

Great. Thank you.

Jeff Stein with Soleil.

I'm wondering if you could talk about the thought process that went into the $50 million cost reduction program. In other words was it a bottoms up saying let's just take $50 million out? Or did you have a revenue number in mind for gearing the expense reduction to? And if so can you just share that with us?

I would say as you are familiar, we've been writing these costs in hand for now (inaudible) efforts for awhile now and so [to] outlast this past year, this past calendar year, even going back to the last holiday season as we saw the consumer start to tighten up back then, we have been making the appropriate adjustments as we moved along.

Once we hit fall of this year, we hit into the mid-October timeframe is when the consumer behavior really started to drop. And we saw that with consumer confidence indexes. We ratcheted up the management team, took a small group of the management team that then worked with each business unit to identify, based on where we could predict where the revenue projections would be for the remainder of this year, and then moving into fiscal '10.

And then to now let's, based off of that, and we adjusted that as we moved through the quarter, as we saw consumer behavior deteriorate further into November and December, we made adjustments to that target. We said based on that revenue target, what are the OpEx ratios we need to get to? Therefore what is the number? And Bill, any other breakdown?

I think that's right, Jeff. I don't think that we are going to share what those targets were, but we projected out what the rest of this fiscal year is. We took a haircut to that and we targeted some OpEx ratio that we booked that more comfortable with. It all added up to this $50 million. We obviously have to continue to monitor where consumer demand is and if consumer demand worsens, we have to continue to look at those operating costs.

As you see we've already taken a number of those steps have already been executed in terms of the savings. You can view them across our service platform, our technology capabilities, our marketing spend and labor so that the painful reduction in forced that we experienced this month, earlier this month took a big chunk of that. Probably 25 or 30% of that total savings is going to come from that labor reduction of about 300 people plus the scaling of the variable labor to accommodating what we anticipate the revenue number would be.

Two other questions real quickly. Can you talk about the composition of the inventory at the end of the quarter? It looks like year on year, it was up over 25% and wondering is this long-lived product with no fashion risk to it or is -- what potential exposure can we have if sales weaken even further?

Bill has done a lot of work in this area. Would you comment on that?

Yes. As we mentioned in our formal remark, inventory is higher than where we wanted it to be. Obviously demand fell off during the second quarter. With that said we did a very detailed review of where our inventory is. It is not fashion-sensitive. So there's a combination of where we are long in some areas, but we will be able to sell it through through our normal channels without taking impact on our margins.

There is some seasonal inventory related to the holiday season, but it is carryover inventory that we can carry over into the next fiscal year.

Final question, guys. Can you talk a little bit about what is happening on the gross margin line? I know that it's very promotional out there, but at the same time I'm sure you guys are beginning to see the benefits of lower fuel surcharges.

So as we move forward, what is your thought process on capturing some of that gross margin windfall versus giving it back to the customer in promotion? How do you see that kind of playing into year-over-year gross margin comparison over the balance of the year?

I will ask Bill to comment on that, the fuel question as part of your question first and then Chris will speak about the gross margins.

Specifically with fuel, what everybody sees at the pump the significant drop in gasoline prices, fuel prices back in October, the index is similar to those are kind of a lag indicator. So there's about a 60 day lag between when you see that and when we get it in our fuel surcharges.

So we started to see the benefit of that in the month of December. But for the quarter, we still had quarter over quarter. Fuel surcharges were hired the share than they were a year ago. If fuel charges remain stable, at the current levels, we will see second half of the year. We will see a benefit on the fuel surcharge front.

In addition, too, on the gross margin, I would say as we move forward we expect to be able to gain some of that back. A couple of factors there. As we look clearly we move into the remainder of this year into a somewhat less competitive arena than we were during the holiday season when every single retailer is a competitor of ours.

But also it's more of an opportunity from a planning point of view. As we mentioned, once we moved into October, November timeframe things dramatically changed and we were more reactionary in protecting the transaction based than we can be on a go-forward planning basis.

If you look at the decisions we made for example, we protected the margin in the home and children's category throughout the quarter, because we were much less focused on protecting the top line in that category. As we said, it's not strategic growth category for us at this point in time.

On the Gourmet Food and Gift Baskets category, that is a strategic growth area for us. And our focus was much more on protecting the transaction or protecting the customer base. So if we look there, we actually -- we are flat to slightly increased in total customer activity there while the same time the economy certainly forced the consumer to spend less on average ticket and also to buy less gifts for customer, but yet we kept our customer count active.

And that was intentional and thereby doing that, we gave up some margin. On a go-forward bases, I think we could start to gain some of that back.

And two last points. Also during the quarter because of the mix with DesignPac and their lower wholesale margins that they have and the big contribution they have in the second quarter, that obviously took our margins down. With that said, it was -- about half of the overall margins the [decrement] in gross margin percentage was due to DesignPac.

So the rest of it was promotion and as Chris mentioned there should be some reconnected. But it's still a very tough consumer demand economy out there and we will have to be promotional (multiple speakers).

Promotional in making sure we are offering price points that are appropriate to the consumer in this economy.

