(IDEX Online) - There’s an old retail adage:  “Happy customers are your best advertisement.”  That seems to be Blue Nile’s mantra, and it is working.

 

Not only is the company expanding its bridal business – mostly diamond engagement rings – but its repeat business – primarily fashion jewelry – is growing at an above average rate.  For its first quarter ended March 2011, Blue Nile management said its non-engagement jewelry business grew more rapidly than its engagement and bridal business. 

 

Here’s what this means:  bridal customers and their friends are returning to Blue Nile for their post-wedding fashion jewelry needs.  Further, bridal customers are also one of the best sources for spreading the word to new customers, according to Blue Nile. 

 

While Blue Nile has become a major online source for engagement jewelry for consumers – this category represents nearly 70% of the company’s sales – its goal is to increase non-engagement jewelry sales to 50% of revenues from the current level of 30%.  Clearly, this will largely occur by transitioning its bridal customers to fashion jewelry customers. 

 

First Quarter Financial Results Solid

Blue Nile posted solid first quarter results:

 

·        Total sales grew by 8.3% to $80.2 million, the largest first quarter in the company’s history. 

 

o       International sales rose by a dramatic 28.1% on a constant currency basis (+34% on a reported basis due to a weakening U.S. dollar during the quarter).  This unusually strong sales increase reflects gains typical of early-stage growth.  International sales were $12.9 million in the first calendar quarter of 2011.  

 

o       U.S. sales rose by 4.3% to $67.3 million.  While this was a solid gain, it was below the U.S. jewelry industry’s first (calendar) quarter gain of 5.5%, and it was below specialty jewelers’ first quarter sales gain of 7.6%, though we expect that gain to be revised downward over the coming months.

 

o       Blue Nile’s pretax profit fell by 2.1%, and its after-tax profit rose by a miniscule 1.4% due to a slight decline in the tax rate.  Despite a revenue gain of over 8%, profits were flat due to a slightly lower gross margin and a slightly higher operating expense ratio.  Further, January sales were particularly soft, so the sales pick-up in February and March were insufficient to leverage relatively fixed costs in the quarter. 

 

The table below summarizes Blue Nile’s first quarter results.

 

 

First Quarter Highlights

The following are highlights from Blue Nile’s first quarter financial results.

 

·        After a disappointing January, Blue Nile management said they increased marketing efforts and expanded the company’s product offerings.  This, coupled with a more optimistic consumer, helped boost sales for the balance of the first quarter. 

 

·        Among engagement and bridal jewelry, Blue Nile noted that diamond engagement ring sales with a retail price of $25,000 and higher set a new quarterly sales record for the company.  This was the fastest growing bridal category for the company.  However, we note that the company’s average ticket for a diamond engagement ring remains close to $6,000, despite a sales spike in very high-priced rings. 

 

·        Non-engagement jewelry was the fastest growing overall category, with the greatest sales increases at high-end price points.  The three non-engagement jewelry categories with the greatest growth were 1) colored gemstone jewelry; 2) pearl jewelry; and 3) sterling silver jewelry.  Clearly, these categories carry much lower retail price points than engagement jewelry, so unit sales growth was exceptionally strong. 

 

·        In international markets, sales in the United Kingdom and Europe were very strong.  Further, the company’s Chinese language website is showing early signs of success. 

 

·        Management noted that the Royal Wedding – Prince William and Princess Kate of England – helped build customer traffic, especially for jewelry with sapphire stones. 

 

·        Blue Nile management said that pre-Mother’s Day demand was strong, but it has not released results for the full Mother’s Day selling period.  It noted that most of the Mother’s Day demand was concentrated in the sub-$500 retail price range.  For most mall mass market jewelers, $100 is the key retail price point for Mother’s Day jewelry. 

 

·        During the first quarter, Blue Nile management “deepened its connection” with its customers by introducing new mobile applications to allow consumers to view the Blue Nile website.  Further, it introduced new ways to pay for merchandise.  Finally, for international customers, they may now pay for goods in local currency. 

 

·        Blue Nile’s marketing spend in the first quarter was in the normal range of 4-5% of sales (it was 5.2% of sales in the fourth quarter of 2010, but has averaged closer to 4% on an annual basis).  Most U.S. specialty jewelers spend just under 4% of sales on advertising, so Blue Nile’s expenditures are slightly above the norm for specialty jewelers.  

 

·        Blue Nile’s gross margin slipped modestly to 21.1% from last year’s 21.3%.  Management cited three significantly higher costs which were affecting their business:  1) higher precious metals costs; 2) higher polished diamond prices; and 3) higher fuel costs (related to shipping and transportation). 

In particular, the increase in diamond costs was related to a greater sales mix of high-value diamonds which carry a lower gross margin.  Further, because Blue Nile does not maintain an inventory of diamonds, it must buy diamonds in the marketplace at current prices (essentially, it is buying diamonds on the spot market).  Polished diamond prices have been rising substantially, so Blue Nile’s diamond costs are rising much faster than most store-based jewelers’ diamond costs.  Store-based jewelers turn their inventory only about once a year, so those merchants are still selling from year-old stock of low-cost diamonds. 

The following table illustrates that Blue Nile had virtually no diamonds in its inventory at the end of the first quarter.  These ratios were about the same at the end of the most recent financial year. 

 

·        Operating expenses rose to 16.7% of revenues from last year’s 16.5% due to costs related to moving into a new headquarters building, product development and marketing initiatives, and personnel costs. 

 

Blue Nile Outlook

Blue Nile’s future looks bright, in our opinion.  The following are some initiatives which management recently disclosed.

 

·        Blue Nile plans to drive diamond engagement ring sales, since this represents the initial purchase of most consumers.  This is the beginning of a lifetime relationship between the shopper and the jeweler.  It plans to drive this business by:

o       Offering more metal choices for engagement rings.

o       Increasing the number of choices at opening price points.

o       Offering more new, fashionable styles.

 

·        The company plans to drive its non-engagement business through several initiatives, including the following:

o       Building repeat business from its existing customer base.

o       Enhancing and broadening its merchandise line.

o       Developing new products.

§         In the next few months, Blue Nile management plans its most aggressive non-engagement jewelry launch in its corporate history.  While management did not give many details, it noted that most of the new introductions would be much more fashion-forward than the company’s current merchandise line-up.  Historically, management has kept styles fairly conservative and traditional; we sense that is about to change. 

 

·        The company’s international business offers much opportunity.  We’d estimate that its international business is mostly diamond engagement rings – perhaps 85% or more of sales – since this is a new, immature business.  The diamond engagement ring business is important because it can build long term customer loyalty, but it comes at a price:  it is a relatively low margin business.  As this business matures, international sales will likely consist of more non-engagement jewelry; while price points are lower, margins are notably higher than the engagement ring business.  In short, we would expect Blue Nile’s long term gross margin to rise slowly, as more of its business consists of non-engagement sales, both domestically and internationally. 

 

·        For the full year, the company is expecting a double-digit sales increase and a double-digit profit gain.  For the second quarter ended June 2011, we look for a sales increase of 8-10% over the same period in 2010.  If the company achieves this level of sales – both for the second quarter and full year – it will take market share from other jewelers, in our opinion.  We expect total U.S. jewelry industry sales to grow by perhaps 4-5% this year.