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Provide Commerce Inc – ‘10-Q’ for 9/30/05

On:  Wednesday, 11/9/05, at 5:09pm ET   ·   For:  9/30/05   ·   Accession #:  1193125-5-221727   ·   File #:  0-50510

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

11/09/05  Provide Commerce Inc              10-Q        9/30/05    5:571K                                   RR Donnelley/FA

Quarterly Report   —   Form 10-Q
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-Q        Quarterly Report                                    HTML    460K 
 2: EX-10.40    Employment Agreement                                HTML     44K 
 3: EX-31.1     Certification of Chief Executive Officer            HTML     11K 
 4: EX-31.2     Certification of Chief Financial Officer            HTML     11K 
 5: EX-32       Certification of CEO and CFO                        HTML      9K 


10-Q   —   Quarterly Report
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Cover Page
"Table of Contents
"Part I. Financial Information
"Item 1. Financial Statements (unaudited)
"Balance Sheets as of September 30, 2005 and June 30, 2005
"Statements of Operations for the three months ended September 30, 2005 and 2004
"Statements of Cash Flows for the three months ended September 30, 2005 and 2004
"Notes to Financial Statements
"Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
"Item 3. Quantitative and Qualitative Disclosures about Market Risk
"Item 4. Controls and Procedures
"Part Ii. Other Information
"Item 1. Legal Proceedings
"Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
"Item 3. Defaults upon Senior Securities
"Item 4. Submission of Matters to a Vote of Security Holders
"Item 5. Other Information
"Item 6. Exhibits
"Signature

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  Form 10-Q  
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     .

 

Commission File Number: 000-20720

 


 

PROVIDE COMMERCE, INC.

(Exact Name of Registrant as Specified in its Charter)

 


 

Delaware   84-1450019

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

5005 Wateridge Vista Drive

San Diego, CA

  92121
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s Telephone Number, Including Area Code: (858) 638-4900

 


 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 

As of October 31, 2005, the registrant had 11,997,283 shares of common stock, par value $0.001 per share, outstanding.

 



Table of Contents

PROVIDE COMMERCE, INC.

QUARTERLY REPORT

 

FORM 10-Q

 

TABLE OF CONTENTS

 

COVER PAGE

   1

TABLE OF CONTENTS

   2

PART I. FINANCIAL INFORMATION

    

ITEM 1. Financial Statements (unaudited)

    

Balance Sheets as of September 30, 2005 and June 30, 2005

   3

Statements of Operations for the three months ended September 30, 2005 and 2004

   4

Statements of Cash Flows for the three months ended September 30, 2005 and 2004

   5

Notes to Financial Statements

   6

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   14

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

   39

ITEM 4. Controls and Procedures

   39

PART II. OTHER INFORMATION

    

ITEM 1. Legal Proceedings

   40

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

   40

ITEM 3. Defaults upon Senior Securities *

   41

ITEM 4. Submission of Matters to a Vote of Security Holders *

   41

ITEM 5. Other Information *

   42

ITEM 6. Exhibits

   42

SIGNATURE

   43

 

* No information provided due to inapplicability of item.

 

2


Table of Contents

PROVIDE COMMERCE, INC.

 

BALANCE SHEETS

(Unaudited)

(in thousands, except share and per share data)

 

    

September 30,

2005


   

June 30,

2005


 
Assets                 

Current assets:

                

Cash and cash equivalents

   $ 4,243     $ 12,308  

Marketable securities

     55,741       53,116  

Accounts receivable, net of allowance for doubtful accounts of $44 and $54 at September 30, 2005 and June 30, 2005, respectively

     1,931       1,649  

Inventory, net

     3,766       3,719  

Prepaid expenses and other current assets

     1,454       1,082  

Income tax receivable

     1,022       76  

Deferred tax assets

     4,800       4,810  
    


 


Total current assets

     72,957       76,760  

Property and equipment, net

     7,176       6,871  

Deferred tax assets

     1,775       1,775  

Other assets

     5,008       4,802  
    


 


Total assets

   $ 86,916     $ 90,208  
    


 


Liabilities and Stockholders’ Equity                 

Current liabilities:

                

Accounts payable and other accrued liabilities

   $ 10,477     $ 13,198  

Accrued compensation

     2,766       3,416  

Deferred revenue

     443       592  
    


 


Total current liabilities

     13,686       17,206  

Accrued pension costs

     1,262       1,186  

Deferred compensation

     1,746       1,181  

Commitments and contingencies

                

Stockholders’ equity:

                

Preferred stock, $0.001 par value, 5,000,000 shares authorized, none issued and outstanding at September 30, 2005 and June 30, 2005.

     —         —    

Common stock, $0.001 par value, 50,000,000 shares authorized, 11,984,985 and 12,356,220 shares issued and outstanding at September 30, 2005 and June 30, 2005, respectively.

     12       12  

Additional paid-in capital

     103,462       104,666  

Treasury stock, at cost

     (11,094 )     (8,849 )

Deferred stock-based compensation

     —         (3,068 )

Accumulated other comprehensive loss

     (105 )     (96 )

Accumulated deficit

     (22,053 )     (22,030 )
    


 


Total stockholders’ equity

     70,222       70,635  
    


 


Total liabilities and stockholders’ equity

   $ 86,916     $ 90,208  
    


 


 

See accompanying notes.

 

3


Table of Contents

PROVIDE COMMERCE, INC.

 

STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except share and per share data)

 

    

Three Months Ended

September 30,


 
     2005

    2004

 

Net sales

   $ 26,782     $ 19,921  

Cost of sales

     14,727       10,875  
    


 


Gross profit

     12,055       9,046  

Operating expenses:

                

Selling and marketing

     5,983       4,843  

General and administrative

     5,703       4,196  

Information technology systems

     1,712       1,223  
    


 


Total operating expenses

     13,398       10,262  
    


 


Loss from operations

     (1,343 )     (1,216 )

Other income, net

     509       270  
    


 


Loss from operations before income tax benefit

     (834 )     (946 )

Income tax benefit

     (367 )     (449 )
    


 


Net loss before cumulative effect of a change in accounting principle

     (467 )     (497 )

Cumulative effect of a change in accounting principle

     444       —    
    


 


Net loss

   $ (23 )   $ (497 )
    


 


Net loss per share before cumulative effect of a change in accounting principle:

                

Basic

   $ (0.04 )   $ (0.04 )
    


 


Diluted

   $ (0.04 )   $ (0.04 )
    


 


Cumulative effect of a change in accounting principle per share:

                

Basic

   $ 0.04     $ —    
    


 


Diluted

   $ 0.03     $ —    
    


 


Net loss per share:

                

Basic

   $ —       $ (0.04 )
    


 


Diluted

   $ —       $ (0.04 )
    


 


Weighted average common shares outstanding:

                

Basic

     11,978,739       11,844,949  
    


 


Diluted

     13,454,914       11,844,949  
    


 


 

See accompanying notes.

 

4


Table of Contents

PROVIDE COMMERCE, INC.

 

STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands, except share and per share data)

 

    

Three Months Ended

September 30,


 
     2005

    2004

 

Operating activities:

                

Net loss

   $ (23 )   $ (497 )

Adjustments to reconcile net loss to cash used in operating activities:

                

Depreciation and amortization

     802       599  

Stock-based compensation

     839       626  

Cumulative effect of a change in accounting principle

     (444 )     —    

Changes in operating assets and liabilities:

                

Accounts receivable

     (282 )     (256 )

Inventory

     (47 )     142  

Prepaid expenses and other current assets

     (372 )     (228 )

Accounts payable and other accrued liabilities

     (2,722 )     (2,852 )

Accrued compensation

     (650 )     (1,092 )

Accrued pension costs

     76       98  

Long term deferred compensation

     565       502  

Deferred revenue

     (149 )     (80 )

Accrued and deferred income taxes

     (946 )     (1,120 )

Other assets

     (206 )     248  
    


 


Net cash used in operating activities

     (3,559 )     (3,910 )
    


 


Investing activities:

                

Purchases of property and equipment

     (1,107 )     (1,529 )

Purchases of marketable securities

     (28,658 )     (7,599 )

Sales/maturities of marketable securities

     26,019       13,950  
    


 


Net cash provided by (used in) investing activities

     (3,746 )     4,822  
    


 


Financing activities:

                

Payment of long-term debt and capital lease obligations

     —         (32 )

Common stock issued in connection with secondary public offering

     —         1,299  

Tax benefit from the exercise of stock options

     555       340  

Proceeds from exercise of common stock options and warrants

     930       229  

Repurchase of common stock

     (2,245 )     —    
    


 


Net cash provided by (used in) financing activities

     (760 )     1,836  
    


 


Net increase (decrease) in cash and cash equivalents

     (8,065 )     2,748  
    


 


Cash and cash equivalents at beginning of the period

     12,308       18,210  
    


 


Cash and cash equivalents at end of the period

   $ 4,243     $ 20,958  
    


 


Supplemental disclosures of cash flow information:

                

Cash paid during the period for:

                

Interest

   $ —       $ 1  

Income taxes

   $ 23     $ 516  

Non-cash financing activities:

                

Stock-based compensation associated with employee and consultant stock options

   $ 839     $ 626  

Unrealized gain (loss) on marketable securities

   $ (9 )   $ 25  

Tax benefit from the exercise of stock options

   $ 555     $ 340  

 

See accompanying notes.

 

5


Table of Contents

PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS

 

(Unaudited)

(in thousands, except share and per share data)

 

1. Description of Business

 

Provide Commerce, Inc. (the “Company”) was incorporated in the State of Delaware and commenced operations on February 6, 1998. The Company operates in one business segment. The Company operates an e-commerce marketplace for perishable goods, such as fresh-cut floral arrangements, potted plants, high quality meat, seafood and fruit, and related merchandise. The Company’s e-commerce marketplace currently consists of www.proflowers.com, www.cherrymoonfarms.com, www.flowerfarm.com, and www.uptownprime.com. Products are purchased by customers and shipped directly from the growers/producers for overnight or other prompt delivery.

 

2. Summary of Significant Accounting Policies

 

Basis of Presentation and Interim Financial Information

 

The accompanying unaudited financial statements of the Company have been prepared in accordance with United States generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission, and do not contain all information included in the audited financial statements and notes thereto. The interim unaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K. In the opinion of management, the information furnished herein reflects all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented.

 

The balance sheet at June 30, 2005 has been derived from the audited financial statements at that date.

 

Net Loss Per Share

 

Basic net loss per common share is calculated by dividing net loss for the period by the weighted average common shares outstanding during the period, less shares subject to repurchase. Diluted net loss per share is calculated by dividing the net loss for the period by the weighted average common shares outstanding, adjusted for all dilutive potential common shares, which includes shares issuable upon the exercise of outstanding common stock options, convertible preferred stock and other contingent issuances of common stock to the extent these shares are dilutive. The Company incurred losses for the three months ended September 30, 2005 and 2004,

 

6


Table of Contents

PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

and, accordingly, has excluded all shares issuable upon exercise of common stock options or warrants and shares subject to repurchase from the calculation of diluted net loss per share for that period, except for the cumulative effect of a change in accounting principle, as follows:

 

     Three Months Ended
September 30,


 
     2005

    2004

 

Calculations for net losses

                

Numerator

                

Net loss before cumulative effect of a change in accounting principle

   $ (467 )   $ (497 )
    


 


Net loss

     (23 )   $ (497 )
    


 


Denominator

                

Basic for net loss before cumulative effect of a change in accounting principle and net loss:

                

Weighted average common shares outstanding

     11,978,842       11,845,851  

Less: Weighted average shares subject to repurchase

     (103 )     (902 )
    


 


Denominator on basic calculation

     11,978,739       11,844,949  
    


 


Basic net loss before cumulative effect of a change in accounting principle per share

   $ (0.04 )   $ (0.04 )
    


 


Basic net loss per share

   $ —       $ (0.04 )
    


 


Diluted for net loss before cumulative effect of a change in accounting principle and net loss:

                

Weighted average common shares outstanding

     11,978,739       11,844,949  
    


 


Denominator on diluted calculation

     11,978,739       11,844,949  
    


 


Diluted net loss before cumulative effect of a change in accounting principle per share

   $ (0.04 )   $ (0.04 )
    


 


Diluted net loss

   $ —       $ (0.04 )
    


 


Calculations for income related to cumulative effect of a change in accounting principle

                

Numerator

                

Cumulative effect of a change in accounting principle

   $ 444     $ —    
    


 


Denominator

                

Basic for cumulative effect of a change in accounting principle:

                

Weighted average common shares outstanding

     11,978,842          

Less: Weighted average shares subject to repurchase

     (103 )        
    


       

Denominator on basic calculation

     11,978,739          
    


       

Basic cumulative effect of a change in accounting principle per share

   $ 0.04     $ —    
    


 


Diluted for cumulative effect of a change in accounting principle:

                

Weighted average common shares outstanding

     11,978,739          
    


       

Denominator on diluted calculation

     13,454,914          
    


       

Diluted cumulative effect of a change in accounting principle per share

   $ 0.03     $ —    
    


 


 

7


Table of Contents

PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

The following table summarizes potential common shares that are not included in the denominator used in net loss per share before cumulative effect of a change in accounting principle and net loss per share for the three months ended September 30, 2005 and 2004, because to do so would be anti-dilutive for the periods presented:

 

    

Three Months Ended

September 30,


     2005

   2004

Options to purchase common stock

   1,123,451    1,242,204

Warrants to purchase common stock

   352,725    502,449
    
  

Total

   1,476,176    1,744,653
    
  

 

Stock-Based Employee Compensation

 

Stock-based awards are granted under the terms of the 2003 Stock Incentive Plan (2003 Plan) and the employee stock purchase plan (ESPP). Additionally, the Company has outstanding stock options under its 1998 and 1999 Stock Option Plans, although these Plans terminated in 2003. Under the 2003 Plan, the Company grants both incentive stock options and non-qualified stock options.