(Operator Instructions). Kristine Koerber from JMP Securities.

A few questions. First, can you comment on CapEx? I mean, you mentioned that you are planning to reduce CapEx for the remainder of FY '09 and bring it down for 2010. I mean what should we be modeling?

A lot of our CapEx was front loaded this year. We started building CapEx actually a year ago, really, at this point in time. So we saw kind of heavy CapEx the last part of last year and through the first part of the share. But in this environment we know it's prudent to take another look at that. Obviously there's maintenance CapEx and there's some areas like for our First Digital platform we want to continue to invest behind.

But other parts of CapEx are more discretionary in nature and we are going to pull them back. So the second half of the year we are going to take a reduction. We spend about $13 million in CapEx first half of the year. Second half of the year is going to be in that $4 million to $5 million range. We are really going to bring it back and then we are going to -- and we are taking a very hard look at fiscal '10 to take it down even further than that.

We don't not have a specific number yet in mind for fiscal '10 but obviously being very prudent while at the same time making sure that we do continue to move our food brands onto that First Digital platform where we're seeing good benefits.

Okay. That's helpful. Is -- looking at the $50 million in cost savings, I mean do you think there is more room beyond that $50 million as far as reining in expenses?

Yes we do and we are constantly monitoring our operations to best identify those. So that's where we have identified the date and where we have the hard plan to implement and have been substantially addressing that with the things that we have already done this month and through the end of last quarter. But clearly we have responsibilities (inaudible) anticipate not only the tough times that we are in, but to plan for even tougher times and better times. And so we have adjustable plans and adjustable budgets based on what we see in the consumer environment.

If it got worse than it is today, we do have the ability to ratchet those expenses down further.

You are beyond the low hanging fruit as far as looking for expense cuts, right?

Clearly.

Briefly, Martha Stewart, how did Martha Stewart perform during the quarter?

Well we are still pretty early in that multi-year relationship with the Martha Stewart products. I think it was impacted as we were, overall, by two facts. One, we had a long large range of -- a broad range of SKUs in the Martha line, and they are at a higher average price point. I think the average higher price points were the area we were most impacted by. Although on newly introduced lower price points it is much better. So we (technical difficulties) around the course of this calendar year and increase in the marketing and the joint venture of marketing with the Martha Stewart Company throughout this calendar year.

So we would not -- there was no core expectation during the last quarter. The gift pack we introduced clearly was up to expectations, did quite well. The Flowerpot, taking a couple of initiatives to narrow the range of SKUs and to moderate the price point that we think will help it to do quite a bit better, even promptly during this second half of the fiscal year and beyond.

And what about on the advertising front going forward? With the Martha Stewart brand?

We will continue to promote with Martha Stewart Living on the media, the introduction of the products we have. The introduction of new products that we have planned particularly in the gift basket and the food gifts area. So we will continue to ramp up those efforts up. Those joint venture marketing after it's rather close to this calendar year.

Lastly, can you talk about the Home and Children's group? What are your longer-term plans at this point? I know you are resizing the business, but what are you thinking longer-term?

As we look in this category we continue to adjust it according to the marketplace and as you -- what our plans were this past year or so was really to kind of maintain the top line and improve the profitability of the business unit. As a marketplace for that category deteriorates further, we are changing our directions and say okay, let's reduce the size of the business to eliminate risk, as Bill said earlier, and eliminate risk in the business. Take -- a lot of that risk will be in the catalog marketing side and the prospecting aspect of it, to make sure that we can produce a decent profitability in that business unit.

As we are doing that, there are obviously a lot of changes and we continue to evaluate all of our options with that business category and as we look to the future we will do exactly that.

What -- I mean have you considered shitting it down or starting to sell off some of the assets?

Clearly in an environment like we are in, with that category performing as poorly as it did, the overall category and those brands specifically for us, clearly we have to explore every option. So you can trust to be assured that we are looking at all of the options we have available and the go forward Plan that we are working on as we pursue all of the options, is to dramatically skill back the size of the business, reduce the risk as much as we can, focus on marketing efforts on the things where we have success that are not catalog-related. Reduce our catalog marketing significantly. Continue to work with our existing customer base in the direct marketing ways that we have established in all of our other brands that are effective. Grow into a smaller business with good cash contribution as we explore all of our options.

David Cohen with Midwood Capital.

My questions have actually been answered.

Ronald Bookbinder from Global Hunter Securities.

Good morning. What percentage of the business is now wholesale and how has the credit environment impacted the independent retailer? And is there an opportunity to pick up some of that business directly?

Very little of our business is wholesale except you would have to look at it on a brand by brand basis. Where we have manufacturing capability, where we have good brands that have retail appeal, we will always explore our wholesale options as a way you extend our brand, contribute some margin dollars and to utilize our fixed planned facilities. So we will explore more, but it is not a big part of our overall business today (multiple speakers).

Yes, but is this proportional, this quarter versus the other quarters because of DesignPac gifts can the business and the food brands with Fannie Mae having the piece. The rest of the year though it's very small -- the other three quarters it's a very small component.

