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Blue Nile (NASDAQ:NILE)

Q1 2013 Earnings Call

May 02, 2013 5:00 pm ET

Executives

Nancy Shipp

Harvey S. Kanter - Chief Executive Officer, President, Director and Member of Stock Award Committee

David B. Binder - Chief Financial Officer and Member of Stock Award Committee

Analysts

Trisha Dill - Wells Fargo Securities, LLC, Research Division

David Wu - Telsey Advisory Group LLC

Ross Sandler - Deutsche Bank AG, Research Division

Kevin Kopelman - Cowen and Company, LLC, Research Division

Paul Swinand - Morningstar Inc., Research Division

Mark R. Miller - William Blair & Company L.L.C., Research Division

Rick B. Patel - Stephens Inc., Research Division

Operator

Good afternoon, ladies and gentlemen. My name is Jarred, and I will be your host operator on this call. [Operator Instructions] At this time, I would like to introduced Nancy Shipp, Director of Investor Relations of Blue Nile.

Nancy Shipp

Good afternoon, and thank you for joining us on our conference call today to review our first quarter 2013 financial results. With me today is Harvey Kanter, President and Chief Executive Officer; and David Binder, Chief Financial Officer. Both will be available for Q&A following today's prepared remarks.

Before we begin, I would like to remind you that we will be making forward-looking statements during this call regarding the company's future performance. These statements are only predictions based on assumptions that are believed to be reasonable at the time they are made and are subject to significant risks and uncertainties.

You should not rely on these forward-looking statements as representing our views in the future, and we undertake no obligation to publicly update or revise these statements. Our actual results may differ materially and adversely from any forward-looking statements discussed on this call.

Our quarterly reports on Form 10-Q, our annual report on Form 10-K and other forms on file with the SEC identifying important risk factors and uncertainties that you should consider when making an investment decision regarding Blue Nile, and they may affect whether our forward-looking statements prove to be correct. Also, please note that during the course of this conference call, we may discuss certain non-GAAP financial measures as we review the company's performance.

We will discuss non-GAAP free cash flow, which is defined as net cash provided by or used in operating activities or operating cash flow less outflows for purchases of fixed assets, including internally used software and website development. We will discuss international sales on a constant exchange rate basis. And we will also discuss non-GAAP adjusted EBITDA, which is defined as earnings before interest and other income, taxes, depreciation and amortization adjusted to exclude the effects of stock-based compensation expense. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release, which contains reconciliations of non-GAAP measures to the nearest comparable GAAP measures.

Now I would like to turn the call over to Harvey.

Harvey S. Kanter

Thanks, Nancy. Good afternoon to everyone, and welcome to Blue Nile's First Quarter 2013 Earnings Conference Call. I am pleased to announce our first quarter results. We achieved record quarter sales of $97.1 million, an increase of 16.9% from the first quarter of 2012.

We also delivered expanding profitability, with earnings per share of $0.07 and an adjusted EBITDA of $3.1 million, increasing 35.8% over last year. We have now delivered 5 consecutive quarters of growth, with the last 4 coming in at double-digit growth rates.

A growing number of customers are recognizing Blue Nile for exceptional quality, value and service, and we reached a record number of engagement customers and shipped a record level of orders to our international markets for any quarter outside of our peak fourth quarters. This is building a powerful brand awareness among current and future customers, driving category leadership and helping us gain share of mind and share of markets. Clearly, we are excited. Our earnings represents solid quarterly performance, but they're even more impressive in the context of the strategic road map we outlined at the beginning of last year.

5 quarters ago, we made the decision to invest in key areas to reinvigorate growth, gain market share, diversify the products we offer and expand our international footprint. These investments have paid off as we have accelerated our growth. Through careful management, we have begun to increase our earnings. We defined a time line and milestones for the road map. And while we are still in the early stages, we are very encouraged with our success so far.

