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NILE > SEC Filings for NILE > Form 10-Q on 5-Nov-2013All Recent SEC Filings

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Form 10-Q for BLUE NILE INC


5-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q and the Annual Report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in "Risk Factors." Management Overview
We are the leading online retailer of high-quality diamonds and fine jewelry. We offer our products for sale through the Blue Nile website in over 40 countries and territories throughout the world. Our primary focus is on growing our business by providing unparalleled quality, selection and value to consumers and delivering exceptional customer service.
We believe that our extensive and unique product selection, connection with our customers through our marketing and customer service efforts, and the value we provide to our customers through our competitive pricing will enable us to maximize our revenue and profitability and increase market share both domestically and internationally. Our online business model allows us to avoid many of the costs that are typically incurred by physical retail stores. As a result, we are able to realize lower gross profit margins while remaining profitable.
In order to increase our sales and market share, we are focused on accelerating the sales growth rate of our business through initiatives across three main categories: 1) the sale of engagement products in the U.S.; 2) the sale of non-engagement products in the U.S.; and 3) the sale of both engagement and non-engagement products in international markets. The engagement product category includes gold or platinum engagement rings with a


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diamond center stone and loose diamonds. Our non-engagement product category includes rings, earrings, necklaces, pendants, bracelets, gifts and accessories containing precious metals, diamonds, gemstones or pearls.
We believe that value is one of the most important drivers of engagement sales, and the current cost of diamonds is a significant factor to our growth rate. Generally, we purchase our diamonds on a real time basis from our suppliers when a customer places an order for a specific diamond. When the cost of diamonds is relatively steady or declines, we believe that our business benefits because we are able to immediately pass those lower costs on to consumers. Diamond prices decreased year-over-year through most of 2012 before stabilizing in the fourth quarter of 2012. Diamond prices have been relatively stable since the fourth quarter of 2012 and throughout the fiscal year 2013. Regardless of diamond pricing dynamics we will remain focused on 1) utilizing our aggressive retail pricing; 2) investing heavily in our engagement products; and 3) providing our customers with a compelling website experience across all devices in order to maintain our momentum, gain market share, and increase our value proposition compared to our competitors.
The total addressable market for the sale of non-engagement products is much greater than that for engagement, and we believe our brand is well positioned to gain market share. To accelerate growth in our non-engagement category, we are
1) maximizing our opportunity to sell wedding bands and diamond jewelry to both new and repeat customers through refined assortment and pricing, promotion, messaging and user experience; 2) focusing on quality and understandable designs to drive sales in fashion jewelry; and 3) providing our customers with a compelling website experience across all devices in order to maintain our momentum, gain market share, and increase our value proposition compared to our competitors. We have and will continue to invest in this area. As part of our plan to accelerate growth in our international business, we are extending our capabilities into markets with the highest potential for growth. We expect significant growth from international markets, both in countries where we have many years of experience, as well as emerging markets. We believe that the Asia-Pacific market, specifically China, represents significant long-term opportunities for us. For fiscal year 2013, we have and will continue to increase our investments in infrastructure, product selection, website and mobile experience, and marketing. In addition, we will continue to explore strategic partnerships to better serve our customers in these markets. Investments during 2012 and during the year-to-date ended September 29, 2013 have increased our selling, general and administrative expenses and increased the amount of inventory we carried compared to the same period last year. We believe that these investments will lead to increased growth in all categories of our business and provide higher profitability over the long-term. Third Quarter of 2013 Summary of Results of Operations We achieved third quarter net sales of $98.9 million, a 10.1% increase from the third quarter of 2012. Net sales increased across each of our three main categories - U.S. engagement net sales increased 7.1%, U.S. non-engagement net sales increased 9.6% and net sales of both engagement and non-engagement products in our international markets increased 22.9% from the third quarter of 2012. International net sales comprised approximately 17.3% of our total net sales for the quarter. Our gross profit increased $1.8 million in the third quarter of 2013, a 10.4% increase compared to the third quarter of 2012. Net income per diluted share was $0.23 in the third quarter of 2013, compared to $0.14 for the third quarter of 2012.

