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Subject: NILE: Blue Nile Q4 2007 CC Transcript Date: 2/14/2008 11:19 AM
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http://seekingalpha.com/article/64354-blue-nile-q4-2007-earnings-call-transcript?source=wildcard


Mark Vadon

Good afternoon everyone and welcome to today’s conference call. In addition to releasing our quarterly and annual financial results today, we made another big announcement. Last week our board of directors promoted Diane Irvine to the role of CEO. Along with that change I have assumed the role of executive chairman. Diane as retained her position on the board of directors and I will continue as chairman of our board. Investors who have followed us over the years release that Diane and I have taken an extremely collaborative approach to managing this business. That approach will not change with our new roles. I started Blue Nile in 1999 with the dream of using the Internet to transform the $60 billion dollar retail jewelry market. In the fall of 1999 I met Diane and instantly new that she would be an essential part of making my dream a reality. Diane joined me at Blue Nile as chief financial officer and over the years she has been my partner at Blue Nile through the best and worst of times and through it all her faith in what we are doing has not wavered. I always said, if one person believes in our mission more passionately than I, it is Diane.

Through the years, in addition to managing the finance function, Diane has been responsible at different times for every functional area of the business and in January, 2007 she was appointed president of Blue Nile. Diane has had full operating responsibility for the business since this summer leaving me the time to work on the longer term growth strategy for our business. With the change announced today we are formalizing the role that Diane had already begun to play. As we move into the next stage or our business, my role will be to continue to help articulate the long term vision for the business, to help manage critical relationships with our partners and to be a sounding board for Diane and the rest of the management team in our mission to create an iconic global brand.

On today’s call I will take us through the highlights of Q4 and the full year. Diane will talk more about where we are going in 2008 and Robin will take us through the details of the Q4 numbers and provide financial guidance for Q1 and 2008.

A year ago, I informed you of our key goals for 2007. I’d now like to revisit these objectives and provide an update on how we performed. First, we said we would focus on generating profitable growth. We drove sales growth of 26.9% in 2007 and delivered an operating margin of 7%, an improvement over the 6.6% in 2006. Our EPS in 2007 grew 36.8% to $1.04. Second, we committed to expand our international operations. We launched two local currency websites in 2007, serving the Canadian and UK markets and opened an operation center in Dublin to service the UK and greater European markets. Our international sales doubled in 2007 from the prior year from over $17 million and grew over 150% in Q4. We have much more to do on the international front and I’ll talk more about this in a moment. Third, we continue to perfect the Blue Nile experience for our customers.

Repeat and referral continues to be the greatest source of business for Blue Nile so it is important that we exceed our customers’ expectations in every way. For the holiday season we enhanced the customer experience by offering free priority overnight shipping on all orders. Additionally, we enhanced all three of our websites in November to highlight our focus on guidance and education and to improve the usability of the sites. Lastly, we committed to continued disciplined cost management. I touched on this a moment ago when I highlighted our improvement in operating margin. For 2007, SG&A excluding stock-based compensation fell from 11.9% of sales to 11.6% of sales. We accomplished this while opening a new operation in Dublin that is still coming up to scale. We continue to capitalize on the leverage in our business model and are working towards our long term goal of SG&A expense equal to 10% of net sales in our business.

The fourth quarter was another good quarter for Blue Nile and capped an excellent year for the company. Revenue for the quarter was up 23.3%. Importantly, we achieved this growth against the backdrop of deteriorating macroeconomic environment in the fourth quarter. As other jewelry retailers announced negative same store sales growth for the holiday season, Blue Nile achieved excellent growth in comparison. For perspective, there are five other significant publically traded US jewelry retailers. For the holiday season Tiffany reported US comp store sales excluding their New York flagship of -4%. Signet reported -8.1% comps for the holiday, Zales was at -9%, Finley at -5.9% and Birks & Mayors reported -10% holiday comps for their US stores. In this environment we reported 23.3% growth including 18.3% growth in December.