Blue Nile's revenue growth is driven by the cornerstone of our business, diamond engagement, and we had a very successful start to the year. Revenue growth grew by 20% and more people bought a Blue Nile diamond engagement ring in the first quarter of 2013 than in any other first quarter in our history.

Our continued growth is confirmation that our business model and efficiency, which drives our value proposition, is clearly recognized by consumers.

Historically, our ability to grow engagement has been impacted by the market price for diamonds. We are particularly pleased that we maintained our double-digit growth rate in what is now a stabilized market for diamonds. This double-digit growth rate momentum is incredibly encouraging.

Blue Nile's philosophy of offering the highest quality diamonds and settings, unique online customization tools, in-depth product education and a no-pressure shopping environment continues to be a disruptive force and an incredibly competitive advantage. As we look to the future, we will focus on elevating product quality, the user experience and our customer service to even greater levels.

As an example, last October, we launched a strategic partnership with Monique Lhuillier, a line that has exceeded our expectations and clearly resonates with the bride-to-be. And in this regard, we are driving to expand our styles and further leverage leading designers where it lines with our brand. We aim to thrill our customers during a very important time in their lives and as a result become the jeweler of choice to mark all of their most special moments.

From our strong position in engagement rings, we are making progress in building our non-engagement business in the United States. This category grew by 7.4% in the first quarter and represents improvement from our growth rate in the fourth quarter of 2012.

In our fourth quarter earnings call, we reflected on lessons learned about the products that resonate with our customers and how we will continue to evolve the mix. Based on what we learned, we shifted our merchandise strategy over the 6 weeks between Christmas and Valentine's Day. We were pleased by our ability to adapt to our consumers' demand so quickly, which resulted in growth acceleration during the quarter and in such a short window of time.

The improvement is led by sales of wedding bands. And in the first quarter, we refined our pricing, promotion and messaging strategy. While we are encouraged by the acceleration in this part of our business, there is much more work to do. In the upcoming months, we are focused on expanding the assortment, evolving our life cycle marketing, improving the user experience and providing enhanced visualization through photography and unique online tools. We are excited by the opportunity inherent in this category. It's a large market, nearly the size of the addressable market for engagement rings. And given our record level of engagement ring sales in Q1, it's a category we should own.

The second part of non-engagement is diamond jewelry, and sales in the U.S. improved in the first quarter here as well. We provided more options to customers by expanding our assortment across multiple price points and enhance our website experience.

However, here again, we have much more work to do. Throughout the rest of this year, we will further expand the assortment, deploy improved targeted marketing, improve visualization on our website and further leverage our diamond supply leadership in the supply chain to accelerate growth.

The market size here is over 5x the size of our core engagement business. And with our expertise in diamond merchandising, we are incredibly well positioned to gain a more meaningful share.

Other fashion jewelry is a third part of our non-engagement business and is an area where we continue to evolve our assortment. We talked about what we learned from our performance in the fourth quarter and specifically how we need to focus on understandable fashion fine jewelry. This is part of an ongoing development and a gradual evolution in the mix. The category continues to be important to us. It helps address a large market and introduce new customers to our brands and the shopping experience.

Internationally, our business performed very well, with growth of 24.8% in the first quarter. This represents a second consecutive quarter of growth, over 20%, and it now equals 18% of our total revenue. Growth rates were significant across all regions, with the highest level of growth from the Asia-Pacific market.

Before I turn to Asia-Pacific, I want to spend a little time talking about our recent success in Canada and Europe. Throughout the first half of 2012, we talked about weakness in Canada and our efforts to expand product assortment and invest in marketing to reverse the trend. These efforts have worked and our performance represents a third consecutive quarter of growth. We look forward to the continued opportunity in this market.

Europe had a pleasant surprise. While the economic environment is challenging for all retailers, we are growing due to the strength of our diamond merchandising and the supply chain, coupled with our local presence in Ireland. We remain cautious but are incredibly encouraged by our current performance.