Results of Operations
Comparison of the Quarter Ended September 29, 2013 to the Quarter Ended September 30, 2012
The following table presents our operating results for the quarters ended September 29, 2013 and September 30, 2012, including a comparison of the financial results for these periods (dollars in thousands, except per share data):


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                                                        Quarter ended
                                              September 29,      September 30,
                                                  2013               2012            $ Change      % Change
Net sales                                    $      98,925     $        89,830     $    9,095         10.1  %
Cost of sales                                       80,238              72,900          7,338         10.1  %
Gross profit                                        18,687              16,930          1,757         10.4  %
Selling, general and administrative expenses        16,165              14,264          1,901         13.3  %
Operating income                                     2,522               2,666           (144 )       (5.4 )%
Other income, net:
Interest income                                         20                  20              -            -  %
Other income, net                                        3                  16            (13 )      (81.3 )%
Total other income, net                                 23                  36            (13 )      (36.1 )%
Income before income taxes                           2,545               2,702           (157 )       (5.8 )%
Income tax expense                                    (361 )               961         (1,322 )     (137.6 )%
Net income                                   $       2,906     $         1,741     $    1,165         66.9  %
Basic net income per share                   $        0.23     $          0.14     $     0.09         64.3  %
Diluted net income per share                 $        0.23     $          0.14     $     0.09         64.3  %

Net Sales
Net sales increased 10.1% during the third quarter of 2013 as compared with the third quarter of 2012. Net sales in the U.S. increased 7.8% to $81.8 million for the third quarter of 2013, compared with $75.9 million in the same quarter last year. U.S. engagement net sales for the third quarter of 2013 increased 7.1% to $57.9 million, compared to $54.1 million for the third quarter of 2012 due to an increase in both the number of shipments and average shipment value. These increases were driven by marketing and pricing strategies to maximize sales. U.S. non-engagement net sales for the third quarter 2013 increased 9.6% to $23.9 million, compared to $21.8 million for the third quarter 2012 due to an increase in the number of shipments offset by a decrease in the average shipment value due to pricing and promotional strategies to maximize sales.
International net sales increased 22.9% to $17.1 million from $13.9 million in the third quarter of 2012 due to an increase in orders, partially offset by a decrease in the average shipment value. Growth was particularly strong in Asia. Internally, we monitor our international sales performance on a non-GAAP basis which eliminates the positive or negative effects that result from translating currency from international sales into U.S. dollars ("constant exchange rate basis"). Changes in foreign exchange rates during the third quarter of 2013, compared to the rates in effect during the third quarter of 2012, had a negative impact of approximately 4.7% on international net sales. Excluding the impact of changes in foreign exchange rates, international net sales increased 27.6% for the third quarter of 2013 compared to the third quarter of 2012.

Gross Profit
Gross profit in the third quarter of 2013 increased 10.4% to $18.7 million from $16.9 million in the third quarter of 2012. The increase in gross profit resulted primarily from the growth in net sales. Gross profit as a percentage of net sales was 18.9% for the third quarter of 2013 and 18.8% for the third quarter of 2012. In the third quarter of 2013, sales of our engagement and non-engagement products grew at approximately the same rate. Sales of our engagement products equaled 72.8% of our total revenue in both periods. Costs for our products are impacted by prices for diamonds and precious metals including gold, platinum and silver, which rise and fall based upon global supply and demand dynamics. In making retail pricing decisions, we take into account fluctuations in the pricing of diamonds and precious metals, which in turn, affect the gross margin that we realize from such products. We expect that gross profit will continue to fluctuate in the future based on changes in product acquisition costs, particularly diamond prices, product mix and pricing decisions.