 

Prior to July 1, 2002, the Company accounted for its stock-based awards using the intrinsic value method under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) and related Interpretations. Under the provisions of APB No. 25, no stock-based employee compensation cost was reflected in net income upon grant of the options, as all options granted under those plans had an exercise price equal to the market value of the underlying stock on the date of grant. Stock-based employee compensation cost was reflected for options which became variable price options due to a change in the strike price of those options.

 

Effective July 1, 2002, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), as amended, using the prospective transition method. Under the prospective method, the Company expensed only those employee stock options that were granted or modified after July 1, 2002. The majority of awards under the Company’s plans vest over a period of four years. The expense associated with stock compensation is amortized over the vesting period of the individual award using an accelerated method of amortization consistent with the method described in Financial Accounting Standards Board (FASB) Interpretation No. 28.

 

Effective July 1, 2005, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), using the modified prospective method of application. Under this method, compensation expense is recognized both for (i) the remaining vesting periods of awards granted, subsequent to July 1, 2002 and (ii) the remaining vesting periods of awards granted prior to July 1, 2002.

 

The impact of adopting SFAS No. 123(R) for the Company’s first quarter of fiscal 2006 was a decrease in compensation expense of $123 ($69 after tax) and an increase of $0.01 for both basic and diluted earnings per share. The Company expects the total expense for stock-based awards during fiscal year 2006 to be approximately $4.0 million. The adoption of SFAS No. 123(R) is expected to incrementally decrease before tax compensation expense by approximately $500 during fiscal 2006. SFAS 123(R) also requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (except tax benefits) to be classified as financing cash flows. In prior periods, such amounts were presented as an operating activity. For the three months ended September 30, 2005 and 2004, $555 and $340 was reported as “Tax benefit from the exercise of stock options” in the financing activities of the Statement of Cash

 

8


Table of Contents

PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

Flows. At adoption, the Company recognized a cumulative effect of change in accounting principle resulting in a net income benefit of $444, which corresponded to the requirement of estimating forfeitures at the date of grant. SFAS 123(R) also eliminated the presentation of the contra-equity account, “Deferred stock-based compensation,” from the face of the Balance Sheet resulting in a reclassification of $3,068 to “Additional paid-in capital.”

 

The effect of applying the fair value recognition provisions of SFAS 123(R) to stock-based compensation for all outstanding and unvested awards in periods prior to July 1, 2002, on net income and earnings per common share for the three months ended September 30, 2005 and 2004, did not result in pro forma income or loss which is materially different from the reported amount. Therefore, such pro forma information is not presented herein.

 

The following weighted-average assumptions were used for options granted in the three months ended September 30, 2005 and 2004 and a discussion of our methodology for developing each of the assumptions used in the valuation model follows:

 

    

Three Months
Ended

September 30,


 
     2005

    2004

 

Dividend yield

   0.0 %   0.0 %

Expected volatility

   45.0 %   54.4 %

Risk-free interest rate

   3.99 %   4.43 %

Expected life of the option term (in years)

   4.1     5.0  

Forfeiture rate

   10.0 %   N/A  

 

    Dividend Yield—The Company has never declared or paid dividends on common stock and has no plans to do so in the foreseeable future.

 

    Expected Volatility—Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate during a period based on comparisons with the implied volatility of traded options of companies which are similar to the Company and other factors which may effect the volatility of the Company’s stock (expected volatility). The Company considered the historical volatility from its initial public offering through the dates of grants, in combination with the implied volatility of options of similar companies, and business and economic considerations in order to estimate the expected volatility, due to the limited time of being a public company.

 

    Risk-Free Interest Rate—This is the U.S. Treasury rate for the week of each option grant during the quarter having a term that most closely resembles the expected life of the option.

 

    Expected Life of the Option Term—This is the period of time that the options granted are expected to remain unexercised. Options granted during the quarter have a maximum term of ten years. The Company estimates the expected life of the option term based on actual past behavior for similar options with further consideration given to the class of employees to whom the options were granted.

 

    Forfeiture Rate—This is the estimated percentage of options granted that are expected to be forfeited or canceled on an annual basis before becoming fully vested. The Company estimates the forfeiture rate based on past turnover data ranging between zero to four years.

 

As of September 30, 2005 the total unrecognized compensation cost related to unvested share-based compensation arrangements was $5.4 million, and the related weighted average period over which it is expected to be recognized is approximately 3.5 years.

 

9


Table of Contents

PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

SFAS 123(R) requires that stock-based compensation expense be reported on the same line on the Statement of Operations as the related cash wages. Historically, the Company has reported stock-based compensation expense as a separate line in the operating expenses section of the Statement of Operations. Under SFAS 123(R), the Company has reported the following amounts of stock-based compensation expense in the Statements of Operations as follows:

 

    

Three Months Ended

September 30,


     2005

     2004

Cost of sales

   $ 4      $ 5

Selling and marketing

     281        216

General and administrative

     359        321

Information technology systems

     195        84
    

    

Total stock-based compensation

   $ 839      $ 626
    

    

 

Stock Options

 

In September 2003, the Company’s Board of Directors approved the 2003 Stock Incentive Plan for issuance of stock options and stock purchase rights to employees, directors, and consultants, which became effective in December 2003. Upon effectiveness of the 2003 plan, the options under the predecessor 1998 and 1999 plans were transferred to the 2003 plan, and no further options will be granted under the predecessor plans. In addition, the Company has reserved an aggregate of 4,608,375 shares of common stock for issuance under the 2003 plan which includes the number of shares carried over from the predecessor plans. The number of shares of common stock reserved for issuance under the 2003 plan will automatically be increased on the first day in January each calendar year, beginning in calendar year 2004, by an amount equal to the lesser of (i) 3% of the total number of shares of the Company’s common stock outstanding on the last trading day in December of the preceding year or (ii) the lesser of 625,000 shares of the Company’s common stock or such amount as determined by the Company’s Board of Directors.

 

In fiscal year 1998, the Company adopted the 1998 Stock Option/Stock Issuance Plan (the “1998 Plan”) and in fiscal year 2000, the Company adopted the 1999 Stock Option/Stock Issuance Plan (the “1999 Plan”) (collectively, the “Plans”). Under the Plans, employees, directors and consultants may be granted options and stock purchase rights to purchase common shares.

 

Both Plans provide for the issuance of up to 5,000,000 shares of common stock. Options granted under the Plans generally expire no later than ten years from the date of grant (five years for a 10% stockholder). Options generally vest and become fully exercisable over a period of five years under the 1998 Plan and over a period of four years under the 1999 Plan.

 

Stock option activity, including 163,463 shares issued outside the Plans, is as follows:

 

     Shares

   

Weighted-
Average

Exercise Price


Balance at June 30, 2005

   2,109,370     $ 6.40

Granted

   472,259       25.63

Exercised

   (126,965 )     7.32

Cancelled

   (65,557 )     14.36
    

     

Balance at September 30, 2005

   2,389,107       9.93
    

     

 

10


Table of Contents

PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

The shares granted during the three months ended September 30, 2005 have a weighted-average grant-date fair value of $10.32. The total intrinsic value of options exercised during the three months ended September 30, 2005 was $930. The total fair value of shares vested at September 30, 2005 was $352.

 

The following table summarizes information about stock options outstanding at September 30, 2005:

 

     Options Outstanding

   Options Exercisable

Range of Exercise
Prices


  

Outstanding

as of

September 30,
2005


  

Weighted-
Average

Remaining

Contractual
Life


  

Weighted-

Average

Exercise Price


  

Exercisable

as of

September 30,
2005


  

Weighted-

Average

Exercise Price


   Aggregate
Intrinsic
Value


$  0.36

   617,100    2.6    $ 0.36    617,100    $ 0.36    $ 222

    1.51

   711,926    5.6      1.51    668,465      1.51      1,009

    2.27

   69,302    7.3      2.27    36,984      2.27      84

  12.15

   8,389    7.9      12.15    4,955      12.15      60

  15.00-15.61

   259,937    8.2      15.04    98,909      15.00      1,484

  18.20-19.69

   55,335    8.9      18.96    13,365      19.24      257

  21.92-22.94

   108,537    9.0      22.15    22,326      21.92      489

  23.35-28.76

   488,791    9.8      25.74    416      23.35      10

  30.01-36.00

   69,790    9.3      31.96    —        —        —  
    
              
         

     2,389,107    6.4      9.93    1,462,520      9.93    $ 3,615
    
              
         

 

Employee Stock Purchase Plan

 

In December 2003, the Company’s board of director’s approved an employee stock purchase plan (“ESPP”), a non-compensatory employee stock purchase plan under Section 423 of the Internal Net sales Code, to provide all qualifying employees an opportunity to purchase shares of the Company’s common stock. Employees may contribute a maximum of 10% of his or her total earnings through payroll deductions. The accumulated deductions will be applied to the purchase of shares on each semi-annual purchase date. However, an employee may not purchase more than 1,500 shares on any purchase date.

 

The plan has a series of successive overlapping offering periods, with a new offering period beginning on the first business day of June and December each year and will have a duration of 24 months. The purchase price per share will be equal to 85% of the fair market value per share on the start date of the offering period in which the participant is enrolled or, if lower, 85% of the fair market value per share on the semi-annual purchase date. The purchase price discount is significant enough to be considered compensatory under SFAS 123. As a result, the Company recorded $216 and $90, in stock based compensation for the three months ended September 30, 2005 and 2004, respectively, related to the ESPP.

 

At September 30, 2005, the Company has authorized an aggregate of 280,000 shares of common stock for issuance under its ESPP. The number of shares of the Company’s common stock reserved for issuance under the plan will automatically increase on the first trading day in January of each calendar year by an amount equal to the lesser of (i) 3% of the total number of shares of the Company’s common stock outstanding on the last trading day in December in the preceding calendar year, (ii) 40,000 shares or (iii) such amount as determined by the Company’s board of directors.

 

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PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

3. Stockholders’ Equity

 

Common Stock

 

In September 2003, the Company’s Board of Directors approved an amendment to the certificate of incorporation and increased the authorized common stock to 50,000,000 shares, which became effective December 22, 2003 in connection with the Company’s initial public offering. During the three months ended September 30, 2005, the Company issued 126,965 shares of common stock upon exercise of outstanding options.

 

Preferred Stock

 

In September 2003, the Company’s Board of Directors approved an amendment to the certificate of incorporation setting the authorized preferred stock to 5,000,000 shares, which became effective December 22, 2003 in connection with the Company’s initial public offering. The preferred stock is “blank check preferred,” which can be created and issued by the Board of Directors without stockholder approval, with rights senior to those of common stock.

 

4. Deferred Compensation Plan

 

In November 2003, the compensation committee of the Board of Directors approved a Deferred Compensation Plan which became effective in January 2004. The Deferred Compensation Plan is an unfunded non-qualified plan for the benefit of non-employee directors and certain designated management and highly compensated employees of the Company. The plan permits participants to defer receipt of certain compensation, as well as certain income for stock option exercises. In addition, the Company may elect to make a matching contribution to any or all of the participants in an amount of fifty percent (50%) of the participant’s deferred annual base salary or annual bonus, but in no event shall the matching contributions exceed ten percent (10%) of the participant’s annual base salary with respect to deferrals of base salary or ten percent (10%) of the participant’s annual bonus with respect to deferrals of annual bonus. As of September 30, 2005, the Company had deferred compensation of $1,746 related to the Deferred Compensation Plan.

 

5. Supplemental Executive Retirement Plan

 

In November 2003, the compensation committee of the Board of Directors approved a Supplemental Executive Retirement Plan (SERP) which became effective in January 2004. The SERP is an unfunded non-qualified plan for the benefit of certain non-employee directors, designated management and highly compensated employees of the Company. Participants under the SERP will be due a benefit (as defined for purposes of the SERP) upon early or normal retirement, disability, death or other termination of employment. The ordinary benefit is a benefit equal to 0.015 multiplied by the number of years of service to the Company and multiplied by the participant’s final average compensation, and reduced by amounts paid under the Deferred Compensation Plan. Amounts due under the SERP will be paid in equal installments over 15 years commencing at normal retirement (age 65). If an ordinary benefit commences prior to normal retirement, the participant will receive the actuarial equivalent of his or her vested benefit at normal retirement, generally to be paid over 15 years.