Asia-Pacific. Asia-Pacific now represents over half of our international revenue. And as I mentioned earlier, it's growing faster than all other regions.

Our business in Hong Kong is robust. We've made significant progress in our ability to serve customers in Mainland China. We're adding staff, increasing our presence to support customer service and fulfillment, developing our capabilities to fulfill orders through partnerships and bringing more product to market. The business in China is still relatively small but the market is enormous and we see incredibly tremendous opportunity for continued growth.

Across all markets and in all our product categories, we continue to see a rapid rise in the number of users coming to our site from mobile devices.

In the first quarter, this equals 40% of our total traffic and is up from 34% in the fourth quarter of last year. While it currently is a challenge to convert mobile users at the same rate as those coming to us from a PC, we consider this a great opportunity. Throughout the second quarter of 2013, we will gradually roll out enhancements in mobile functionality, which should improve conversion and further accelerate our growth rates.

This leading-edge mobile experience can help us improve visualization, and we will leverage touch-based navigation to bring the brilliance of our products closer to customers.

Now before I turn the call over to David, I would like to acknowledge the tremendous effort and the great work of the associates here at Blue Nile. We launched this strategic plan over a year ago. The success we've achieved so far is a reflection of the team's dedication, commitment and skill to the effort. We have lofty goals for the future and a lot of work to do, but we are incredibly energized and very excited about building a world-class global jewelry brand. David?

David B. Binder

Thanks, Harvey, and welcome to everyone on the call this afternoon. As Harvey mentioned, we are excited to report great results in the first quarter, with double-digit revenue growth and a significant increase in profitability versus the same quarter last year.

Now turning to the details of the financial performance in the first quarter, net sales totaled $97.1 million, representing an increase of 16.9% versus the first quarter of 2012.

U.S. engagement sales for the first quarter grew 19% to $55.3 million compared to $46.4 million in the first quarter last year. This record level of first quarter revenue follows 3 consecutive quarters of double-digit growth.

For us, it is a compelling fact that more people bought their engagement ring from Blue Nile this first quarter than in any previous first quarter in our history and in any other quarter in our history outside of fourth quarter peaks.

We are particularly pleased to generate this level of growth as the market price of diamonds has stabilized since the end of last year.

Additionally, growth is strongest at our core price points. Orders and revenue from customer spending less than $25,000 on their engagement ring grew at a significantly faster rate than those at higher price points.

Now looking at our sales of non-engagement products in the U.S. Sales in this category grew 7.4% to $24.2 million versus $22.6 million in the first quarter last year. While our goal is to accelerate this part of our business at a faster rate, we are encouraged that revenue growth in the first quarter was higher than that in the fourth.

Sales of diamond jewelry and wedding bands were particularly strong. As Harvey mentioned that this is an increased area of focus for us and we look to further accelerate growth of these products throughout this year.

Overall in this category, we will continue to work to refine the assortments, refine website display and navigation, as well as improve our targeted marketing. We continue to see great opportunities to increase the contribution of sales from these products, which will gradually expand margins in the business and drive new customers to Blue Nile.

As we work through these improvements in 2013, we expect to maintain the historically high number of new customers we acquired in 2012.

Now turning to our international markets. International sales in the first quarter increased 24.8% to $17.6 million compared to $14.1 million last year. On a constant currency basis, international sales increased by 25.9%. This high level of performance is similar to the fourth quarter of 2012 and growth at these levels is the highest we have reported since the third quarter of 2011.

Sales grew at double-digit rates across all of our regions and growth was greatest from Asia-Pacific, which now represents over half of our international revenue.

For the overall business, gross profit was $17.6 million, up by $2.4 million from our result in the first quarter last year. Gross profit as a percentage of net sales was 18.2% compared to 18.4% last year. The decrease in gross profit as a percentage of net sales resulted entirely from a shift in the mix of our revenue to the lower margin engagement products. The mix of revenue from engagement grew to 71.7% in the first quarter of 2013 versus 69.6% in the same period of last year.