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Selling, General and Administrative Expenses Selling, general and administrative expenses increased 13.3% to $16.2 million in the third quarter of 2013 compared to $14.3 million in the third quarter of 2012. Marketing and advertising costs increased $1.0 million in the third quarter of 2013, primarily due to increased spending on online marketing vehicles and other marketing efforts to drive traffic to our website, both domestically and internationally. Compensation and benefits expense increased $0.6 million due to increased headcount to support key business initiatives. Credit card interchange and payment processing fees increased approximately $0.2 million in the third quarter of 2013 due primarily to higher sales volumes. Selling, general and administrative expenses as a percentage of net sales increased to 16.3% in the third quarter of 2013 compared to 15.9% in the third quarter of 2012 as expenses accelerated faster than sales. Operating Income
Operating income was $2.5 million in the third quarter of 2013 compared to $2.7 million in the third quarter of 2012. The decrease in operating income is primarily due to $1.9 million increase in selling, general and administrative expenses partially offset by the $1.8 million increase in gross margin. Income Taxes
Our effective tax rate decreased to (14.2)% in the third quarter of 2013 from 35.6% in the third quarter of 2012. The decrease in the effective rate is primarily due to the domestic production activities deduction related to the current and prior tax years recorded in the third quarter of 2013.

Comparison of the Year to Date Ended September 29, 2013 to the Year to Date
Ended September 30, 2012
The following table presents our operating results for the years to date ended
September 29, 2013 and September 30, 2012, including a comparison of the
financial results for these periods (dollars in thousands, except per share
data):
                                                       Year to date ended
                                               September 29,        September 30,
                                                    2013                2012           $ Change      % Change
Net sales                                    $        304,050     $       263,914     $  40,136         15.2  %
Cost of sales                                         247,620             214,515        33,105         15.4  %
Gross profit                                           56,430              49,399         7,031         14.2  %
Selling, general and administrative expenses           49,338              44,190         5,148         11.6  %
Operating income                                        7,092               5,209         1,883         36.1  %
Other income, net:
Interest income                                            84                 105           (21 )      (20.0 )%
Other income, net                                         143                  96            47         49.0  %
Total other income, net                                   227                 201            26         12.9  %
Income before income taxes                              7,319               5,410         1,909         35.3  %
Income tax expense                                      1,375               1,937          (562 )      (29.0 )%
Net income                                   $          5,944     $         3,473     $   2,471         71.1  %
Basic net income per share                   $           0.48     $          0.26     $    0.22         84.6  %
Diluted net income per share                 $           0.47     $          0.25     $    0.22         88.0  %

Net Sales
Net sales increased 15.2% during the year-to-date ended September 29, 2013, compared with the year-to-date ended September 30, 2012, due primarily to an increase in the average shipment value. Net sales in the U.S. increased 13.9% to $252.2 million during the year-to-date ended September 29, 2013, compared with $221.5 million