 

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PROVIDE COMMERCE, INC.

 

NOTES TO FINANCIAL STATEMENTS—(Continued)

 

The following is a summary of the Company’s net periodic benefit cost including the components for the three months ended September 30:

 

     2005

   2004

Service cost

   $ 57    $ 74

Interest cost

     12      16

Amortization of prior service cost

     7      8
    

  

Net periodic benefit cost

   $ 76    $ 98
    

  

 

The SERP is an unfunded obligation of the Company in which earned plan benefits will be paid out of general operating funds as they come due. To offset the cost of the plan, the Company has purchased life insurance policies on all of the participants within the plan. The Company is the sole beneficiary on these policies. Using this structure and professional actuarial guidance, the Company anticipates that there will be no net cost over the full life of the plan.

 

6. Income Tax

 

During the three months ended September 30, 2005 and 2004, the Company recognized a tax benefit of $367 and $449, respectively. The effective tax rate anticipated for the year ending June 30, 2006 of 44% is a result of the statutory rates and the permanent book/tax differences including stock-based compensation recognized under SFAS 123(R).

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the related notes to those statements included elsewhere in this report. This discussion may contain forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of the factors described in the “Risks and Uncertainties” section below and elsewhere in this report. Except as may be required by applicable law, we undertake no obligation to publicly update any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

 

PROVIDE COMMERCESM, PROFLOWERS®, UPTOWN PRIME®, FLOWERFARM.COM® and CHERRY MOON FARMSSM are trademarks or service marks of Provide Commerce, Inc. We have trademark rights in these and other marks in the U.S. and have registrations issued and pending in the U.S. We also have registrations issued or pending for the trademark PROFLOWERS® in Australia, Brazil, Canada, China, the European Union, India, Japan, Mexico, New Zealand and Switzerland. This report also refers to brand names, trademarks, service marks and trade names of other companies and organizations, and these brand names, trademarks, service marks and trade names are the property of their respective holders.

 

Overview

 

We operate an e-commerce marketplace of websites for perishable goods that consistently delivers fresh, high-quality products direct from the supplier to the customer at competitive prices. We combine an online storefront, proprietary supply chain management technology, established supplier relationships and integrated logistical relationships with FedEx and UPS to create a market platform that bypasses traditional supply chains of wholesalers, distributors and retailers. The benefits to our customers include value, freshness, quality, accurate fulfillment, direct customer service and selection, all with a guaranteed delivery date. The benefits to our suppliers include enhanced margins, broader customer reach and better inventory management. We believe our business model is highly scalable with low capital investment requirements beyond our existing technology and systems and minimal inventory carrying costs.

 

We were incorporated in February 1998 and officially launched our website, www.proflowers.com, in August 1998. Since inception, we have focused on developing our supply chain management technology, refining and broadening our relationships with our delivery partners, generating flower sales, establishing and promoting our brands, pursuing relationships with other retailers, and preparing to launch websites featuring additional product offerings.

 

We plan to assess and target additional categories based on our market platform’s ability to add value by streamlining the supply chain for the benefit of customers and suppliers. We have identified premium meat, seafood and fresh fruit as initial categories where we believe we can leverage our customer base, marketing and distribution relationships and infrastructure. In October 2003, we launched and are now operating Uptown Prime at www.uptownprime.com, offering premium meat and seafood, and Cherry Moon Farms at www.cherrymoonfarms.com, offering fresh premium fruit.

 

In December 2003, we completed an initial public offering whereby 4,334,000 shares of our common stock were sold at an offering price of $15 per share. Of the 4,334,000 shares sold, 2,666,667 were sold by us and an aggregate of 1,667,333 shares were sold by selling stockholders. In January 2004, the underwriter’s over-allotment option was exercised whereby 316,100 shares of our common stock were sold at an offering price of $15 per share; all of said shares were sold by selling stockholders. We received net proceeds of approximately $34.8 million in connection with the offering. In addition, 221,715 shares of outstanding Series A preferred stock were converted into 760,383 shares of common stock and 5,816,285 shares of outstanding Series B preferred stock were converted into 2,104,853 shares of common stock.

 

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In July 2004, we completed a secondary public offering whereby 1,981,019 shares of our common stock were sold at an offering price of $19.63 per share. Of the 1,981,019 shares sold, 100,000 shares were sold by us and an aggregate of 1,881,019 shares were sold by selling stockholders. We received net proceeds of approximately $1.4 million in connection with the secondary offering.

 

To date, we have derived our revenues primarily from the sale of flowers, plants and gifts from our www.proflowers.com website. For the three months ended September 30, 2005, we reported net sales of $26.8 million, an increase of 34.4% from $19.9 million for the three months ended September 30, 2004, and a net loss of $(23,000) as compared to a net loss of $(497,000) for the three months ended September 30, 2004. Since inception through fiscal 2002, we have incurred significant losses. As of September 30, 2005, we have an accumulated deficit of $22.1 million.

 

We use our market platform to manage the delivery of flowers from the supplier to the consumer in a manner that reduces our inventory risk. We do not take title to flowers shipped direct from our growers to our customers until pick-up by our third-party carriers. We take title to flowers from growers outside the U.S. that we briefly maintain as inventory while in-transit to one of our distribution facilities and while being prepared and packaged for shipping. Our longer-term inventory consists of grower shipping supplies, including boxes, and accessories, including flower vases, chocolates and plush toys.

 

Results of Operations

 

The following table sets forth our results of operations expressed as a percentage of net sales for the three months ended September 30, 2005, and 2004:

 

     Three Months
Ended
September 30,


 
     2005

    2004

 

Statement of Operations Data:

 

     

Net sales

   100.0 %   100.0 %

Cost of sales(1)

   55.0     54.6  
    

 

Gross profit(1)

   45.0     45.4  

Operating expenses:

            

Selling and marketing(1)

   22.3     24.3  

General and administrative

   21.3     21.1  

Information technology systems

   6.4     6.1  
    

 

Total operating expenses(1)

   50.0     51.5  
    

 

Operating loss

   (5.0 )   (6.1 )

Other income, net

   1.9     1.3  
    

 

Loss before income tax

   (3.1 )   (4.8 )

Income tax (benefit)

   (1.4 )   (2.3 )
    

 

Net loss before cumulative effect of a change in accounting principle

   (1.7 )   (2.5 )

Cumulative effect of a change in accounting principle

   1.7     —    
    

 

Net loss

   (0.0 )   (2.5 )
    

 


(1) Under EITF 01-9, Accounting for Consideration Given by a Vendor to a Customer, the cost of a “free offer” at purchase, such as a free glass vase, should be included in cost of sales. Historically, these promotional costs have been included as a marketing expense. We have reclassified these costs into cost of sales for all periods presented. The accompanying financial statements give retroactive effect to the reclassification for all periods presented.

 

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Net Sales

 

     Three Months Ended September 30,

 
     2005

   2004

   % Increase

 
     (in thousands, except percentages)  

Net sales

   $ 26,782    $ 19,921    34.4 %

 

Our net sales are derived primarily from the sale of flowers, plants and gifts from our www.proflowers.com website and the sale of gourmet foods from our www.uptownprime.com and www.cherrymoonfarms.com websites. We also generate net sales from fees that we receive from retailers for whom we design and operate websites to sell perishable products under their own brands.

 

The increase in net sales for the three months ended September 30, 2005 compared to the same period last year resulted primarily from an increase in the number of orders by new and existing customers.

 

In order to provide better comparability between accounting periods, the information presented in the following table represents the numbers of customers included in our database at period end, orders placed by existing customers, net sales from existing customers, new customers and average order value in our core floral business, which is defined as consumer sales from the ProFlowers business. Results from our activities other than our core floral business are not reflected as they are not material relative to our floral activities. Information for our other activities will be presented in the future when they become material.

 

     Three Months Ended September 30,

 
     2005

   2004

   % Increase

 
     (in thousands, except percentages and
average order values)
 

Database of customers at period end

     4,457      3,211    38.8 %

Orders placed by existing customers

     359      270    32.9 %

Net sales from existing customers

   $ 16,957    $ 13,008    30.4 %

New customers

     150      117    28.2 %

Average order value

   $ 49.32    $ 46.96    5.0 %

 

Growth in the number of new customers for the three months ended September 30, 2005 is a result of our advertising and marketing campaigns which are designed to attract and maintain customers. We believe continued strength in repeat orders is a result of our strong customer satisfaction and our retention marketing efforts.

 

In October 2003, we launched and are now operating Uptown Prime at www.uptownprime.com, offering premium meat and seafood, and Cherry Moon Farms at www.cherrymoonfarms.com, offering fresh premium fruit. We expect premium meat, seafood, and fresh premium fruit net sales to grow in significance to our business as we develop and deploy our premium meat, seafood, and fresh premium fruit websites. We expect that between 5% and 7% of our net sales will be derived from premium meat and fresh premium fruit in fiscal 2006. You must consider our prospects for expanding our premium meat, seafood and fresh premium fruit net sales during fiscal 2006 and beyond in light of the risks associated with expanding into new product categories and the other risks outlined in “Risks and Uncertainties” below.

 

We offer a variety of arrangements for branded retailers or direct marketers that want to use our market platform to offer perishable products, including a co-branded website, a private label website or a hybrid of the two. The arrangements are currently structured to involve a combination of revenue sharing and fee-based agreements. For revenue sharing agreements, we pay the retailer a portion of the net sales generated from its website. Fee-based retailer arrangements involve a combination of up-front development costs and per-transaction fees paid to us by the retailer. Our branded retailer arrangements regardless of the payment structure represented an immaterial percentage of our net sales for the three months ended September 30, 2005.

 

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Gross Profit

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase

 
     (in thousands, except percentages)  

Gross profit

   $ 12,055     $ 9,046     33.3 %

Gross profit percentage

     45.0 %     45.4 %      

 

Our gross profit consists of net sales less cost of sales. Our cost of sales consists primarily of flower and other product costs and shipping charges. Other costs included in cost of sales are producer and delivery supply costs, distribution facility labor costs and the cost of promotional and replacement products.

 

The slight decrease in the gross profit percentage for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 was a result of an increase in our product and product delivery costs due to higher fuel costs which was partially offset by a higher average order value. We also experienced a slightly less profitable product sales mix in our core floral business. In addition, we experienced an increase in fixed costs associated with the distribution centers which support our operations.

 

We expect our gross profit in absolute dollars to increase in the future as we increase our net sales. We expect that our gross profit percentage will fluctuate in the future as we expand into new product categories based upon our product mix, average order value, product costs, shipping costs, product replacement and refund rates and handling and packaging costs for the various products. Our gross profit may also fluctuate in the future as a result of fluctuations in carrier costs due to fuel surcharges.

 

Selling and Marketing

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase

 
     (in thousands, except percentages)  

Selling and marketing

   $ 5,983     $ 4,843     23.6 %

As a percent of net sales

     22.3 %     24.3 %      

 

Our selling and marketing expenses consist primarily of payroll and payroll related costs for our category development and marketing and customer service staff, online and offline advertising costs, and market and customer research costs. Advertising expenses are generally expensed as incurred. For advertising contracts which cover an extended period of time, the costs are expensed over the life of the contract based on the terms of the contract, such as orders placed, radio spots run or Internet advertisements placed. Our advertising efforts target the acquisition of new customers and repeat orders from existing customers.

 

The increase in the selling and marketing expenses for the three months ended September 30, 2005 compared to the same period last year is primarily due to an increase in payroll and payroll related costs as our marketing staff headcount has increased in an effort to drive increases in net sales, an increase in customer service seasonal labor to support our increased customer sales and satisfaction activity and an increase in targeted business-to-business advertising.

 

The decrease in marketing costs for the three months ended September 30, 2005 as a percentage of sales compared to the same period last year is primarily a result of decreased costs related to online and offline direct marketing and advertising. These costs were partially offset by an increase, as a percentage of sales, in our customer service seasonal labor to support our increased customer sales and satisfaction activities.

 

We expect selling and marketing expenses to continue to increase in absolute dollars in the future as a result of continued expansion of our sales and marketing efforts. While we currently expect selling and marketing expenses to increase in absolute dollars, we expect them to remain generally comparable to fiscal 2005 as a

 

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percentage of net sales for fiscal 2006. However, as we identify opportunities to increase our growth in net sales, we may increase our marketing expense to take advantage of those opportunities.

 

General and Administrative

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase

 
     (in thousands, except percentages)  

General and administrative

   $ 5,703     $ 4,196     35.9 %

As a percent of net sales

     21.3 %     21.1 %      

 

Our general and administrative expenses consist primarily of payroll and payroll related costs for our employees, (except those associated with fulfillment, customer service, technology and sales and marketing employees), depreciation of fixed assets, credit card fees, facilities costs (other than facilities costs associated with cost of goods sold), legal and accounting professional fees, insurance, bad debt expense, phone, travel, deferred compensation and retirement plan expenses and other general corporate expenses.