Selling, general and administrative expenses increased 9.5% to $16.5 million in the first quarter compared to $15.1 million in the first quarter last year. Total SG&A expenses as a percentage of net sales equaled 17% compared to 18.1% in the prior year, demonstrating leverage in the business and expanding profitability. Within our SG&A total, marketing expense equaled 6% of revenue, down from 6.4% last year.

We continue to invest for growth, in part through marketing. And while this rate of spend is down versus last year, it still represents a relatively high level of spend historically. With greater revenue scale, we were able to expand operating margins while continuing to increase the amount we're investing for growth.

Operating income for the first quarter totaled $1.2 million compared to $219,000 in the first quarter last year, an increase of $1 million. Gross profit increased by $2.4 million. Marketing expense increased by $500,000 and other operating expenses increased by approximately $900,000. The increase in other operating expenses primarily relates to investments in headcount to support our revenue growth and execute our strategic initiatives.

Net income totaled $832,000. First quarter earnings per diluted share equaled $0.07 compared to $0.01 in the first quarter of 2012. Net income per diluted share include stock-based compensation expense of $0.05 for both the first quarter of 2013, as well as in the first quarter of 2012.

Non-GAAP adjusted EBITDA for the first quarter of 2013 was $3.1 million compared to $2.3 million for the first quarter last year, an increase of $800,000.

We ended the first quarter with cash and cash equivalents of $40.5 million compared to $61.2 million in the prior year, representing a decrease of $20.7 million.

Over the past 4 quarters, we spent a total of $40.2 million to repurchase 1.5 million shares. Of this total, we spent $1.4 million in the first quarter of 2013 purchasing 44,000 shares. I also want to highlight that we continue to purchase shares into the second quarter. To date, we spent a total of $2.5 million in the second quarter to purchase an additional 78,000 shares. Combined with our activity in the first quarter, we purchased a total of 122,000 shares this year.

Cash flow used in operations totaled $44.4 million during the first quarter. As expected, we reduced our accounts payable by $41.4 million, consistent with our negative working capital model and the peak sales period in the prior fourth quarter.

Over the past 12 months, we generated $21.3 million in cash from operations. This compares to $18.4 million in cash generated from operations in the 12-month period ending the first quarter of 2012.

Our inventory balance at the end of the first quarter of 2013 equaled $34 million compared to $30.4 million at the end of the first quarter last year, an increase of $3.6 million or 11.7%. As our inventory balance is growing at a rate slower than revenue, our turns are increasing. We look to continue this momentum throughout this year and enhance our yield and operating cash flow.

Now turning to our guidance. For the second quarter of 2013, we expect net sales between $100 million and $105 million and earnings per diluted share between $0.13 and $0.17. For the full year, we continue to expect net sales to be between $440 million and $470 million and earnings per diluted share to be between $0.75 and $0.85.

I'll now turn the call over to the operator, and we're happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from Trisha Dill with Wells Fargo.

Trisha Dill - Wells Fargo Securities, LLC, Research Division

Just wondering about the promotional environment versus last quarter. I know you talked about service bonding to the elevated promotional levels. So how did Q1 compare to Q4 in that regard?

Harvey S. Kanter

Thanks, this is Harvey. The reality is the events moved around a little bit from week-to-week. But on the whole, the level of promotional pace was comparable to last year.

Trisha Dill - Wells Fargo Securities, LLC, Research Division

Okay, great. And then any comments on sort of the cadence of sales throughout the quarter, as well as early read on Mother's Day thus far?

David B. Binder

Trish, this is David. First of all, the second half of your question, Mother's Day is in a couple of weeks and we certainly factor what we're seeing in the ramp-up of Mother's Day in the current guidance for second quarter. I would say that ongoing promotional cadence is part of the business. It was in the fourth quarter. It's not necessarily increasing from what we were doing then, but we're continuing to use promotion to drive excitement and traffic to the website. And with that, converting customers -- that what we think are healthy margins for the business.

