Everyone knows that the jewelry business is tough for U.S. merchants. But, even Blue Nile, which has been posting dramatic sales gains quarter after quarter, hit a wall in the three-month period ended March 2008. Sales to its U.S. customers were down 1 percent from the prior year’s first quarter. That compares to a whopping 34 percent sales gain in last year’s first quarter.

 

While the company reported that first quarter revenues were $70.5 million, up 3.8 percent from the prior year, all of the increase came from sales in international markets, including Canada, the U.K., Western Europe, and to a lesser extent, market tests in Eastern Europe and Asia. Sales in non-U.S. markets were $5.7 million, up 124 percent from last year’s $2.5 million in the first quarter. Blue Nile’s sales in the U.S. were $64.8 million this year, down 1 percent from last year’s $65.3 million in the first three months of the year.

 

The table below summarizes first quarter financials for Blue Nile:

 

 

Sales Comparisons Weak

Management cited several factors which had a negative impact on demand in the first quarter, including the following:

 

• The sluggish U.S. economy with all of its ramifications – tighter credit, soft housing market, subprime mess and other factors – took its toll on jewelry demand.
• Consumers appear to be reluctant to take on new debt to purchase a diamond engagement ring, according to management. We believe credit sales were down as a percentage of total sales at Blue Nile.
• Comparisons were tough against last year’s record-setting 34 percent sales increase in the first quarter.
• Demand early in the quarter was very weak, though sales improved as the quarter went along.
• The highest price points experienced the weakest demand. Further, the company made a single sale of $1.5 million last year; it was not repeated this year.
• A 3 percent decline in total orders during the quarter hurt sales.
• A promotion with Google last year added significant revenues (an estimated $1-2 million) in last year’s first quarter; this promotion was not repeated this year.

Despite those weak sales, there is reason for cheer at Blue Nile headquarters:

 

• Blue Nile may have gained market share in the first quarter versus most of the larger chains. Even with a slight decline in sales – down 1 percent – the company is posting better sales comparisons than most other chain jewelers.
• The average ticket increased by 6.5 percent to $1,637, though this was mostly due to easy comparisons related to the Google promotion in last year’s first quarter which had a negative impact on the average ticket. If the impact of the Google promotion is removed, Blue Nile’s average ticket declined 4 percent in the first quarter of this year. Despite these modest swings in the average ticket, Blue Nile’s average ticket is still well above the typical mass market jeweler’s average ticket of $350 and is also above the average ticket for guild jewelers of about $1,100.
• While company management would not cite “conversion” statistics – browsers-to-buyers – it indicated that its primary focus in the first quarter was to increase the conversion rate. While total orders were down modestly – primarily due to last year’s Google promotion (without that promotion last year, total orders this year would have been up 8 percent) – Blue Nile sales professionals simply did not let a customer “walk” with ease; they worked harder than ever to make the sale.
• The company is making significant headway in penetrating international markets. Its initial tests in Asia and Eastern Europe indicate that there is a huge opportunity for the company in those markets. International sales were about 8 percent of the company’s total sales in the first quarter, up from just under 4 percent of sales in last year’s first quarter.

By product category, management reported the following sales trends:

 

• Diamond engagement rings (roughly 70 percent of total revenues):
• $5,000 and below retail price = strongest demand
• $25,000-to-$50,000 retail price = relatively strong demand
• $5,000-to-$25,000 retail price = relatively weaker demand
• $100,000 and higher retail price = very weak demand
• Demand for other jewelry – non-engagement jewelry – was relatively flat.
• Demand for diamond wedding bands was very strong. Apparently, consumers are opting out of a traditional diamond solitaire ring in favor of a diamond-encrusted wedding band.

Gross Margin Rises, Despite Higher Commodity Costs

Unlike almost any other jeweler, Blue Nile has been able to increase its gross margin in an environment of sharply rising commodity costs. In part, the increase in its gross margin is due to the company’s sales mix; in part, it is due to a conscious effort to pass along higher commodity costs to its customers. During the quarter, the company’s gross margin was 19.8 percent of sales, compared to 19.5 percent last year.

 

Expense Ratio Up Sharply

Blue Nile’s expense ratio rose sharply in the quarter due to several factors:

 

• Sluggish sales had a negative impact on efficient absorption of relatively fixed overhead expenses.
• Stock-based compensation rose by 42 percent to $1.7 million in the quarter.
• Expansion into new international markets was costly.
• Expenses with the company’s new fulfillment center were high.

Management’s Forecast: Improved Results in the Second Half

While disclaiming the ability to see into the future, management has set some aggressive goals for the year:

 

• Total sales should rise by 10 percent for the full year. That implies perhaps a mid-teen rise in the second half. In part, this sales gain will be driven by international sales; in part, domestic demand could also solidify. If Blue Nile posts a 10 percent sales gain in 2008, its sales will be about $350 million, making it one of the largest jewelers in the U.S.
• Second quarter sales are expected to be flat to up 5 percent.
• Income before interest, taxes, depreciation, amortization, and stock compensation is expected to rise by 10 percent or so this year.
• The company’s total capital expenditures for the full year are estimated to be about $2.5 million. Think about that for a minute: revenues of $350 million will be supported by a capital expenditure of only $2.5 million. This is just another example of how Blue Nile can compete more effectively than store-based jewelers.

Blue Nile also says vendors have lined up to deliver goods to the company. Because Blue Nile is growing – versus most other jewelers who are posting sales declines, and because Blue Nile pays its bills faster than most other jewelers, the company has had no supply disruptions. Further, it is able to get preferential treatment in some cases, in our opinion.