 

The increase in absolute general and administrative expenses for the quarter ended September 30, 2005 compared to the same quarter last year is primarily due to increases in payroll and payroll related costs, depreciation of fixed assets and legal expenses. The increase in payroll and payroll related costs is a result of increasing headcount in order to support the growth of our company and payment of severance to terminated employees. The increase in depreciation is a result of investments in fixed assets to support our increased sales volumes. The increase in legal expenses is a result of the costs incurred to defend ourselves in various lawsuits and general corporate legal expenses.

 

The increase as a percentage of net sales was caused primarily by the increases in payroll and payroll related costs and legal expenses which were partially offset by a decrease in the net cost of deferred retirement compensation and retirement plan expenses and related investment income or expense.

 

We expect general and administrative expenses to continue to increase in absolute dollars in the future as a result of continued expansion of our administrative infrastructure in support of a broader technology and product portfolio and general corporate expenses. However, we also anticipate that annual general and administrative expenses will remain relatively constant or decrease as a percentage of net sales as a result of net sales growing faster than general and administrative expenses.

 

Information Technology Systems

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase

 
     (in thousands, except percentages)  

Information technology systems

   $ 1,712     $ 1,223     39.9 %

As a percent of net sales

     6.4 %     6.1 %      

 

Our information technology system expenses consist primarily of payroll and payroll related costs for information technology personnel, software support services and other general information technology expenses. Information technology system expenses are expensed as incurred. Information technology system expenses are net of software capitalization of major site and product development efforts under Statement of Position 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal Use.

 

The increase in information technology costs in absolute dollars for the quarter ended September 30, 2005 compared to the same quarter last year is a result of an increase in payroll and payroll related costs and an increase in stock-based compensation. These costs were partially offset by an increase in the capitalized costs

 

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associated with internally developed software of approximately $410,000 and approximately $334,000 for the three months ended September 30, 2005 and 2004, respectively. We incurred the increased payroll and payroll related costs and stock-based compensation in order to support the infrastructure necessary for continued growth of our business.

 

The increase in information technology system expenses, as a percentage of net sales, for the three months ended September 30, 2005 compared to the same period last year was primarily a result of our growth in payroll and payroll related costs and stock-based compensation, which outpaced our growth in net sales. In addition, the rate of increase in capitalized information technology expenditures was less than the rate of growth in net sales.

 

We expect information technology system expenses to increase in absolute dollars in fiscal 2006 compared to fiscal 2005 but to remain at a relatively constant percentage of net sales for fiscal 2006 compared to fiscal 2005 as we continue to invest in our infrastructure to support the growth of our business. Our information technology expenses may fluctuate in the future should we capitalize either greater or fewer expenses associated with capital software projects.

 

Other Income, Net

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase

 
     (in thousands, except percentages)  

Other income, net

   $ 509     $ 270     88.8 %

As a percent of net sales

     1.9 %     1.3 %      

 

Other income, net includes primarily investment income. The increase for the three months ended September 30, 2005 compared to the same quarter last year was a result of improved returns on invested assets and higher invested balances.

 

Income Tax Benefit

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase
(Decrease)


 
     (in thousands, except percentages)  

Income tax benefit

   $ (367 )   $ (449 )   (18.3 )%

As a percent of net sales

     (1.4 )%     (2.3 )%      

 

The income tax benefit reflects a reduction in anticipated income tax payable as a result of the loss incurred in the first fiscal quarter of 2006 and a decrease in the estimated effective rate. The effective tax rate anticipated for fiscal year 2006 of 44% is a result of the statutory tax rates and stock-based compensation recognized under SFAS 123(R).

 

Net Loss

 

     Three Months Ended September 30,

 
     2005

    2004

    % Increase
(Decrease)


 
     (in thousands, except percentages)  

Net loss

   $ (23 )   $ (497 )   (95.4 )%

As a percent of net sales

     (0.0 )%     (2.5 )%      

 

The change in net loss is a result of the changes in net sales and expenses as previously discussed and the cumulative effect of a change in accounting principle of $444,000 associated with the adoption of SFAS 123(R).

 

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Liquidity and Capital Resources

 

     September 30,
2005


   June 30,
2005


   % Increase
(Decrease)


 
     (in thousands, except percentages)  

Working capital

   $ 59,273    $ 59,554    (0.5 )%

Cash and cash equivalents

   $ 4,243    $ 12,308    (65.5 )%

 

Since our inception, we have financed our operations through sales of stock, and, more recently, internally generated cash flows from operations. The decreases in cash at September 30, 2005 over June 30, 2005 resulted primarily from net cash used in operations of approximately $3.5 million reduced further by the purchase of fixed assets of approximately $1.1 million and repurchases of $2.2 million of shares of our common stock. In May 2005, we announced that our board of directors authorized a stock repurchase program under Rule 10b-18 of the Exchange Act of up to $25 million of shares of our common stock in the open market and negotiated purchases over a period of one year. For the three months ended September 30, 2005, we had repurchased 89,700 shares of our common stock in open market transactions at varying prices for an aggregate purchase price of approximately $2.2 million, which together with prior repurchases leaves approximately $13.9 million available for potential future repurchases of common stock.

 

Net cash used in operating activities was $(3.6) million for the three months ended September 30, 2005 as compared to $(3.9) million for the three months ended September 30, 2004.

 

We use cash in investing activities primarily to purchase computer hardware and software, office equipment and furniture. Investing activities also includes the purchase and sale of marketable securities in order to provide for cash flow needs or invest excess cash. Net cash provided by (used in) investing activities totaled $(3.7) million and $4.8 million in the three months ended September 30, 2005 and 2004, respectively.

 

Net cash provided by (used in) financing activities was $(0.8) million and $1.8 million for the three months ended September 30, 2005 and 2004, respectively.

 

The change in marketable securities is a result of the net sales or purchases of marketable securities to meet our cash requirements or invest additional cash.

 

We believe that our available cash and cash flows from operations will be sufficient to satisfy our working capital and capital expenditure requirements for at least the next 12 months. Changes in our operating plans, lower than anticipated net sales, increased expenses or other events, including those described in “Risks and Uncertainties” below may cause us to seek debt or additional equity financing in the future. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could negatively impact our growth plans and our financial condition and results of operations. Additional equity financing may be dilutive to the holders of our common stock and debt financing, if available, may involve significant cash payment obligations and covenants and/or financial ratios that restrict our ability to operate our business.

 

Critical Accounting Policies

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, estimates are evaluated, including those related to the timing of marketing expense, lives and depreciation of fixed assets, reserves for bad debts and credit card chargebacks, reserves for inventory and impairment of long-lived assets. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Management believes there have been no material

 

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changes during the three month period ended September 30, 2005 to the critical accounting policies reported in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended June 30, 2005 as filed with the Securities and Exchange Commission on September 13, 2005.

 

Recently Issued Accounting Standards

 

We adopted SFAS No. 123(R), Share-Based Payments, effective July 1, 2005 using the modified prospective method. We had adopted the fair-value-based method of accounting for stock-based payments effective July 1, 2002 using the prospective method described in FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure. We use the Black-Scholes formula to estimate the value of stock options granted to employees. We applied SFAS 123(R) not only to new awards but also to previously granted awards that were not fully vested on the effective date. Because we adopted SFAS 123(R) using the prospective transition method (which applied only to awards granted, modified or settled after the adoption date), compensation cost for some previously granted awards that were not recognized under SFAS 123 will be recognized under SFAS 123(R). SFAS 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under previous literature.

 

The impact of adopting SFAS No. 123(R) for our first quarter of fiscal 2006 was a decrease in compensation expense of $123,000 ($69,000 after tax) and an increase of $0.01 for both basic and diluted earnings per share. We expect the total expense for stock-based awards during fiscal year 2006 to be approximately $4.0 million. The adoption of SFAS No. 123(R) is expected to incrementally decrease before tax compensation expense by approximately $0.5 million during fiscal 2006. SFAS 123(R) also requires the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. In prior periods, such amounts were presented as an operating activity. For the three months ended September 30, 2005 and 2004, $0.6 million and $0.3 million was reported as “Tax benefit from the exercise of stock options” in the financing activities of the Statement of Cash Flows. At adoption, we recognized a cumulative effect of change in accounting principle resulting in a net income benefit of $0.4 million, which corresponded to the requirement of estimating forfeitures at the date of grant. SFAS 123(R) also eliminated the presentation of the contra-equity account, “Deferred stock-based compensation,” from the face of the Balance Sheet resulting in a reclassification of $3.1 million to “Additional paid-in capital.”

 

The following weighted-average assumptions were used for options granted in the three months ended September 30, 2005 and 2004 and a discussion of our methodology for developing each of the assumptions used in the valuation model and how they differ from the assumptions used under SFAS 123 follows:

 

     Three Months
Ended
September 30,


     2005

  2004

Dividend yield

   0.0%   0.0%

Expected volatility

   45.0%   54.4%

Risk-free interest rate

   3.99%   4.43%

Expected life of the option term (in years)

   4.1   5.0

Forfeiture rate

   10.0%   N/A

 

    Dividend Yield—We have never declared or paid dividends on common stock and have no plans to do so in the foreseeable future. Under SFAS a dividend yield of 0.0% was also used.

 

   

Expected Volatility—Volatility is a measure of the amount by which a financial variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate during a period based on comparisons with the implied volatility of traded options of companies which are similar to us and other

 

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factors which may effect the volatility of our stock (expected volatility). We considered the historical volatility from our initial public offering through the dates of grants, in combination with the implied volatility of options of similar companies, and business and economic considerations in order to estimate the expected volatility. Under SFAS 123, only the historical volatility was considered for purposes of the volatility assumption.

 

    Risk-Free Interest Rate—This is the U.S. Treasury rate for the week of each option grant during the quarter having a term that most closely resembles the expected life of the option. The same Treasury rate was also used under SFAS 123.

 

    Expected Life of the Option Term—This is the period of time that the options granted are expected to remain unexercised. Options granted during the quarter have a maximum term of ten years. The Company estimates the expected life of the option term based on actual past behavior for similar options with further consideration given to the class of employees to whom the options were granted. Under SFAS 123, an expected life of the option term of five years was used.

 

    Forfeiture Rate—This is the estimated percentage of options granted that are expected to be forfeited or canceled on an annual basis before becoming fully vested. We estimate the forfeiture rate based on past turnover data ranges between zero to four years. No forfeiture rate was assumed under SFAS 123. Instead, forfeitures were recognized as they occurred.

 

Risks and Uncertainties

 

The following information sets forth factors that could cause our actual results to differ materially from those contained in forward-looking statements we have made in this report, the information incorporated herein by reference and those we may make from time to time. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In addition, there may be other risks of which we are currently unaware or that we do not currently believe are material that could become important factors that harm our business, financial condition or results of operations. You should also consider the other information described in this report.

 

Risks Related to Our Business

 

Our quarterly operating results may fluctuate significantly. You should not rely on them as an indication of our future results.

 

Our future net sales and results of operations may fluctuate significantly from quarter to quarter due to a combination of factors, many of which are outside of our control. The most important of these factors include:

 

    seasonality and timing of holidays;

 

    the timing, costs and effectiveness of marketing programs;

 

    our ability to enter into and renew key corporate and strategic partnerships;

 

    our ability to enter into or renew key marketing arrangements;

 

    our ability to compete with traditional and Internet retailers;

 

    our ability and the ability of our competitors to deliver high-quality perishable products to customers in a timely manner;

 

    the performance of our third-party carriers, FedEx and UPS;

 

    the condition of the retail economy; and

 

    the timing and effectiveness of capital expenditures.

 

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We may be unable to adjust spending quickly enough to offset any unexpected sales shortfall resulting from any of these or other factors. If we have a shortfall in net sales in relation to our expenses, our operating results will suffer. Our operating results for any particular period may not be indicative of future operating results. You should not rely on quarter-to-quarter comparisons of results of operations as an indication of our future performance. In future periods, it is possible that our results of operations may be below the expectations of public market analysts and investors. This could cause the trading price of our common stock to fall.

 

We achieved annual net income for the first time during fiscal 2003, and we cannot assure you we will continue to operate profitably.

 

We achieved annual net income for the first time in our corporate history during fiscal 2003 of $4.3 million and achieved annual net income attributable to common stockholders of $18.0 million in fiscal 2004, which included a release of a valuation allowance against deferred tax assets of $14.0 million. Our annual net income was $8.9 million in fiscal 2005. However, we may not be able to continue to achieve positive net income in future fiscal years, especially as we introduce new product categories. We expect our operating expenses to increase in the future, as we, among other things:

 

    expand into new product categories and accessories for our existing product lines;

 

    continue with our marketing efforts to build our brand names;

 

    expand our customer base;

 

    establish research and development efforts to advance our proprietary supply chain technology and develop new technology;

 

    upgrade our operational and financial systems, procedures and controls;

 

    continue to absorb the costs and implement the responsibilities of being a public company; and

 

    retain existing personnel and hire additional personnel.

