Tuesday, October 31, 2006

FTD...Harvesting the Flowers to Grow the Weeds?

Founded in 1910, FTD Group (FTD) is the largest floral company in the world.FTD, originally known as “Florists Telegraph Delivery” connects 20,000 North American florists as well as about 50,000 florists in 174 countries worldwide.

The business divides itself into two segments, the Consumer Segment and the Florist Segment. The Consumer Segment is an Internet and telephone marketer of flowers and specialty gift items to consumers, operating primarily through its www.ftd.com Web site and the 1-800-SEND-FTD toll-free telephone number. The Consumer segment does not own or operate any retail locations. The Consumer Segment is a particularly interesting business to me with very low working capital requirements because FTD-member florists and specialty gift providers maintain all physical inventory and bear the cost of warehousing and distribution. The Florist Segment provides a comprehensive suite of products and services to enable florists to send and deliver floral orders.The largest sub-segment within the Florist Segment is Member Services which is the primary provider of business services to FTD-member florists to promote their revenue growth and operating efficiencies. This includes national advertising and “clearinghouse services” which eliminate counterparty credit risks between sending and receiving florists.

The company was taken private in February of 2004 in a leveraged buyout by Leonard Green & Partners. It was taken public again in February of 2005. An interesting pass for Leonard Green et al. For its initial investment of $185 million, mostly in preferred but including $40 million in equity, the IPO brought total proceeds of $208.4 million, paying off the preferred, providing $14 million in management fees for the “experience” and providing investment bankers with $7 million in transaction and closing fees. The Green firm retains about 55% of the equity for what appears to be at this point, a zero investment at this point. Like I say, nice pass! Get ready for more...Green filed a shelf registration S-3 on October 13th. More about that a little later.

The company did report decent numbers this morning for the first quarter, reporting 18 cents versus 11 cents a year ago. The CEO was very enthusiastic about the quarter in the conference call, not often that you hear a CEO describe the quarter as “For those of you who have had a chance to get through the release, you’ll see we had just an amazing quarter...really great on all fronts....just kind of an across the board homerun.” It appears that about 4 cents of the increase came from tax rate and forex changes.

Revenues were up about 27% including the Interflora acquisition...ex that, up about 9%. The Consumer Segment had revenue growth of 14% with Internet orders constituting 88.1% of total.The domestic Florist Segment had revenues down 1.1% but that included a comparison against a greeting cards business that FTD no longer owns...on a comp basis, revenues were up only about 4%. Advertising and selling expenses in florist had averaged about $13.3 million per quarter last year...now suddenly, they are running at $10.47 million. That $11.3 million in savings would represent about 40 cents per share pre-tax in savings or 24 cents after tax. This is substantial, but is it sustainable?

Historically, the company has announced the number of florists in the network. The last year and a half has seen a decline in the number of florists from 20,000 florists to somewhere around 19,000. FTD management has decided that analysts no longer need to know about this. It seems that 1-800-FLOWER’s Bloomnet may be taking some share.

The balance sheet has been impacted by the Interflora acquisition with total debt of about $348 million versus the June 2006 FYE of about $220 million and the prior fiscal of $238 million.

The market seems to have liked today’s earnings report. Reduction of advertising and selling expenses especially this drastically has provided some decent leverage, but how is this addressing the shrinkage in the number of florists? If part of the package of services that the firm sells to its members is national advertising, will the network members be content to receive fewer benefits for the same membership fee? Will the number of florists in the network continue its decline?

Could the cost reductions be temporary to perhaps “grease the skids” for another offering? Excuse my cynicism.

Some years ago, Peter Lynch described the practice of selling one’s winners and keeping one’s losers as harvesting the flowers to grow the weeds. Ironically, FTD management, in my opinion, is doing exactly that. Slashing of unnecessary expenses is a good thing, but cutting important expenses on a distribution system that drives your business seems foolhardy.

Disclaimer: Neither I, my family, or clients has a current position in any of the securities mentioned in this post. And no, I am not a florist.



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