As a luxury category the jewelry sector is perhaps more volatile and more prone to economic downturns than other categories of retail. Within the category, we have steadily gained market share over the years. If you look at an index of comp store sales for the major industry players and then compare our growth numbers over time to this index you’ll see that for several years we have consistently been growing some 20 points faster than the category but, our quarterly numbers do tend to move up or down with changes in comp store sales of other industry leaders. For us as a business, the goal is really to consistently gain share through good and bad markets. If our category is negatively impacted by a macroeconomic slowdown, our goal will be to continue to rapidly gain share focusing on the relative growth versus the category. You will see that our guidance for 2008 today is more conservative than historically. This guidance is reflective of our view of the environment for high end jewelry. With the current uncertainty among consumers we feel that it is prudent to plan conservatively and hope to be surprised by the upside.

Turning back to the 2007 numbers, engagement had strong performance in the fourth quarter and full year. The average sales price in 2007 for an engagement ring sold on our website was just over $6,200, well above the industry average. We are pleased to see this category perform consistently well for us. All other product categories from diamond earning to pendants to wedding bands showed impressive growth for the quarter and the year. For the full year, our non-engagement jewelry sales reached over $100 million and accounted for about 32% of total revenue compared to about 30% of revenue in 2006. Our high end sales growth was strong. Sales in this category with prices over $25,000 grew greater than 50% in the fourth quarter and in fact, grew greater than 50% year-over-year in every quarter of 2007. As the fourth quarter came to a close and the first quarter started however, we began to see weakness at very high price points. We believe that the uncertain macroeconomic environment is finally having an impact on this sector of the market.

International expansion, as I stated earlier, is a key strategic initiative for our business. Q4 marked the first holiday season for our Canadian and UK websites with transactions in local currency. The response to our business in these new markets has been exceptional. International sales in the fourth quarter were $7.2 million, up over 150% from Q4 of 2006. We are excited about the expansion of our shipping capabilities to 12 new countries that we announced last week. Already with almost no marketing spend in these markets we have received multi thousand dollar orders from Japan, Australia, New Zealand, Singapore, Hong Kong, Germany and Switzerland. Our offering in these markets is limited but it is providing us with insights into these new areas and is giving us confidence in continuing to push rapidly into international markets.

I would now like to turn the call over to Diane who will provide us with an overview of where we are going in 2008.

Diane Irvine

Before I begin talking about our goals for the coming year, I want to take a moment to recognize all that Mark has accomplished as CEO in building Blue Nile’s business. Mark started Blue Nile in 1999 with just a few people, several telephones and computers, a website and a dream of creating a great business with a unique economic model and the opportunity to build a lasting brand. Mark is a true visionary who has built an amazing business, one that has redefined the consumer experience for diamonds and jewelry. Under Mark’s leadership Blue Nile invented a category, the online retailing of diamonds and jewelry and has become its undisputed leader. Mark is in many ways the quintessential customer for our products and he has created a culture at Blue Nile that obsesses about our customers and strives to create the perfect customer experience. Mark has lead us through nearly nine years of growth, through the ups and downs of the Internet from a raw start up to a highly profitable business with sales of over $300 million in 2007.

Since the day Mark offered me the opportunity to join Blue Nile in 1999 it has been an honor and privilege to work alongside him. He has built a team of talented incredible people who are passionate about what they do and committed to building a very special business for the long term. Mark has established exceptional relationships with our employees, our suppliers and business partner and our investor and he has done it all with intelligence, honestly, a sense of humor and a rare humility. I am very honored to succeed Mark as CEO and I look forward to continuing to work with him for many years. I truly believe the best is yet to come for Blue Nile.

Over the past eight years we have accomplished a tremendous amount. As we enter 2008 we have an extremely strong domestic business that is well positioned to continue to gain market share. We dominate the sale of diamond jewelry over the Internet and have become one of the country’s largest jewelers through any channel. We continue to rapidly gain share from physical retailers because we offer greater selection, exceptional value and a superior customer service. On the International front, we have a rapidly growing business with opportunities across many different geographic markets. Looking forward many years, the opportunities for us internationally rival those of the US market. We have an incredible business model and an extremely talented team. Combined, this gives us great opportunity as we move into the next several years.