 

After investment in items including those described above, we expect to maintain profitability for the foreseeable future, although no assurances can be made that we will be profitable. In order to maintain profitability as we expand into new product categories, we will need to generate net sales exceeding historical levels and/or reduce relative operating expenditures. We do not have significant experience offering product categories other than flowers. We may not be able to generate the required net sales from flowers and other perishable products or reduce operating expenses sufficiently to sustain or increase operating profitability. If we have a shortfall in net sales without a corresponding reduction to our expenses, our operating results may suffer. It is possible that results of operations may be below the expectations of public market analysts and investors, which could cause the trading price of our common stock to fall.

 

We have operated our flower category for approximately seven years and our premium meat and fresh fruit categories for approximately two years. This limited operating history makes evaluating our business and its prospects difficult.

 

We have a limited operating history on which an investor can evaluate our business. We were incorporated in February 1998 and officially launched our website, www.proflowers.com, in August 1998. To date, we have derived our net sales primarily from the sale of flowers, plants and gifts from our www.proflowers.com website. We began selling premium meat and fresh premium fruit in October 2003. An investor in our common stock must consider the risks, uncertainties and difficulties frequently encountered by companies in new and rapidly evolving online retail markets such as these we have targeted. If we do not successfully manage these risks or successfully execute our business strategy, our business, results of operations and financial condition will be adversely affected.

 

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If our customers do not find our expanded product categories appealing or if we are unable to successfully leverage our business strategy into our new product categories, our business may suffer.

 

We have recently expanded our product lines into other categories of perishable goods. In October 2003, we launched and are now operating two additional websites under our gourmet food business unit: Uptown Prime, offering premium meat and seafood; and Cherry Moon Farms, offering fresh premium fruit. In any possible future expansion of our categories, we intend to leverage our e-commerce platform, marketing and shipping relationships and customer base to develop opportunities for us and other retailers using our platform to offer perishable products. While our market platform has been incorporated into and tested in the online floral retail market, we cannot predict whether it can be successfully applied to other perishable product categories over time. In addition, expansion of our business strategy into new product categories may require us to incur significant marketing expenses, develop relationships with new suppliers and comply with new regulations. These requirements could strain our management, financial and operational resources. Additional challenges that may affect our ability to expand into new product categories include our ability to:

 

    establish or increase awareness of our new brands and product categories;

 

    acquire, attract and retain customers at a reasonable cost;

 

    achieve and maintain a critical mass of customers and orders across all of our product categories;

 

    maintain or improve our gross margins and fulfillment costs;

 

    compete effectively in highly competitive markets for the sale of perishable goods online;

 

    attract and retain suppliers to provide our expanded line of perishable products to our customers on terms that are acceptable to us; and

 

    establish ourselves as an important participant in the market for perishable products, such as premium meat, seafood and fresh fruit.

 

We cannot be certain that we will be able to successfully address any or all of these challenges in a manner that will enable us to expand our business into new product categories in a cost-effective or timely manner. If our new product categories are not received favorably by consumers, our reputation and the value of the applicable new brand and our other brands could be damaged. The lack of market acceptance of our new product categories or our inability to generate satisfactory net sales from any expanded product categories to offset their cost could harm our business.

 

We depend on two third-party carriers, and the failure of these carriers to deliver our product offerings in a timely or accurate manner could harm our business.

 

We currently rely primarily on two third-party carriers, FedEx and UPS, for shipments of our products to customers. We are therefore subject to the risks, including capacity and volume constraints, security concerns, employee strikes or other labor stoppages, inclement weather, equipment failures or other delays and fluctuations in fuel costs, associated with the carriers’ ability to provide timely and cost-effective order fulfillment and delivery services to meet our distribution and shipping needs. Under our contracts with both parties, we have agreed to waive specified refunds and guarantees for service failures and for commitment times during our seasonal peak periods in exchange for favorable pricing on our shipments with them. Failure to deliver products to our customers in a timely and accurate manner would harm our reputation, our brands and our results of operations.

 

We re-negotiate various provisions of our agreements with FedEx and UPS on a periodic basis and are subject to possible terminations by either party upon 60 days prior notice from or to FedEx and 30 days prior notice from or to UPS. We may face substantial increases in the cost of delivery services from our delivery partners as a result of increases in the prices of gasoline and fuel, heightened security measures or other factors. If in the future we fail to negotiate rates or other terms as favorable to us as the existing terms of our agreement,

 

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such failure will adversely affect our business and results of operations. In addition, if for any reason FedEx or UPS is unable or unwilling to deliver products to our customers in a timely manner or on acceptable terms, we may not be able to secure alternative shipping partners on acceptable terms in a timely manner, or at all.

 

We depend on three flower suppliers for approximately 57% of our core floral business products, and the loss of any of these suppliers could harm our business.

 

For the three months ended September 30, 2005 and for fiscal 2005, we depended on three flower suppliers for approximately 59.3% and 56.9%, respectively, of all of our core floral business products, which are defined as all products associated with consumer sales from our ProFlowers business. If any one of these three flower suppliers were to become unable or unwilling to continue to supply flowers to our customers, our business could be harmed. We do not have long-term contracts with any of our flower suppliers for order fulfillment, and these suppliers can terminate their relationships with us at any time. If a flower supplier discontinues its relationship with us, we will be required to obtain a suitable replacement, which may cause delays in delivery or a decline in product quality, leading to customer dissatisfaction and loss of customers. We expect to encounter similar risks as we develop our premium meat, seafood and fruit and other perishable product supplier relationships.

 

If our marketing efforts are not effective, our brands may not achieve the broad recognition necessary to succeed.

 

We believe that broader recognition and a favorable consumer perception of our brands, including our Provide Commerce, ProFlowers, Uptown Prime and Cherry Moon Farms brands, are essential to our future success. Accordingly, we intend to pursue an aggressive brand-enhancement strategy through a variety of online and offline marketing and promotional techniques, involving the Internet, print, radio, email, direct mail, public relations and television. These initiatives will involve significant expense. If our brand enhancement strategy is unsuccessful, these expenses may never be recovered and we may be unable to increase future net sales. Successful positioning of the Provide Commerce, ProFlowers, Uptown Prime and Cherry Moon Farms brands will largely depend on:

 

    the success of our advertising and promotional efforts;

 

    our ability to provide a consistent, high-quality customer experience; and

 

    our ability to continue to provide high-quality products to our customers in a timely manner.

 

Due to the change in our corporate name in September 2003 and expansion of our product categories in October 2003, our ProFlowers brand is our only brand that has received broader recognition by customers who associate it with our www.proflowers.com website and the sale of flowers and floral products. To increase awareness of our new corporate name and brands and our other proposed brands and product offerings, we will need to continue to spend significant amounts on advertising and promotions. These expenditures may not result in a sufficient increase in net sales to cover such advertising and promotional expenses. In addition, even if brand recognition increases, the number of new customers or the number of transactions on our branded websites may not increase. Also, even if the number of new customers increases, those customers may not purchase products through our branded websites on a regular basis.

 

We have historically experienced seasonality in our business, which we expect to continue and which could cause our operating results to fluctuate.

 

We have historically experienced seasonality in our ProFlowers business due to the nature of our products, and we expect this seasonality to continue. Our net sales and earnings are generally lowest in the third calendar quarter, which is our first fiscal quarter. Sales of our products are highly concentrated in the first calendar quarter due to Valentine’s Day, in the second calendar quarter due to Mother’s Day and generally Easter, and in the fourth calendar quarter due to the Thanksgiving and end-of-year holidays. In addition, due to variability in the date for Easter, comparisons of quarterly earnings between years can be impacted since Easter can occur in either the first or second calendar quarters, which are our third and fourth fiscal quarters. In anticipation of increased

 

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sales activity during these periods, we utilize a significant number of temporary employees to supplement our permanent staff. We also increase our inventory levels at our distribution facilities. If net sales during these periods do not meet our expectations, we may not generate sufficient net sales to offset these increased costs and our operating results may suffer.

 

In addition, our business may be adversely affected by the particular day of the week on which certain major holidays fall due to logistical challenges in delivering shipments on the actual date or the dates immediately prior to such holiday.

 

The relatively recent launch of our new branded websites targeting premium meat, seafood and fresh fruit makes it difficult for us to assess the impact of seasonal factors on our business in the future. We expect that our new product categories will also be subject to seasonal fluctuations, reflecting a combination of seasonality trends for the products and services offered by our new branded websites and seasonality patterns affecting Internet use generally. For example, demand for our current and new product offerings is likely to increase during holiday periods, such as Father’s Day and Christmas, while Internet use in general may decline during the summer months. Our results may also be affected by seasonal fluctuations in the products made available to us for sale by participating suppliers. Cyclical variations for new products we plan to offer may either smooth or increase our existing seasonality. Unanticipated fluctuations in seasonality could adversely affect our operating results and cause us to miss our internal and third-party earnings projections, which could cause our stock price to decline.

 

We face intense competition from both traditional and online retail companies with greater brand recognition and resources, which may adversely affect our business.

 

The e-commerce market segments in which we currently compete are intensely competitive, and we have many competitors in different industries. Many of the products we offer can be purchased at supermarkets and warehouse stores as well as specialty markets. Our floral competitors include traditional florists, catalog and online floral providers such as 1-800-FLOWERS and Hallmark Flowers, and floral wire services such as FTD and Teleflora. In the premium meat and seafood category, we believe our competitors include specialty butchers, mail order companies, seafood specialty catalogs and other online meat providers, such as Omaha Steaks Company. We believe competitors in the fresh fruit category include local farmers’ markets and specialty catalog companies, such as Harry & David. Additionally, we compete with specialty food companies and general gift companies.

 

Competition in the e-commerce channel may intensify, especially as we expand into product categories in addition to flowers. The nature of the Internet as an electronic marketplace facilitates competitive entry and comparison shopping and renders it inherently more competitive than conventional retailing formats. This increased competition may reduce our ability to expand our business, and thus reduce our sales and operating profits, or both. Many of our current and potential competitors enjoy substantial competitive advantages, including:

 

    greater name recognition;

 

    a longer operating history;

 

    a more extensive customer base;

 

    broader product and service offerings; and

 

    greater resources for competitive activities, such as sales and marketing, research and development, strategic acquisitions, alliances and joint ventures.

 

As a result, these current and potential competitors may be able to secure merchandise from suppliers on more favorable terms, and may be able to adopt more aggressive pricing policies. Other companies in the retail and e-commerce service industries may enter into business combinations or alliances that strengthen their competitive positions. These business combinations or alliances might prevent them from also entering into

 

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relationships with us or prevent us from taking advantage of such combinations or alliances. They also may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. Intense competition may lead to:

 

    price reductions, decreased net sales and lower profit margins;

 

    loss of market share; or

 

    increased marketing expenditures.

 

Utilization of our deferred tax assets is dependent on future taxable income.

 

We have a federal tax net operating loss carryforwards at June 30, 2005 of approximately $13.9 million, which represents a substantial amount of our deferred tax assets. In calculating our tax provision, and assessing the likelihood that we will be able to utilize the deferred tax assets, we have considered and weighed all of the evidence, both positive and negative, and both objective and subjective. We have factored in the inherent risk of forecasting net sales and expenses over an extended period of time. We have also considered the potential risks associated with our business, as outlined in other risk factors in this report, and have taken into account material permanent differences in the treatment of net sales and expenses for purposes of financial reporting and tax accounting, such as the treatment of stock options, limitation on meals and entertainment and stock-based compensation.

 

Based on information available through our third quarter of fiscal 2004, and sufficient positive evidence, particularly the fact that we reported taxable income for the prior three fiscal years and forecasted future book and tax income, we reversed the valuation allowance during fiscal 2004. Although we anticipate generating future taxable income, we cannot guarantee that we will generate sufficient taxable income to fully utilize our deferred tax assets.

 

Failure to provide our customers with high-quality products and customer service may harm our brand and cause our net sales to decline.

 

We believe that our success in promoting and enhancing our brands will depend on our success in providing our customers high-quality products and a high level of customer service. Product orders placed by our customers are fulfilled by our third-party suppliers. We work with our suppliers to develop best practices for quality assurance; however, we do not directly or constantly control any of our suppliers. If our suppliers do not fulfill orders to our customers’ satisfaction, our customers may not shop with us again. In addition, because we do not have constant, direct control over these third-party suppliers, interruptions or delays in the products they supply may be difficult to remedy in a timely fashion. If any of our suppliers is incapable of or unwilling to fulfill our product orders, we will attempt to ship the products from another source to guarantee right-day delivery; however, we may not be able to ship the products from an alternate source in a timely manner or at all. Furthermore, we depend on our customer service department to respond to our customers should they have questions or problems with their orders. During peak periods, we also rely on temporary employees and outsourced staff to respond to customer inquiries. Temporary employees and outsourced staff may not have the same level of commitment to our customers as our full-time employees. If our customers are dissatisfied with the quality of the products or the customer service they receive, or if we are unable to deliver products to our customers in a timely manner or at all, our customers may stop purchasing products in the related category from us. Also, they may choose not to purchase products from another of our product categories, which could adversely affect our business and results of operations.