To that point, DesignPac gifts is a company that only does sales to other retail outlets, a wholesale type business. We knew that going in. It has a lower gross margin contribution, but it also has significantly lower operating expense ratio as well. So that's the business we (inaudible) it's a platform to build our consumer business upon which has a higher gross margin on it.

So we view any wholesale opportunities. For example in DesignPac there's an opportunity to build base, to lever facilities, to extend the brand and to contribute gross margin dollars where appropriate.

And the second half of your question?

How has the credit environment impacted the independent retailer and is there an opportunity for you to pick up some of that business directly?

I'm not really sure I'm going to answer that. I think everyone is suffering a constrained credit environment. Clearly we are hearing from a possible acquisition point of view that there are lots of folks who are in businesses adjacent to ours. For example, in the gift food businesses, that they are suffering and they are being told by their banks that there really [is an] opportunity for them to borrow to sustain them through the period ahead before they get to another selling cycle. Many of them have just one selling quarter.

We are fortunate that we have three quarters where we have good sales opportunity including this spring quarter which is our biggest in the flower business and to this current quarter which has Valentine's Day.

So I don't know where the opportunities are except on the acquisition front, but frankly, we are going to be very, very interested in minding these and stewarding these very precious assets we have in a strong balance sheet. So anything that we would lead to do in that area with the opportunistic and very very seriously considered.

Okay. Thank you.

(Operator Instructions). Jeff Stein. Soleil.

Can you talk a little bit about the credit risk amongst your floral shop customers? It looks to me like you saw very dramatic slowdown in revenue growth in that category in the quarter if you back out the acquisition you made.

So I am wondering, No. 1, how much of the slowdown is due to just florists in your network just shutting down and going away? How much of the slowdown is due to perhaps just a lack of additions of new florists and then, thirdly, are any of them either scaling back on the number of services they are taking from you? Or are they just cutting out one of the wire services?

Overall on BloomNet our focus for the last year and a half has not been on growing the size of the network. We think you're right that the number of retail florists will continue to contract. That is why we are not focused on growing the network. We already have the scale we want. We already have the coverage we want. We already have the capabilities in terms of the quality and performance that we want from BloomNet. And we were to improve that all the time, but it's not working by improving it by growing the topline number of florists. That's been static.

We think that there is still some decline to come in the number of retail florists. So we are very, very sensitive on the credit side to not increasing our exposure there. The good news is we are on the positive side of the flow with regard to opening their florist because we have such a large number of orders that we are putting into those shops on a monthly basis which is a big focus of ours to continue to improve that.

And we have an increasing number of shops in the BloomNet network. We send their orders out to be delivered in other markets through the BloomNet network. In fact, increasing the number of orders in the system with that kind of a rotation.

But what we saw in this quarter is -- and when you say an increase, an increase in the number of services that they purchased from us. This is not a quarter where we expected big, big topline growth because we are not growing the topline number. We didn't have special products that you might have seen the last quarter of last fiscal year, a new directory.

So overall BloomNet, steady, consistent, growing the depth of our relationship with our customers and you'll see us increasing our development at first in terms of the remainder of products and services.

We just introduced a whole new of products and services -- products for them that we will introduce through BloomNet products to our florists which has been very well received in the first two weeks of its (inaudible).

A question for Bill on the issue of severance. I'm wondering will all the severance charges and any other charges associated with this $50 million cost-cutting program be booked in the current fiscal year and I presume that when you gave the guidance that you'd expect to make money the rest of the year that that would also include any severance cost?

Yes and yes. Basically what we have done is we have been scaling back our variable labor force throughout the first half of the year in accordance with the business as people have left the organization, those severance cost have been incurred.

As we -- Jim mentioned earlier this month, we have done a larger reduction in workforce. Those severance costs will be accounted for in this quarter and, yes, the guidance that we've given for the second half of the year includes the fact that there is severance cost being paid this year. And it will all be paid -- it'll all be accounted for this year.

Anything further, Mr. Stein?

No. That's all. Thank you.

(Operator Instructions). It appears there are no further questions today. Gentlemen, I will turn the conference back to you.

Thank you, everyone. We are finishing a very tough quarter, tough environment for us. We think we made good adjustments within the quarter as best we could and now in this second -- in our third fiscal quarter making a great deal more of those adjustments. We see our operating expense variable improving as a good achievement for us here. We are working on many more of them to come. We have a good solid balance sheet. We have the tools in our bag, I think, to continue to adjust the environment around us and we are continuing as Chris and Bill mentioned to invest in our future in terms of our great marketing efforts. Our 1-800-BASKETS business, our Fresh Digital platform and our BloomNet services and taking advantage of the environment that is presented to us in terms of creative media partnerships so we can achieve as well.

So we think we are doing the things we can do and look forward to continuing our conversation with you. And I would like to remind you that Valentine's Day is is fast approaching and we have a broad range of gifts at great values designed to say I love you to that special someone in your life.

So don't hesitate. Call (inaudible) or come in today. Thanks for your time today.

That does conclude our conference call today. Thank you all for your participation.