Trisha Dill - Wells Fargo Securities, LLC, Research Division

Great. And then just the cadence of sales throughout the quarter?

David B. Binder

So we expect the cadence to be similar to what we did for the ramp-up towards Valentine's Day and actually what we did for Mother's Day even last year. We feature -- throughout most of our peak holidays, we'll feature daily exclusives, which will give a limited onetime price for an exceptional product. And we really focus on that kind of promotional messaging to drive a lot of audience to the site and a lot of education about the products that we sell. The activity this year is very similar to what we did last year.

Operator

Your next question comes from David Wu with Telsey Advisory Group.

David Wu - Telsey Advisory Group LLC

Just first on the non-engagement side, can you talk about how the performance measured up to your internal expectations, and if you're still looking to make any adjustment to the merchandising mix? And any new offerings that you have lined up?

Harvey S. Kanter

This is Harvey again. The overall expectations at -- were similar to what we talked about in Q4, which we're evolving our strategy. So we have pared back, for lack of a better way to say it, the expectations for how quickly the non-engagement fashion part of the mix will ramp. As we've regrouped a little bit from our learning in Q4, we've moderated the expectation around the level of fashion the customer will accept today. And in the ensuing months and years, we expect that we'll continue to evolve but we've pared back our expectations. Conversely, we said that we underplayed the level of diamond jewelry in the mix and the opportunity to really drive the wedding band business. And I would say the broad-based themes are very similar in terms of our expectations to what I just spoke of. We're happy and comfortable with the evolution of how it's transpiring and in its build. And it's in line with, relatively speaking, with our expectations and obviously, in line with the guidance that we authored a quarter ago. The other half of your question, if you could just repeat that again that would be great.

David Wu - Telsey Advisory Group LLC

Just any new offerings that you have lined up that we should be looking out for.

Harvey S. Kanter

Well, I've made a couple comments in the opening notes. Without giving away specifics and secrets about what's coming, I would say that the 2 or 3 things that you can rest assured we will continue to do is we are growing the things that have been successful. We talked about extending Monique a little bit, and we will continue to pursue that. We've talked about the extension of the band business and we are continuing to pursue that. We have some, what I would describe as, enhancements that might be disruptive. They certainly will be industry leading in that regard. And then we're continuing to really drive the extension of the diamond jewelry business as we it -- the opportunity that the after fourth quarter was the biggest incremental opportunity for us to really grow revenue that we didn't take advantage of at the level in Q4 we could have.

David Wu - Telsey Advisory Group LLC

And with Monique Lhuillier, are you planning to extend it into the fashion side?

Harvey S. Kanter

Yes, we are and we've talked about that already. We really see the customer response to that being meaningful.

David Wu - Telsey Advisory Group LLC

And are you looking to do anymore exclusives?

Harvey S. Kanter

We are continuing to look at offering proprietary mix to the customer. And you can imagine that could take a couple different turns. But we do believe that the ability to bring to market no different than the 150,000 diamonds that are exclusively offered on our website. The opportunity to bring to market exclusive jewelry across both bands, diamond jewelry and other fashion is an important part of creating differentiation in the marketplace.

David Wu - Telsey Advisory Group LLC

Great. And if we look at the price point performance, are the ASPs still declining on the non-engagement side?

David B. Binder

David, this is David. So we talked a bit about how diamond jewelry and wedding bands really performed well and turned around from the fourth quarter. And those typically have higher ASPs than the overall average mix within non-engagement. But we're trying to see ASPs pick up a little bit versus where they've been in the most recent past. And the way we look at it is the cadence will shift around. The short-term focus for us, because there are so much opportunity, is to really accelerate growth in those product categories. As we are refining -- continuing to refine the product assortment in some of the more fashion categories, when we start to see traction there and if that starts to accelerate at a greater rate than the overall average, we may see ASPs start to come down again. That's something that would be a big dynamic for us, more so in the fourth quarter. It's a large percentage of your non-engagement revenue is going to come into the fourth quarter, and I would expect our businesses to evolve that way throughout this year.