 

If the number of customers using our satisfaction guarantee increases, our net income could decrease.

 

We guarantee that all of our flowers will last at least seven days and our plants at least 14 days. We offer our customers a 100% satisfaction guarantee on our floral, meat, seafood and fruit products during the relevant periods. We expect to offer a similar 100% satisfaction guarantee on other products that we may offer in the future. If our customers are not satisfied with the products they receive, we either send them a replacement

 

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product or issue a refund. If a significant number of customers request replacement products or refunds, our net income could decrease and our reputation as a provider of high-quality products could be harmed.

 

We are dependent on our strategic relationships to help promote our branded websites and expand our product offerings; if we fail to maintain or enhance these relationships, our development could be hindered.

 

We believe that our strategic relationships with leading Internet portal companies, other online retailers, radio advertisers and direct marketers are critical to attract customers, facilitate broad market acceptance of our products and brands and enhance our sales and marketing capabilities. For example, 25.5% of our total customer orders placed in fiscal 2005, and 31.5% of our total customer orders placed in fiscal 2004, were generated from customers who linked to our website from websites operated by other retailers or Internet portal companies with whom we have or had a strategic relationship. A failure to maintain existing and to establish additional strategic online relationships that generate a significant amount of traffic from other websites could limit the growth of our business. Establishing and maintaining relationships with leading Internet portal companies, other online retailers, radio advertisers and direct marketers is competitive and expensive. In particular, many Internet portal companies have significantly increased their rates. We may not successfully enter into additional relationships or renew existing ones beyond their current terms. We may also be required to pay significant fees to maintain and expand existing relationships. Further, many Internet portal companies, other online retailers, radio advertisers and direct marketers that we may approach to establish an advertising presence or with whom we already have an existing relationship may also provide advertising services for our competitors. As a result, these companies may be reluctant to enter into, maintain or expand a relationship with us. Our net sales may suffer if we fail to enter into new relationships or maintain or expand existing relationships, or if these relationships do not result in traffic sufficient to justify their costs.

 

In addition, we are subject to many risks beyond our control that influence the success or failure of our strategic partners. For example, traffic to our branded websites could decrease if the traffic to the website of an Internet portal company on which we advertise decreases. Our business could be harmed if any of our strategic partners experience financial or operational difficulties or if they experience other corporate developments that adversely affect their performance under our agreements.

 

If the supply of flowers or any other perishable product we offer for sale becomes limited, the price of these products could rise or these products may be unavailable and our net sales and gross margins could decline.

 

Many factors, such as weather conditions, agricultural limitations and restrictions relating to the management of pests and disease, affect the supply of flowers and the price of our floral products. If the supply of flowers available for sale is limited, prices for flowers could rise, which could cause customer demand for our floral products to be reduced and our net sales and gross margins to decline. Alternatively, we may not be able to obtain high-quality flowers in an amount sufficient to meet customer demand. Even if available, flowers from alternate sources may be of lesser quality and/or may be more expensive than those currently offered by us. We expect that we will encounter similar risks with premium meat, seafood, fresh fruit and other perishable products as we expand our e-commerce platform into these product categories.

 

In the first quarter of fiscal 2006 and in fiscal 2005, 62.3% and 58.4%, respectively, of the flowers we sold were grown by farmers located abroad, primarily in Colombia, Ecuador and Holland, and we expect that this will continue in the future. We also may purchase premium meat, seafood, fresh fruit and other perishable products from suppliers in foreign countries. The availability and price of these products could be affected by a number of other factors affecting foreign suppliers, including:

 

    import duties and quotas;

 

    time-consuming import regulations or controls at airports;

 

    changes in trading status;

 

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    economic uncertainties and currency fluctuations;

 

    changes or uncertainties in oil and fuel prices;

 

    local and regional weather patterns;

 

    foreign government regulations with respect to diseases such as mad cow;

 

    political unrest;

 

    governmental bans or quarantines; or

 

    trade restrictions, including U.S. retaliation against foreign trade practices.

 

System interruptions, natural disasters and other unexpected problems could prevent us from fulfilling orders for our customers.

 

Our computer and telecommunications systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, failure in the Internet backbone service providers or Internet service providers, earthquakes, acts of war or terrorism, acts of God, human error, computer viruses, physical or electronic break-ins and similar events. Any of these events could lead to system interruptions, delays and loss of critical data, and make our websites or toll-free customer service centers inaccessible to our customers or prevent us from efficiently fulfilling orders or providing services to other retailers who rely on our market platform to assist them in operating their online businesses. For instance, in January 2004, a router failure at one of our Internet service providers caused approximately two hours of degraded website response times and availability, and in July 2005, a circuit failure at one of our Internet service providers caused approximately nine minutes of degraded website response times and availability. This effect would be magnified if interruptions were to occur during one of our peak selling periods, such as Valentine’s Day or Mother’s Day. We do not have fully redundant systems in different geographical areas or a formally tested disaster recovery plan. Our business interruption insurance may be inadequate to compensate for all losses that may occur.

 

Despite any precautions we may take, the occurrence of a natural disaster, the closure of a hosting facility we are using without adequate notice for financial reasons or other unanticipated problems could result in lengthy interruptions in our services. In addition, the failure by our hosting facilities to provide our required data communications capacity could result in interruptions in our service. Any slowdown, damage to or failure of our systems could result in interruptions in our service. We cannot assure you that we will adequately, and in a timely manner, implement systems to improve the speed, security and availability of our Internet and telecommunications systems. Frequent or long service delays or interruptions in our service or disruptions during a peak holiday season will reduce our net sales and profits, and our reputation and future net sales and profits will be harmed if our customers believe that our system is unreliable.

 

We may not be able to increase capacity or introduce enhancements to our branded websites in a timely manner or without service interruptions.

 

A key element of our strategy is to generate a high volume of traffic on our branded websites. As traffic on our branded websites grows, we may not be able to accommodate all of the growth in user demand on our branded websites and in our toll-free customer service center. Our inability to add additional hardware and software to upgrade our existing technology or network infrastructure to accommodate in a timely manner increased traffic on our branded websites, in our toll-free customer service centers and increased sales volume, may cause decreased levels of customer service and satisfaction. Failure to implement new systems effectively or within a reasonable period of time could adversely affect our business, results of operations and financial condition.

 

We also intend to introduce additional or enhanced features and services to retain current customers and attract new customers to our branded websites. If we introduce a feature or a service that is not favorably received, our current customers may not use our branded websites as frequently, and we may not be successful in attracting new customers. We may also experience difficulties that could delay or prevent us from introducing

 

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new services and features. Furthermore, these new services or features may contain errors that are discovered only after they are introduced. We may need to significantly modify the design of these services or features to correct errors. If customers encounter difficulty with or do not accept new services or features, our business, results of operations and financial condition could be adversely affected.

 

We rely on suppliers and distribution facilities to fulfill our customer’s orders and to distribute our products into the carrier delivery system.

 

In the future, we may be unable to fulfill our customers’ orders through one or more of our various suppliers or distribution facilities in a timely manner, or at all, due to a number of factors that may affect one or more of such suppliers or distribution facilities, including:

 

    a failure to maintain or renew one or more of our existing lease agreements for any of our company-operated distribution facilities;

 

    a prolonged power or equipment failure;

 

    an employee strike or other labor stoppage;

 

    a disruption in the transportation infrastructure including bridges and roads;

 

    a refrigeration failure; or

 

    a fire, flood, hurricane, tornado or other disaster.

 

In the event that we are unable to fulfill our customers’ orders through one or more of our suppliers or distribution facilities, we will attempt to re-ship the orders from another source to ensure timely delivery. However, we cannot guarantee that our other suppliers and distribution facilities will have the capacity or the variety of flowers to fulfill all orders from a given supplier or distribution facility or that we will be able to deliver the affected orders in a timely manner. In addition, if operations from one or more of our suppliers or distribution facilities become permanently disrupted due to any of the above or other factors, we may not be able to secure a replacement distribution facility in a location on terms acceptable to us or at all. Our business and results of operations could be materially and adversely affected if we experience temporary or permanent disruptions at one or more of our suppliers or distribution facilities.

 

If we fail to protect our intellectual property rights, our ability to compete could be harmed.

 

Protection of our intellectual property is critical to our success. Patent, trademark, copyright and trade secret laws and confidentiality and other contractual provisions afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. We face numerous risks in protecting our intellectual property rights, including the following:

 

    our pending patent applications, copyrights, trademarks, trade secrets and other intellectual property rights may be challenged or invalidated by our competitors;

 

    we only have six U.S. patent applications pending in the United States Patent and Trademark Office and none of the patent applications have yet to issue;

 

    our pending patent applications may not issue, or, if issued, may not provide meaningful protection for related products or proprietary rights;

 

    in the event one or more of our pending patent applications issue into a patent, there may be prior art in existence that the United States Patent and Trademark Office has not considered which may invalidate one or more patent claims;

 

    we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by employees, consultants or advisors;

 

    the laws of foreign countries, including Australia, Brazil, Canada, China, the European Union, India, Japan, Mexico, New Zealand and Switzerland where we have issued or pending trademarks, may not protect our intellectual property rights to the same extent as the laws of the U.S., and mechanisms for enforcement of intellectual property rights may be inadequate in foreign countries;

 

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    our competitors may lawfully develop proprietary software or other technology that competes with our proprietary supply chain technology; and

 

    we may be unable to successfully identify or prosecute unauthorized uses of our proprietary technology.

 

As a result, our means of protecting our intellectual property rights and brands may not be adequate. Furthermore, despite our efforts, third parties may have violated and may in the future violate, or attempt to violate, our intellectual property rights. Infringement claims and lawsuits would likely be expensive to resolve and would require substantial management time and resources. In addition, we have not sought, and do not intend to seek, trademark, patent and other intellectual property protections in most foreign countries. In countries where we do not have such protection, businesses may use our trademarks to sell products or to develop a distribution method that incorporates our patented technology.

 

We may be sued by third parties for alleged infringement of their proprietary rights.

 

Companies that participate in the e-commerce and supply chain management industries or others may hold a large number of patents, patent applications, trademarks and copyrights. Participants in these industries are involved in litigation based on allegations of patent infringement or other violations of intellectual property rights. Intellectual property disputes frequently involve highly complex and costly technical or scientific matters, and each party generally has the right to seek a trial by jury which adds additional costs and uncertainty. Accordingly, intellectual property contests, with or without merit, could be costly and time-consuming to litigate or settle, and could divert management’s attention from executing our business plan. In addition, our distribution technology may not be able to withstand any third-party claims against its use. If we were unable to obtain any necessary license following a determination of infringement or an adverse determination in litigation or in interference or other administrative proceedings, we may need to redesign some of our distribution technology to avoid infringing a third-party’s patent and could be required to temporarily or permanently discontinue using the related aspect of our technology.

 

Recently enacted and proposed changes in securities laws and regulations are likely to increase our costs.

 

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, will increase our expenses as we evaluate the implications of new rules and devote resources to respond to the new requirements. The Sarbanes-Oxley Act mandates, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations. In particular, we have incurred and expect to incur additional administrative expense and have devoted and expect to continue to devote substantial management time as we have implemented controls and procedures required by Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our independent registered public accounting firm to attest to, our internal control over financial reporting. Although in connection with this report we have not identified any material weaknesses in our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act, any significant deficiencies that are not adequately addressed could lead to material weaknesses in our internal control over financial reporting in the future. If our internal control over financial reporting is determined to be ineffective, investors could lose confidence in the reliability of our financial reporting, which could adversely affect our stock price.

 

In addition, The Nasdaq National Market, on which our common stock is listed, has also adopted comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased and will continue to increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, which could harm our results of operations and divert management’s attention from business operations. We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance in the future, and we may be required to accept reduced coverage or incur

 

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substantially higher costs to obtain coverage. Further, our directors and executive officers could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficultly attracting and retaining qualified directors and executive officers, which would adversely affect our business.

 

Current and future governmental and industry regulations may significantly limit our business opportunities.

 

New laws or regulations may be enacted with respect to the Internet or existing laws may be applied or interpreted to apply to the Internet, which may decrease the growth in the use of the Internet or our branded websites. As use of the Internet continues to evolve, we expect that there will be an increasing number of laws and regulations pertaining to the Internet in the U.S. and throughout the world. These laws and regulations may relate to liability for information received from or transmitted over the Internet, online content regulation, user privacy, taxation and quality of products and services sold over the Internet. Moreover, the applicability to the Internet of existing laws governing intellectual property ownership and infringement, copyright, trademark, trade secret, obscenity, libel, employment, personal privacy and other issues is uncertain and developing. Further, the growth and development of online commerce may prompt calls for more stringent consumer protection laws, both in the U.S. and abroad. We also may be subject to regulation not specifically related to the Internet, including laws affecting direct marketers and advertisers. The adoption of or modification of laws applicable to the Internet could affect our ability to market our products, decrease the demand for our products, increase our costs or otherwise adversely affect our business.