While we have an unprecedented business model for the jewelry industry, as we enter 2008, the health of the economy and general consumer confidence is definitely at the forefront of our mind. As a retailer of luxury goods, we have anticipated that a slowdown in consumer spending will have an impact on our business and we have seen a softening in the current quarter as a result of the challenging macro environment. Therefore, we are very cautious in our outlook. Our focus is on establishing this business for the long term and building market share. In a period of economic uncertainty, we believe we have a great opportunity to attract customers to the exceptional products and outstanding value that we offer. In this environment we will be a very challenging competitor. Consider physical retailers of jewelry who typically have high fixed costs and run at gross margins of roughly 50%. In an environment where demand falls, this high fixed cost structure combined with the asset intensive nature of physical retail can lead to dramatic declines in profitability. Already in 2008 there have been two very significant Chapter 11 filings in jewelry retail and news of store closings from national chains.

Our model is very different. We have both the best cost structure in our industry and a capital efficiency that is unique within jewelry retail. While we are not immune to pull backs in consumer spending we believe our model allows us to weather economic downturns with continued profitability much better than any of our competition. With this as the competitive backdrop our focus in 2008 will be to continue to execute with excellence for customers, gain market share and emerge from any downturn with a stronger relative position to our competition than ever before. We will be very disciplined about running our business efficiently through this uncertain period. We will remain diligent and focused on profitable growth and free cash flow generation. Our high level objectives for the business in 2008 are: first, we will enhance the Blue Nile customer experience. We believe we deliver an unmatched customer experience at Blue Nile. Our intent is to continuously raise the bar for ourselves in this area. Over the next year we have many initiatives under the way to enhance the customer experience and ultimately increase conversion. Some of these include a comprehensive service and training initiative for our customer service team, the enhancement of our website features and functionality and a broadening of the offerings within our jewelry assortment.

We see 2008 as a time for us to capture additional market share and emerge with an even stronger competitive position. While physical store jewelers may need to cut back on service and selection to combat the economic downturn we have the ability to leverage our online platform and grow our business through a period of slower consumer spending while offering exceptional service and selection to our customers. We view this period as a tremendous opportunity to gain market share and to create value for our shareholders.

Our second objective is to focus on an efficient and lean cost structure. We have an efficient operating model that distinguishes us from our brick and mortar competitors. Our SG&A as a percentage of sales was just over 13% in 2007 compared to traditional jewelry retailer rates of 35 to 45%. We have a very efficient cost structure that doesn’t require a network of stores and high overhead costs as in physical retailer. In an uncertain economic environment it is more important than ever for us to maintain our lean cost structure. We will look at ways to improve efficiency in all areas of the business and prioritize projects that will drive the top line. Our focus on cost control is deeply ingrained into the culture of Blue Nile. That focus has been a key part of our success from the beginning of our business and it will remain with the company for the future regardless of economic environment.

Third, we will drive international growth. Expansion into new international markets will be a key initiative for 2008. As we announced last week, we now offer shipping to 12 new countries in both Europe and Asia pacific making the Blue Nile brand accessible to consumers in those markets. We believe there is great opportunity for us to capture market share in these countries where there is little, if any, online competition. The selection of diamonds in these countries today is fairly limited. Our entry into these new countries provides those consumers with access to over 60,000 high quality diamonds and dramatically expands their selection. We’ve had a very promising start with our business in Canada, the UK and Ireland and now we’re very excited about the future growth opportunities in those markets as well as the 12 new countries we began shipping to last week.

We believe 2008 is a year for Blue Nile to capture a significant share in the jewelry market both domestically and overseas. Our prospects are bright and despite the current economic headwinds we are optimistic about the long term potential for Blue Nile. I’d now like to turn the call over to Robin.
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