David Wu - Telsey Advisory Group LLC

Great. And in terms of the marketing spending, should we start to see the marketing-to-sales ratio return back to more normalized level, in sort of the 4% to 5% range? And what's sort of the timing on that?

David B. Binder

Some of what really influences how much we invest on a common size basis in marketing has to do with the mix of revenue. With engagement continuing to over-index in its growth rate and become bigger as part of the mix, you would expect to see marketing spend relative to revenue starting to come down. The real -- the sort of mid- and longer-term goals for our business is to accelerate the non-engagement part of the business. And at that point, you might see marketing spend start to creep up a little bit. The dynamic would be that gross margins improve, marketing expense may increase as well, but your overall operating margins would expand.

Operator

Your next question comes from Ross Sandler with Deutsche Bank.

Ross Sandler - Deutsche Bank AG, Research Division

Just another question similar to what I asked last quarter, but I think you guys had said that you were not charging taxes in any state last quarter. Your guidance is unchanged for '13. So we assume you're not expecting to see any change in trajectory following this proposed tax legislation change. How do you look at the potential impact, if at all? And then how do you think about managing pricing in the face of what looks like an 8% increase in overall cost for online consumers, and I've got one follow-up.

David B. Binder

Ross, there was a lot of questions there. So -- and you have a follow-up. So first of all, we do charge sales tax in a couple of states. We've always charged sales tax in Washington state since our inception and we added sales tax in New York state in 2008. So we have a little bit of experience there. We don't really know what was going to happen with the current proposed legislation. It does seem like it's moving its way through Congress, and we're obviously watching that very closely. I would say that we currently don't expect it to be implemented this year, although it's a possibility. And we're prepared if that does take effect. But that is to say that it's not included in our 2013 guidance, as we don't expect it to be in place by the fourth quarter this year. Looking out to potential impacts to the business going forward, I mean, the way we look at it is our business has a fundamentally lower cost structure. We're based on a much higher level of efficiency. Our revenue per employee is $1.6 million, which is far and above the levels that our competitors spend, and we flow that efficiency through to our pricing. That price advantage that we have with our customers is regardless of sales tax. So we still see a compelling value proposition with or without sales tax. And we believe in the long run, our business is compelling and can continue on this trajectory. We are a little bit cautious that when you change the charges that you're imposing to your customers in the short run that it might be a little bit disjointed, but it's not really clear to us what impact that would be in the immediate term.

Ross Sandler - Deutsche Bank AG, Research Division

Okay. And then a question on customer acquisition, so have you guys -- I mean, you're trying a bunch of new channels. We've seen flash sales in non-engagement. Have you looked at -- I guess, how has the success been there? Is that a channel that you find as a high-quality channel? And then are things like Pinterest and some of the other new social media channels compelling from a customer acquisition standpoint? Or do you think it's going to be mostly kind of your core SCM display and older-school online marketing activities?

David B. Binder

Yes. Great questions, Ross. When we started to focus more and more on customer acquisition and lifetime value, we introduced a lot of daily deal channels and we went deeper in some of the more innovative, targeted display in social networking. Flash sales maybe is the lesser opportunity for us because it typically implies a beginning margin structure, which is inconsistent with our business model. But we did expand channels, particularly in daily deal sites at the end of 2011 and into 2012. And those are an ongoing part of our customer acquisition. The quality of the customers that we bring in are pretty high. They tend to be lower ASPs, new to the brand and good repeat rates. So we plan to continue to use those channels and make sure that the quality of the customers continues to be at that high level.