 

We are affected by regulations applicable to the importation of flowers and the sale and handling of food items.

 

Our importation of certain flower offerings and our sale and handling of premium meat, seafood and fresh fruit offerings subject us to various federal, state and local government regulations, including regulations imposed by the United States Food & Drug Administration, or FDA, the United States Department of Labor, Occupational Safety and Health Administration, or OSHA, the United States Department of Agriculture, or USDA, and Animal and Plant Health Inspection Service, or APHIS. We have designed our importation procedures and our food handling operations to comply with such regulations. However, the FDA, OSHA, USDA, APHIS or another federal, state or local food regulatory authority may require changes to our importation procedures and food sales and handling operations. We may not be able to make the requested governmental changes or obtain any required permits, licenses or approvals in a timely manner, or at all. Failure to make requested changes or to obtain or maintain a required permit, license or approval could cause us to incur substantial compliance costs and delay the availability of, or cancel, certain product offerings. In addition, any inquiry or investigation from a regulatory authority could have a negative impact on our reputation. Any of these events would harm our business and adversely affect our results of operations.

 

Various legal rules and regulations related to the collection, dissemination and security of personal information may affect our ability to solicit our customers and potential customers with emails or telephone calls and to collect or disseminate personal data about our customers.

 

A growing body of laws designed to protect the privacy of personally identifiable information as well as to protect against its misuse may adversely affect the growth of our business and our marketing efforts. These laws include the Federal Trade Commission Act, the Children’s Online Privacy Protection Act and Federal Trade Commission, or FTC, regulations implementing that act, the Fair Credit Reporting Act, the Gramm Leach Bliley Act and related regulations, California’s Online Privacy Protection Act of 2003 as well as other legal federal, state, and local provisions. The FTC has the authority to protect against the misuse of consumer information by targeting companies that collect, disseminate or maintain personal information in an unfair or deceptive manner, as well as companies that fail to notify parents and obtain parental consent before collecting information from children. The FTC has conducted dozens of investigations into the privacy and security practices of companies that collect information on the Internet. The provisions of these laws and related regulations are complicated, and we do not have extensive experience in complying with them. The evolving nature of the FTC’s and other governmental bodies’ enforcement efforts, and the possibility of new laws in this area, may adversely affect our

 

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ability to collect and disseminate or share demographic and personal information from users and our ability to email or telephone users, all of which could adversely affect our marketing efforts and business. In addition, even technical violations of these laws can result in significant penalties. Given the volume of transactions we process as a consumer-focused e-commerce company, any violations of applicable privacy laws could expose us to significant liability.

 

Our branded websites use various “cookies” without the customer’s knowledge or consent. These cookies may or may not be saved on customer’s hard drives. We use cookies for a variety of reasons, including the collection of data derived from the customer’s Internet activity. Most currently available web browsers allow users to remove cookies at any time or to prevent cookies from being stored on their hard drive. Some commentators, privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies or other data collecting tools. Any reduction or limitation in the use of cookies or other data collecting tools could limit the effectiveness of our sales and marketing efforts. We could incur expenses if new regulations concerning the use of personal information are introduced or if our privacy practices are investigated.

 

We depend on continued use of the Internet and growth of the online perishables retail market.

 

Our net sales may not grow if the Internet does not continue to grow as an accepted medium for commerce in flowers and other perishable product categories. Consumer use of the Internet as a medium for commerce, and especially commerce in perishable products, is a recent phenomenon that is subject to a level of uncertainty. A number of factors may inhibit Internet usage, including:

 

    inadequate network infrastructure;

 

    consumer concerns for Internet privacy and security;

 

    inconsistent quality of service;

 

    lack of availability of cost-effective, high-speed service; and

 

    consumer concerns over purchasing perishable goods over the Internet.

 

If use of the Internet as a medium for commerce in perishable products does not continue to grow, or grows at a slower rate than we anticipate, our sales will be lower than expected and our business will be harmed.

 

Our business would be injured by extensive credit card fraud.

 

Our general and administrative expense would increase if we experience significant credit card fraud or fraud with respect to our bill-me-later functionality, a third party payment option similar to traditional credit cards. A failure to adequately control fraudulent credit card transactions or bill-me-later transactions would increase our general and administrative expense because we do not carry insurance against this risk. We have developed technology to help detect the fraudulent use of credit card information. Nonetheless, to date, we have suffered losses as a result of orders placed with fraudulent credit card data even though the associated financial institution or bill-me-later service provider approved payment of the orders. Under current credit card practices, we are liable for fraudulent credit card transactions if we do not obtain a cardholder’s signature.

 

Online security breaches could harm our business.

 

The secure transmission of confidential information over the Internet is essential in maintaining consumer confidence in our branded websites. Even occasional security breaches of our system or other Internet-based systems could significantly harm our business and damage our reputation. Any penetration of our network security or other misappropriation of our customer’s personal information could subject us to potential liability. We may be subject to claims based on unauthorized purchases with credit card information, or aiding and abetting identity theft or other similar fraud claims. Claims could also be based on other misuses of personal information, such as for unauthorized marketing purposes. These claims could result in litigation and financial liability. We rely on licensed encryption and authentication technology to effect the secure transmission of

 

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confidential information, including credit card numbers. It is possible that advances in computer capabilities, new discoveries or other developments could result in a compromise or breach of the technology that we use to protect customer transaction data.

 

We may incur substantial expense to protect against and remedy security breaches and their consequences. A party that is able to circumvent our security systems could steal proprietary information or cause interruptions in our operations. Our insurance policies’ limits may not be adequate to reimburse us for losses caused by security breaches. We cannot guarantee that our security measures will prevent security breaches.

 

Consumer spending on flowers and other perishable products we sell or intend to sell may vary with general economic conditions in the U.S.

 

Negative trends in the general economy, including trends resulting from actual or threatened military action by the U.S. and threats of terrorist attacks on the U.S. and abroad, could cause a decrease in consumer spending on flowers, premium meat, seafood, fresh fruit and perishable products in general. Also, any reduction in consumer confidence or disposable income in general may affect the demand for our products. If general economic conditions do not improve or deteriorate further and our customers have less disposable income, consumers may spend less on our products and our quarterly operating results may suffer.

 

We may not successfully address problems encountered in connection with any future acquisitions.

 

In December 1999, we purchased Flower Farm Direct, Inc. Subsequently, we amortized and wrote off approximately $9.0 million of goodwill related to the acquisition. We expect to continue to consider opportunities to acquire or make investments in other technologies, products and businesses that could enhance our technical capabilities, complement our current products and services or expand the breadth of our markets or customer base. We have limited experience in acquiring other businesses and technologies. Potential and completed acquisitions and strategic investments involve numerous risks, including:

 

    problems assimilating the purchased technologies, products or business operations;

 

    problems maintaining uniform standards, procedures, controls and policies;

 

    unanticipated costs associated with the acquisition, including accounting charges and transaction expenses;

 

    diversion of management’s attention from our core business;

 

    adverse effects on existing business relationships with suppliers and customers;

 

    risks associated with entering markets in which we have no or limited prior experience; and

 

    potential loss of key employees of acquired organizations.

 

If we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our business may be disrupted, and our operating results may suffer. In addition, if we finance acquisitions by issuing equity or convertible debt securities, our existing stockholders would be diluted.

 

We may have difficulty managing any growth that we might experience.

 

We expect to continue to experience growth in the scope of our operations and the number of our employees. If this growth continues, it will place a significant strain on our management team and on our operational and financial systems, procedures and controls. Our future success will depend in part on the ability of our management team to manage any growth effectively. This will require our management to:

 

    maintain our cost structure at an appropriate level based on the net sales we generate;

 

    manage multiple, concurrent development projects;

 

    hire and train additional personnel;

 

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    implement and improve our operational and financial systems, procedures and controls; and

 

    manage operations in multiple time zones.

 

Any failure to successfully manage our growth could distract management’s attention, and result in our failure to execute our business plan.

 

If we are required to collect sales and use taxes on the products we sell in additional jurisdictions, we may be subject to liability for past sales and our future sales may decrease.

 

In accordance with current industry practice and our interpretation of current law, as of September 30, 2005, we collected sales and use taxes or other such taxes with respect to shipments of goods into the 16 states in which we have sufficient operations to require us to collect and pay taxes. The operation of our distribution facilities, the operations of any future distribution facilities and other aspects of our evolving business may, however, result in increased sales and use tax obligations. Some states have imposed, sought or are now seeking to impose taxes on Internet access, and multiple or discriminatory taxes on electronic commerce. The imposition of these various taxes may increase the tax collection obligations on companies that engage in electronic commerce as we do.

 

Federal legislation limits the imposition of U.S. state and local taxes on Internet-related sales. In 1998, Congress passed the Internet Tax Freedom Act, which placed a moratorium on state and local taxes on Internet access, unless such tax was already imposed prior to October 1, 1998, and on multiple or discriminatory taxes on electronic commerce. The original moratorium expired in November 2003 while Congress debated several proposals to retain the moratorium. On December 3, 2004, Congress passed the Internet Tax Nondiscrimination Act, which retroactively extended the moratorium on these taxes from November 1, 2003 until November 1, 2007 and also requires state and local governments that are currently imposing such taxes to eliminate them by specified dates.

 

When the moratorium expires on November 1, 2007, state and local governments may be free once again to impose new taxes on Internet-related sales. If Congress does not extend the law as they currently have done, or chooses to lift the moratorium prematurely, we may be required to collect and pay any new taxes imposed.

 

We are dependent on our management team and key employees, and the loss of any of them could harm our business.

 

Our success depends, in part, upon the continued availability and contributions of our senior management team, particularly William Strauss, our chief executive officer, and Abraham Wynperle, our president and chief operating officer. Important factors that could cause the loss of key personnel include:

 

    members of our management team may terminate their employment with us at any time;

 

    we do not maintain key-man life insurance on any of our employees;

 

    significant portions of the stock options held by the members of our management team are vested; and

 

    many of the stock options held by our executive officers provide for accelerated vesting in the event of a sale or change of control of our company.

 

The loss of key personnel or an inability to attract qualified personnel in a timely manner could slow our technology and product development and harm our ability to execute our business plan.

 

Our accounting and financial system is not integrated with our transaction processing system.

 

We use an internally developed system for substantially all aspects of transaction processing, including order management, credit card processing and shipping. Our accounting and financial system is purchased from a third-party. Because our current transaction processing system, which provides frequent operational reports, is not integrated with our accounting and financial system, we must manually input data in order to prepare information for accounting and financial reporting. This manual input of data may make it more difficult for management to obtain accurate financial statements and reporting information on a timely basis. We intend to

 

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increase the integration between our transaction processing and accounting systems. We cannot guarantee that we will complete this increased integration in a fast and effective manner. Any inability to do so may have a material adverse effect on our business, financial condition and results of operations.

 

If third parties acquire rights to use similar domain names or phone numbers or if we lose the right to use our domain names or phone numbers, our brands may be damaged and we may lose sales.

 

Our Internet domain names are an important aspect of our brand recognition. We cannot practically acquire rights to all domain names similar to www.providecommerce.com, www.proflowers.com, www.uptownprime.com, www.flowerfarm.com or www.cherrymoonfarms.com. If third parties obtain rights to similar domain names, these third parties may confuse our customers and cause our customers to inadvertently place orders with these third parties, which would result in lost sales for us and could damage our brand.

 

The phone number that spells 1-888-FRESHEST is also important to our brand and business. While we have obtained the right to use the phone numbers 1-888-FRESHEST, 1-800-FRESHEST and 1-800-PROFLOW, as well as common toll-free “FRESHEST” and “PROFLOW” misdials, we may not be able to obtain rights to use the FRESHEST and PROFLOW phone numbers as new toll-free prefixes are issued, or the rights to all similar and potentially confusing numbers. If third parties obtain the phone number which spells “FRESHEST” or “PROFLOW” with a different prefix, these parties may also confuse our customers and impede our customer service efforts, causing lost sales and potential damage to our brands. In addition, under applicable Federal Communication Commission, or FCC, rules, ownership rights to phone numbers cannot be acquired. Accordingly, the FCC may rescind our right to use any of its phone numbers, including 1-888-FRESHEST and 1-800-PROFLOW.

 

If our third-party technology providers do not adequately maintain our telephone service, we may experience system failures and our business may suffer.

 

We are largely dependent on AT&T and SBC Pacific Bell to provide telephone service to our customer service centers. If AT&T or SBC Pacific Bell experience system failures or fail to adequately maintain our systems, we would experience interruptions and our customers might not continue to utilize our services. Frequent or long system failures or interruptions in our service or disruptions during a peak holiday season could materially harm our business and results of operations.

