When Blue Nile announced its financial results for the three-month period ended June, it became clear that the company has put additional pricing and market share pressure on store-based jewelers by reducing diamond jewelry prices even further. Its second quarter gross margin plunged like the neckline of Jennifer Lopez’s blouse – from 22.8 percent last year to 19.9 percent this year. And, more startling, Blue Nile’s sales rose like a rocket in the quarter – up 30 percent, far ahead of the 7.5 percent increase for total jewelry industry sales.

 

Slashing prices is a time-honored technique for boosting sales, but lately many store-based jewelers say that their price-based promotions have been distinctly unsuccessful.

 

Despite its relatively small size – an estimated $250 million in sales this year or about 0.4 percent market share – Blue Nile and other online jewelry retailers are not only putting pricing pressure on store-based retailers, but their online financial model is also causing traditional jewelers to re-think their business model.

 

Online Jewelers Sell for Less

Store-based jewelers have long recognized that online jewelers sell the same diamonds and jewelry for a much lower retail price. As a result of selling goods for lower prices, the typical online jewelry retailer has traditionally generated a gross margin (revenues less cost of goods sold) in the 25-30 percent range, or about half of the gross margin generated by most store-based retailers. Because online jewelers have an economic model with a much lower operating cost base, they can sell for less and still post bottom-line margins that are at or above store-based retailers’ bottom-line margins.

 

As a result of much lower online prices for jewelry, Internet-based jewelers have made significant market share inroads. Currently, U.S. online jewelry sales represent just over 3 percent of total jewelry sales; this is well above the 2 percent or so for all categories of retail goods in America.

 

The graph below summarizes sales trends for Internet jewelers for the second quarter ended June 2006. Except for Odimo, which sold off a large portion of its revenue-producing business – diamond.com, all publicly held online jewelers posted dramatically greater sales gains than the overall U.S. jewelry industry.

 

 

 

The typical financial business model for online jewelers is dramatically different from store-based jewelers, as the table below illustrates. Not only are online jewelers’ gross margins lower, but their inventory turn is substantially higher, the need for capital is much lower, and other financial metrics are more appealing to bankers and Wall Street.

 

 

Source: Company Reports

 

 

Online Jewelers’ Second Quarter Results Strong

The table below summarizes online jewelers’ key financial metrics for the June quarter. Not only are gross margins much lower than store-based jewelers, but inventory turns are dramatically higher. This yields a greater GMROI (gross margin return on investment), a key financial metric for lenders and other capital providers.

 

The average ticket among online jewelers varies substantially. Most mass market jewelers – Kay and Zale, for example – post an average ticket of about $300. Guild jewelers generate an average ticket over $800.

 

 

Source: Company Reports

 

Outlook: Continued Market Share Gains for Online Jewelers

Most economists are predicting that the U.S. economy – and perhaps the global economy – is set to slow over the next 18-24 months. If this occurs, jewelry demand will diminish. Consumers will be seeking merchants who offer great prices for high-quality goods. Online retailers should be the major beneficiaries of this trend.

 

Our long term forecast for the online jewelry market is shown on the graph below. We believe that online jewelers can capture as much as 7-8 percent of the jewelry market by 2010, roughly double the current market share level.

 

 

Source: U.S. Dept. of Commerce & JIRI

 

Blue Nile’s June Quarter Results

Here are the highlights of Blue Nile’s results for the second quarter ended June 2006.

 

• Sales were up 29.9 percent, the largest increase in the past six quarters. This was well above management’s prior guidance.
• The average selling price was $1,637, up 13.6 percent from last year’s second quarter. The increase was driven mostly by greater unit volume of engagement rings due to Blue Nile’s new lower prices for diamonds. Blue Nile’s average engagement ring ticket was $5,700 last year, more than double the industry average of $2,750. Notably, Blue Nile management says the increase in the average selling price was not due to higher commodity prices.
• During the quarter, Blue Nile posted seven transactions above $100,000, including one transaction above $200,000.
• Blue Nile’s total orders increased by 15.3 percent in the quarter due to both an increase in traffic and a higher conversion rate.
• Blue Nile’s sales are being driven by older consumers who are purchasing upgrade rings as well as better educated, more affluent, young techies.
• Sales were strong across all of Blue Nile’s categories; sales were up strongly every month.
• Management also claimed that its new marketing initiatives were successful, but declined to be specific, citing competitive issues.

• The gross margin was 19.9 percent, down sharply from last year’s 22.8 percent.
• During the first quarter, Blue Nile reduced its diamond prices. This strategy was successful in driving incremental sales in the second quarter.
• The reduced gross margin was also the result of higher costs of gold, silver, and platinum which were not fully passed on to customers. However, this had only a few basis points of negative impact on the quarter’s gross margin.

• The operating cost ratio fell to 13.6 percent from last year’s 14.1 percent. Sales leverage drove Blue Nile’s operating cost ratio down in the quarter.