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during the year-to-date ended September 30, 2012. U.S. engagement net sales for the year-to-date ended September 29, 2013 increased 15.8% to $177.1 million from $152.9 million for the year-to-date ended September 30, 2012. U.S. non-engagement net sales for the year-to-date ended September 29, 2013 increased 9.5% to $75.1 million, compared to $68.6 million for the year-to-date ended September 30, 2012.
International net sales increased 22.3% in the year-to-date ended September 29, 2013 to $51.9 million, from $42.4 million in the year-to-date ended September 30, 2012. Foreign exchange rates during the year-to-date ended September 29, 2013, compared to the rates in effect during the year-to-date ended September 30, 2012, had a negative impact of approximately 2.4% on international net sales. Excluding the impact of changes in foreign exchange rates, international net sales increased 24.7% in the year-to-date ended September 29, 2013 over the year-to-date ended September 30, 2012. Gross Profit
Gross profit increased $7.0 million to $56.4 million in the year-to-date ended September 29, 2013 compared to $49.4 million in the year-to-date ended September 30, 2012. The increase in gross margin dollars resulted primarily from an increase in net sales. Gross profit as a percentage of net sales was 18.6% in the year-to-date ended September 29, 2013 as compared to 18.7% in the year-to-date ended September 30, 2012. This percentage decrease was primarily due to product mix. Engagement net sales were 72.1% of our total year-to-date revenue versus 70.9% in the prior year. Our engagement products generally provide lower gross margin as a percentage of revenue than our non-engagement products.
Selling, General and Administrative Expenses Selling, general and administrative expenses increased 11.6% to $49.3 million in the year-to-date ended September 29, 2013 compared to $44.2 million in the year-to-date ended September 30, 2012. Compensation and benefits expense increased $2.2 million due to increased headcount to support key business initiatives and higher incentive compensation expense. Marketing and advertising costs increased $2.0 million, primarily due to increases in the rate and volume of our online marketing activities and other marketing strategy efforts to drive traffic and sales in our domestic and international markets. Credit card interchange and payment processing fees increased approximately $1.0 million due to higher sales volumes and rates. As a percentage of net sales, selling, general and administrative expenses were 16.2% in the year-to-date ended September 29, 2013, as compared to 16.7% in the year-to-date ended September 30, 2012 as sales accelerated faster than expenses. Our online business model with a relatively low cost structure allows us to gain efficiency as sales increase. Operating Income
Operating income increased 36.1% to $7.1 million in the year-to-date ended September 29, 2013 compared to $5.2 million in the year-to-date ended September 30, 2012. The increase in operating income for the year-to-date ended September 29, 2013 was due to an increase in gross margin dollars partially offset by an increase in selling, general and administrative expenses. Income Taxes
Our effective tax rate decreased to 18.8% in the year-to-date ended September 29, 2013 from 35.8% in the year-to-date ended September 30, 2012. The decrease in the effective rate is primarily due to the domestic production activities deduction related to the current and prior tax years recorded in 2013.
Liquidity and Capital Resources
We are primarily funded by our cash flows from operations. The significant components of our working capital are inventory and liquid assets such as cash and trade accounts receivable, reduced by accounts payable and accrued expenses. Our business model typically provides certain beneficial working capital characteristics. While we collect cash from sales to customers within several business days of the related sale, we typically have extended payment terms with our suppliers.
Our liquidity is primarily dependent upon our net cash provided by operating activities. Our net cash provided by operating activities is sensitive to many factors, including changes in working capital and the timing and magnitude of expenditures. Working capital at any specific point in time is dependent upon many variables,


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including our operating results, seasonality, inventory management, the timing of cash receipts and payments, and vendor payment terms.
As of September 29, 2013, we had working capital of $5.9 million, including cash and cash equivalents of $47.9 million and inventory of $30.9 million, offset by accounts payable of $73.8 million. Current levels of cash and cash equivalents reflect increased proceeds from stock option exercises offset by the seasonal pay down of accounts payable and the repurchase of shares of our common stock in fiscal year 2013.
Net cash of $33.9 million was used in operating activities for the year-to-date ended September 29, 2013, compared to net cash used in operating activities of $21.0 million for the year-to-date ended September 30, 2012. The increase in cash used for operating activities was attributable to a higher net payment of accounts payable and accrued liabilities in the current year. Net payment of accounts payable totaled $42.1 million for the year-to-date ended September 29, 2013 compared to $28.9 million for the year-to-date ended September 30, 2012. The net payment of accrued liabilities totaled $5.2 million for the year-to-date ended September 29, 2013 compared to $3.5 million for the year-to-date ended September 30, 2012. In the first quarter of each year, we generally have a significant pay down of our accounts payable balance built up during the previous year's fourth quarter holiday season.
Net cash of $4.4 million and $6.1 million was used in investing activities for the year-to-date periods ended September 29, 2013 and September 30, 2012, respectively. In May 2012, net cash of $4.0 million was used to purchase preferred shares in a privately-held company and provide a loan to the same privately-held company in exchange for a note receivable. Net cash of $4.1 million and $2.1 million was used for the year-to-date periods ended September 29, 2013 and September 30, 2012, respectively, for purchases of property and equipment to support our operations. Our capital needs are generally relatively low and include, without limitation, investments in technology and website enhancements, capital improvements to our leased warehouse and office facilities, and furniture and equipment.
Net cash used in financing activities for the year-to-date ended September 29, 2013 was $0.8 million, primarily related to the repurchase of common stock of $9.3 million partially offset by $8.3 million of proceeds from stock option exercises. Net cash used in financing activities for the year-to-date ended September 30, 2012 was $32.1 million, primarily related to repurchases of common stock of $38.9 million partially offset by proceeds from stock option exercises of $6.8 million.
On February 7, 2012, our board of directors authorized the repurchase of up to $100.0 million of our common stock during the 24-month period following such approval date under our buyback program. During the year-to-date ended September 29, 2013, we repurchased an aggregate of 269,140 shares of our common stock for $9.3 million. Since the reauthorization on February 7, 2012 through September 29, 2013, we have repurchased an aggregate of 1,761,126 shares for a total of $48.2 million. This left approximately $51.8 million under this repurchase authorization.
On October 28, 2013, our board of directors authorized the renewal of our share repurchase program. Under this renewed program, we are authorized to repurchase up to $100.0 million of our common stock over the next 24 months, subject to limitations under Delaware law and the market conditions described below. Since the inception of the buyback program in the first quarter of 2005 through September 29, 2013, we have repurchased an aggregate of approximately 7.8 million shares for a total of $274.7 million. Our shares may be repurchased from time to time in open market transactions or in negotiated transactions off the market. The timing and amount of any shares repurchased is determined by our management based on their evaluation of market conditions and other factors, including our cash needs. Repurchases may also be made under a Rule 10b5-1 plan. We continually assess market conditions, our cash position, operating results, current forecasts and other factors when making decisions about stock repurchases.
For the fourth quarter to date through November 4, 2013, we have repurchased an additional 30,100 shares of our common stock for $1.1 million.