 

If we lose our telephone service, we will be unable to operate a significant portion of our customer service. Our future success depends upon these third-party relationships because we do not have the resources to maintain telephone services without these or other third parties. Failure to maintain these relationships or replace them on financially attractive terms may disrupt our operations or require us to incur significant unanticipated costs.

 

Product liability claims may subject us to increased costs.

 

Several of the products we sell and intend to sell, including perishable food products, may expose us to product liability claims in the event that the use or consumption of these products results in personal injury. We may incur significant costs in defense of product liability claims. Product liability claims often create negative publicity, which could materially damage our reputation and our brands. Although we maintain insurance against product liability claims, our coverage may be inadequate to cover any liabilities we may incur.

 

Health concerns relating to the consumption of beef, fruit or other food products could have a negative impact on our premium meat, seafood fruit and related product offerings and could negatively impact our results of operations.

 

The success of our premium meat and seafood website and other planned perishable product offerings could be affected by health concerns related to the consumption of beef, certain seafood, or fruit or negative publicity concerning food quality, illness and injury generally, such as negative publicity concerning e-coli, “mad cow” or “foot-and-mouth” disease. This negative publicity may adversely affect demand for our premium meat, seafood, or fruit products which could materially harm our business and results of operations.

 

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Risks Related to the Securities Markets

 

We expect that the price of our common stock will fluctuate substantially.

 

The market price of our common stock has been, and is likely to continue to be, highly volatile. The market price may fluctuate substantially due to many factors, including:

 

    actual or anticipated fluctuations in our results of operations;

 

    changes in securities analysts’ expectations or our failure to meet those expectations;

 

    announcements of significant contracts by us or our competitors;

 

    changes in our pricing policies or the pricing policies of our competitors;

 

    inability to maintain our current relationship with our delivery carriers, FedEx and UPS;

 

    developments with respect to intellectual property rights;

 

    the introduction of new products or product enhancements by us or our competitors;

 

    the commencement of or our involvement in litigation;

 

    our sale of common stock or other securities in the future;

 

    conditions and trends in the e-commerce industry;

 

    changes in market valuation or earnings of our competitors;

 

    the trading volume of our common stock;

 

    changes in the estimation of the future size and growth rate of our markets; and

 

    general economic conditions.

 

In addition, the stock market in general, and the Nasdaq National Market and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of e-commerce companies have been particularly volatile, including our stock price since our initial public offering in December 2003. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class-action litigation has often been instituted against that company. Such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources.

 

In May 2005, our board of directors authorized a stock repurchase program of up to $25 million of our common stock in open market and negotiated purchases over a period of one year. Through September 30, 2005, we had repurchased 498,200 shares of our common stock in open market transactions at varying market prices. Our prior repurchases and any repurchases we may make in the future may not prove to be at optimal market prices and our use of cash for the stock repurchase program may not prove to be the best use of our cash resources.

 

Because of the significant stock ownership of our largest stockholder, our largest stockholder will be able to exert significant influence over us and our significant corporate decisions.

 

As of September 30, 2005, our largest stockholder and persons affiliated with our largest stockholder beneficially owned 33.7% of our outstanding common stock. In addition, as of the same date, our executive officers, directors and other stockholders holding more than 5% of our outstanding capital stock and their affiliates, in the aggregate, beneficially owned approximately 60.8% of our outstanding common stock. These persons, acting together, may have the ability to control our management and affairs. Our majority stockholder and persons affiliated with our majority stockholder will have the ability to exert significant influence over the

 

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outcome of all matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. This concentration of ownership may harm the market price of our common stock by, among other things:

 

    delaying, deferring or preventing a change in control of our company;

 

    impeding a merger, consolidation, takeover or other business combination involving our company;

 

    causing us to enter into transactions or agreements that are not in the best interests of all stockholders; or

 

    discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of our company.

 

Future sales of our common stock may depress our stock price.

 

If our common stockholders sell substantial amounts of common stock in the public market, or if the market perceives that these sales may occur, the market price of our common stock may decline. Certain of our directors and executive officers, including our chairman, our chief executive officer and our president and chief operating officer, have in the past established, and may in the future establish, programmed selling plans under Rule 10b5-1 for the purpose of effecting sales of common stock. We have also registered all shares of common stock that we may issue under our employee benefits plans. As a result, these shares can be freely sold in the public market upon issuance, subject to restrictions under the securities laws. In addition, the holders of up to 5,419,302 shares of common stock, based upon shares outstanding as of September 30, 2005 and assuming exercise of such holders’ outstanding options and warrants, have rights, subject to some conditions, to require us to file registration statements covering the resale of their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. These registration rights of our stockholders could impair our ability to raise capital by depressing the price at which we could sell our common stock.

 

An active trading market for our common stock may not be sufficiently developed.

 

Prior to our initial public offering in December 2003, there was no public market for our common stock. An active trading market may not be sufficiently developed or sustained. The lack of an active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. The lack of an active market may also reduce the fair market value of your shares. An inactive market may also impair our ability to raise capital by selling shares of capital stock and may impair our ability to acquire other companies or technologies by using our shares as consideration.

 

Our future capital needs are uncertain and we may need to raise additional funds in the future, and such funds may not be available on acceptable terms or at all.

 

Our capital requirements will depend on many factors, including:

 

    changes in our operating plan;

 

    lower than anticipated net sales;

 

    increased expenses in new technology and research and development projects;

 

    the number and timing of acquisitions and other strategic transactions; and

 

    the costs associated with our expansion, if any.

 

Our existing sources of cash and cash flows, may not be sufficient to fund our activities. As a result, we may need to raise additional funds, and such funds may not be available on favorable terms, or at all. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products and execute our business plan, take advantage of future opportunities, or respond to competitive pressures or unanticipated customer requirements. This may materially harm our business, results of operations and financial condition.

 

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Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market price of our stock.

 

Our amended and restated certificate of incorporation and restated bylaws contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. Some of these provisions:

 

    authorize the issuance of preferred stock which can be created and issued by the board of directors without prior stockholder approval, with rights senior to those of our common stock;

 

    prohibit stockholders from removing directors without cause, calling special stockholder meetings or taking action by written consent;

 

    limit stockholders from filling board vacancies; and

 

    require advance written notice of stockholder proposals and director nominations.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk represents the risk of loss arising from adverse changes in market rates and foreign exchange rates. At September 30, 2005, we did not have any outstanding bank debt; however, the amount of outstanding debt or liabilities related to benefit plans may fluctuate at any time and we may from time to time be subject to market risk. We do not believe that a change of 100 basis points in interest rates would have a material effect on our results of operations or financial condition. We derive substantially all of our net sales from sales within the U.S. We have business relationships with foreign growers and other vendors. Approximately $108,000 or 80.1% of total payments to these foreign growers and vendors for the three months ended September 30, 2005 was made in U.S. dollars. Although transactions in foreign currencies represent approximately 19.9% of total payments to foreign vendors, the amount is less than 1% of total payments to all vendors and suppliers. Since transactions in foreign currencies are immaterial to us as a whole, we do not consider it necessary to hedge against currency risk at this time.

 

ITEM 4. CONTROLS AND PROCEDURES

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on their evaluation, our chief executive officer and principal financial officer concluded that our disclosure controls and procedures were (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) effective at the reasonable assurance level to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure.

 

There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. Legal Proceedings

 

On August 23, 2005, Florists’ Transworld Delivery, Inc. (FTD) filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division against us, alleging claims for unfair competition by false advertising, deceptive trade practices and intentional interference with prospective economic advantage. The claims relate to our print and radio advertising. FTD seeks injunctive relief and monetary damages, including punitive damages and attorneys’ fees and costs. On September 13, 2005, we filed our answer and counterclaim. The response to the counterclaim was filed by FTD on October 4, 2005.

 

On October 4, 2005, an action was filed on Los Angeles County Superior Court, entitled Theodore G. Phelps, individually and on behalf of others similarly situated v. Provide Commerce, Inc., et al., Case No. BC340863. The action alleges causes of action for unfair competition, false advertising and breach of warranty relating to our print and radio advertising. The plaintiff seeks to certify the case as a California and nationwide class consisting of “all persons residing in the U.S. who purchased [the Company’s] products during the four year period prior to the filing of the lawsuit to the date of judgment in this action.” The plaintiff seeks injunctive relief, restitution, money damages and attorneys’ fees.

 

We believe that each of these lawsuits is without merit and intend to vigorously defend against each of such lawsuits. Due to the uncertainty of the ultimate outcome of these matters, the impact on future financial results is not subject to reasonable estimates.

 

As of October 31, 2005, we were not a party to any other material legal proceedings that management believes would adversely affect our business. We may, however, become subject to lawsuits in the ordinary course of business.

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Use of Proceeds

 

Our initial public offering of common stock, $0.001 par value, was effected through a Registration Statement on Form S-1 (File No. 333-109009) that was declared effective by the Securities and Exchange Commission on December 16, 2003. The net offering proceeds to us, after deducting underwriting discounts and commissions and estimated offering expenses, were approximately $34.8 million. As of September 30, 2005, we have not used any of the net proceeds from the offering. We intend to use the net proceeds from the offering for: (i) sales and marketing activities; (ii) promotion of existing and future product categories; and (iii) general corporate purposes. In addition, we may use a portion of the net proceeds to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. We have no commitments with respect to any acquisition or investment.

 

The amounts actually expended for each of the purposes listed above and the timing of our actual expenditures will depend on numerous factors, including the status of our efforts to increase our number of relationships with other retailers to use our market platform, sales and marketing activities, technological advances, amount of cash generated or used by our operations and competition. We have not determined the amount or timing of expenditures in the areas listed above and will retain broad discretion in the allocation and use of the net proceeds. Pending the uses described above, we have invested the net proceeds in short-term, interest-bearing, investment-grade securities.

 

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Issuer Purchases of Equity Securities

 

On May 3, 2005, we announced that our board of directors authorized a stock repurchase program under Rule 10b-18 of the Exchange Act of up to $25 million of shares of our common stock in open market and negotiated purchases over a period of one year. The following table provides information regarding our stock repurchases in the quarter ended September 30, 2005:

 

Month


   Total Number of
Shares
Purchased
During Month(1)


   Average
Price Paid Per
Share(2)


   Cumulative
Number of Shares
Purchased as Part
of Publicly
Announced Plan


   Maximum Dollar Value
of Shares That May
Yet Be Purchased
Under the Plan(3)


July 2005

   —        —      408,500    $ 16,151,264

August 2005

   25,000    $ 25.23    433,500    $ 15,520,549

September 2005

   64,700    $ 24.95    498,200    $ 14,536,741
    
                  

Total

   89,700                   
    
                  

(1) The purchases were made in open-market transactions.
(2) Excludes commissions paid, if any, related to the share repurchase transactions.
(3) Represents the difference between the $25,000,000 of share repurchases authorized by our board of directors and the value of the shares repurchased from May 2005 through the indicated month.

 

ITEM 3. Defaults Upon Senior Securities

 

None.

 

ITEM 4. Submission of Matters to a Vote of Security Holders

 

None.

 

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Table of Contents
ITEM 5. Other Information

 

None.

 

ITEM 6. Exhibits

 

Exhibit 3.1(1)   Amended and Restated Certificate of Incorporation .
Exhibit 3.2(1)   Bylaws.
Exhibit 4.1   Reference is made to exhibits 3.1 and 3.2.
Exhibit 4.2(1)   Form of Common Stock Certificate.
Exhibit 10.25(2)   Third Amendment to Employment Agreement, dated December 17, 1999, between us and Abraham Wynperle, dated September 9, 2005.
Exhibit 10.30(2)   Second Amendment to Employment Agreement, dated September 9, 2005, between us and William Strauss.
Exhibit 10.40   Employment Agreement, dated September 12, 2005, between us and W. Eric Carlborg.
Exhibit 31.1   Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2   Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32*   Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to the Registration Statement on Form S-1 (No. 333-109009) filed on September 22, 2003, as amended.
(2) Incorporated by reference to the Annual Report on Form 10-K for the fiscal year ended June 30, 2005.
* These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Provide Commerce, Inc., whether made before or after the date hereof, regardless of any general incorporate language in such filing.

 

42


Table of Contents

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Provide Commerce, Inc.

 

Date: November 9, 2005   By:   /S/ W. ERIC CARLBORG        
       

W. Eric Carlborg

Chief Financial Officer

 

43


Dates Referenced Herein   and   Documents Incorporated by Reference

This ‘10-Q’ Filing    Date    Other Filings
11/1/07
6/30/06
Filed on:11/9/054,  8-K,  DEF 14A
10/31/05
10/4/054
For Period End:9/30/054
9/13/0510-K,  4
9/12/054,  8-K
9/9/05
8/23/05
7/1/054
6/30/0510-K,  4,  4/A
5/3/054,  4/A,  8-K
12/3/044
9/30/0410-Q,  4
12/22/034
12/16/033,  3/A,  4,  4/A
11/1/03
9/22/03S-1
7/1/02
12/17/99
10/1/98
2/6/98
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