• Blue Nile’s inventory turn fell to 16.1 times this year from last year’s 17 times. This is still dramatically above the average inventory turn of 1 time for the typical store-based jeweler (0.7 times turn, including “memo” goods).

• Blue Nile’s international sales are still small – just under $2 million in the quarter from two markets, the U.K. and Canada.

• Blue Nile’s market share is coming from store-based jewelers who claim that their wholesale diamond prices are higher than Blue Nile’s retail selling price for diamonds. Blue Nile is not taking any notable market share from other online jewelers. In other words, the world is shifting toward online jewelers.

Odimo’s June Quarterly Results

Odimo had a tough quarter. While it sold off its online diamond sales operations and generated much needed capital, its financial condition continues to deteriorate. Odimo’s auditors have rendered a “going concern” opinion, which says that there is a danger that the company may not be able to remain in business due to financial distress. The highlights of Odimo’s June quarter follow.

 

• Odimo sold its online diamond sales operation to Ice.com in May for about $9.5 million. As a result of the sale, Odimo is prohibited from online retail sales of jewelry and diamonds for five years. Odimo will continue as an online retailer of brand name watches and luxury goods through two websites, ashford.com and worldofwatches.com.

• Odimo’s shares were delisted from the NASDAQ Global Market (formerly the “National Market”) in August, after the close of the second quarter, due to failure to maintain a market value of at least $5 million for its shares.

• Alan Lipton, the company’s chief executive officer, resigned in May. He remains as chairman of the board. He is no longer receiving compensation as an officer of the company.

• The company’s credit facility with Silicon Valley Bank of $2 million was paid in full and terminated. This leaves the company with no outside source of capital. In our opinion, it will be difficult for Odimo to purchase adequate stock to support potential demand, especially in anticipation of the upcoming holiday season.

• Revenues during the quarter were $4.4 million, down 62 percent from last year’s $11.5 million. About $4.6 million of the decline came from the lost diamond and fine jewelry sales related to the sale of the diamond.com business. In addition, luxury goods sales in the quarter fell by $600,000, and watch sales fell by $1.8 million.

• Total orders fell by 54 percent in the quarter due both to the sale of assets as well as a decline in sales to existing customers.
• Total visits by customers declined by 47 percent in the quarter.
• The average order value fell 21 percent to $318 in the three-month period. In part, this is due to the reduced mix of diamond and jewelry sales which have an inherently higher average ticket.

• Odimo’s gross margin rose slightly to 24.7 percent from last year’s 24.6 percent. Management offered no explanation.

• Odimo’s operating expense ratio was exceedingly high due to extremely large costs related to general and administrative expenses. As a percentage of sales, G&A costs were 55.4 percent versus the prior year’s 22.6 percent.  

• Other financial ratios are non-comparable due to the financial transaction which occurred during the quarter.

Abazias’ June Quarter Results

Abazias continues to make progress, though it is still only a tiny competitor in the online jewelry business. Highlights from the company’s first quarter are as follows:

 

• Revenues were up by 46 percent to $1.1 million in the three-months ended June 2006 versus the same period last year.

• Abazias’ gross margin fell to 13.2 percent from last year’s 16 percent. A slight shift in the sales mix as well as higher commodity prices had a negative impact on the gross margin.

• Operating costs in total dollars were flat year-to-year, but declined sharply as a percentage of sales due to higher sales levels.

• For the three-month period, the company operated at about break-even. Cash flow was about break-even.

• Management believes that it can ramp up sales sufficiently to generate positive cash flow in future quarters. In addition, the company says it can increase its gross margin from current depressed levels. Its operating cash deficit continues to be funded by its majority stockholder.

• The company has asked shareholders to approve a 1-for-20 reverse stock split. Currently, ABZS shares are selling for about $0.08 per share. A 1-for-20 reverse split would suggest that its shares could sell for $1.60 per share, post-split.

Bidz.com June Quarter Results

Bidz.com, an auction platform for jewelry, was unable to complete its Initial Public Offering in the quarter. Unfortunately, an insufficient number of current shareholders would not agree to a lockup period. By agreeing to a lockup, shareholders cannot sell their shares for a specific period of time after the IPO. Usually, lockup periods run from 90 days to one year; Bidz.com’s lockup period was for 180 days. However, management believes that the IPO can be completed, perhaps in the near future. Highlights from the company’s second quarter include the following:

 

• Revenues reached $32 million, up 80 percent from the quarter ended June 2005.
• The average ticket rose nearly 26 percent to $133.
• The number of new buyers in the quarter reached 57,520, more than double last year’s 23,651 new buyers.
• The U.S. continues to account for nearly 80 percent of the company’s revenues; 20 percent of its revenues are derived from overseas markets.

• Bidz.com’s gross margin rose to 23.7 percent from 20.1 percent last year primarily due to the implementation of a 3 percent transaction fee in November 2005.

• Sales and marketing expenses rose to 8.8 percent of revenues, more than double last year’s 4 percent as the company increased its promotions to attract new buyers.

• The company incurred over $1.2 million in unusual costs related to its failed IPO in the quarter.