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On February 11, 2013, we entered into a Credit Agreement which provides for a $35.0 million unsecured, revolving credit facility (the "Revolving Loan"). We currently do not have any outstanding debt under the Credit Agreement. We believe that our current cash and cash equivalent balances, cash flow from operations and our ability to borrow under the Revolving Loan will be sufficient to meet our anticipated operating and capital expenditure needs for at least the next 12 months. However, projections of future cash needs and cash flows are subject to many factors and to uncertainty. We continually assess our capital structure and opportunities to obtain credit facilities, sell equity or debt securities, or undertake other transactions for strategic reasons or to further strengthen our financial position.
Contractual Obligations
There have been no material changes to our contractual obligations during the period covered by this report from those disclosed in our Annual Report filed with the SEC on February 25, 2013.
Off-Balance Sheet Arrangements
As of September 29, 2013, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Non-GAAP Financial Measures
To supplement our condensed consolidated financial statements presented in accordance with GAAP, our management internally monitors our sales performance on a non-GAAP constant exchange rate basis that eliminates the positive or negative effects that result from translating international sales into U.S. dollars. Our management does not itself, nor does it suggest that investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. Investors should also note that the non-GAAP financial measures we used may not be the same non-GAAP financial measures, and may not be calculated in the same manner, as that of other companies. Whenever we use such non-GAAP financial measures, we provide a reconciliation of non-GAAP financial measures to the most closely applicable GAAP financial measures. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures. Our management believes that international sales on a constant exchange rate basis provide meaningful supplemental information to the company and to investors. Management believes the constant exchange rate measurement provides a more representative assessment of the sales performance and provides better comparability between reporting periods.
The following table reconciles year-over-year international net sales percentage increases (decreases) from the GAAP sales measures to the non-GAAP constant exchange rate basis:

Quarter ended                              Effect of foreign     Year over year growth on
September 29, 2013  Year over year growth  exchange movements  constant exchange rate basis
International net
sales                       22.9%                (4.7)%                   27.6%
Quarter ended                              Effect of foreign     Year over year growth on
September 30, 2012  Year over year growth  exchange movements  constant exchange rate basis
International net          (3.3)%
sales                                            (1.8)%                   (1.5)%



Year to date ended                         Effect of foreign     Year over year growth on
September 29, 2013  Year over year growth  exchange movements  constant exchange rate basis
International net
sales                       22.3%                (2.4)%                   24.7%
Year to date ended                         Effect of foreign     Year over year growth on
September 30, 2012  Year over year growth  exchange movements  constant exchange rate basis
International net           5.7%
sales                                            (1.8)%                    7.5%
. . .
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