Harvey S. Kanter

Relative to social media, the reality is it looks like you would infer that it's accretive way to continue to push both awareness and engagement. And so we are continuing to really drive social media as a way to create sharing and engagement. And if you really look at the social media practice we have, it's most influencing and interacting with women, which is the greatest opportunity we see to engage them more and drive revenue from that gender, if you will. On social media, in terms of Facebook, we have a little under 450,000. On Pinterest, we have right around 40,000. We still believe based on everything we can see that we're in the top 1% of brands on -- jewelry brands on Facebook. And clearly, the #1 jeweler on Pinterest. Revenue from social media was in the millions last year without quoting you a specific number. And if you actually look today on Facebook, you would see that we launched a Mother's Day promotion called Thanks Mom. And it's -- all of the intent isn't about specifically driving a sale. It's about driving engagement for the brand and what we are doing. And through that, creating greater awareness and really a viral effort that will drive customers to the site. And through that, the most active level engagement really is what we feel [ph] in the industry, from our perspective, to look at social media as a great acquisition strategy.

Operator

Your next question comes from Kevin Kopelman with Cowen and Company.

Kevin Kopelman - Cowen and Company, LLC, Research Division

Just a question on international. How are you thinking about the opportunity there in terms of investing versus profitability?

Harvey S. Kanter

This is Harvey. We continue to look at the need to create the infrastructure and to be ready as the business in Asia evolves and the pace of opportunity increases. We are cautiously investing, but there's no question we are investing. We talked about the increased level of leasing space for our call center, for our fulfillment, our partnership. And that investment is moderate, if you will. But it's definitely with an orientation towards investment and growth as opposed to in any way really maximizing profit in the short term.

Kevin Kopelman - Cowen and Company, LLC, Research Division

Okay. And then just a follow-up on marketing. You talked about how the mix shift between engagement and non-engagement will play out in the marketing line. But it seems like at least in Q1 that you really got a lot of leverage there. It seems like even beyond whatever impact the mix you guys set [ph] -- would you say that's accurate? And is that more of just a one quarter thing? Or is that an ongoing trend and one of the key drivers?

David B. Binder

Great, great question. Marketing spend was at -- in 2012 in the first quarter, our marketing spend was 6.4% of revenue and this most recent quarter was at 6%. Some of that favorable variance or that more efficient variance has to do with the fact that the first quarter of 2012 we really launched our strategy to reaccelerate growth. And at that time, the business was 17% smaller. And for us to really get momentum in customer acquisition, the investment was a bit oversized for the scale of the business. You're absolutely right that in the first quarter of this year, our mix are shifting more towards engagement and our marketing spend is probably coming down a little bit faster than that mix would otherwise imply. And that really has to do with the fact that when you get to certain scale, you're going to drive efficiencies and marketing even as you're spending more dollars. So we would expect that cadence to continue somewhat with just the overall scale in the business. And frankly, we'd like to see the efficiency start to abate if we really get the mix shift more towards the higher margin products, we'll get that part of the business growing even faster.

Operator

[Operator Instructions] Your next question comes from Paul Swinand with Morningstar.

Paul Swinand - Morningstar Inc., Research Division

I just wanted to try to get a little more color on the international business. I know you said it's doing a lot better. It stalled out a little bit before. Is there any more color you can give us in the strategy and with an eye to making us think that it will be sustainable?

David B. Binder

Sure. This is David. I mean, we can go by some of the major regions and then look at initiatives that we put to market, and it is really about building a sustainable base to grow the business to scale. In Canada, we had been struggling. 3 quarters ago, we talked about investments we were making to expand our product assortment. So the full suite of what you could buy from Blue Nile in the United States is available in Canada. When we did that, we obviously, attracted more customers. It also gave us more of a platform to market. and all of those investments really started to pay off with great return to growth. Asia-Pacific is probably the bigger ongoing opportunity for us. With our presence that we are building in Mainland China, we're able to create more awareness, more marketing, more authenticity in the local market that is driving sales in Mainland China, but even more so across Greater China and Hong Kong and in other markets. And I would look at that and say it's a good growth story for us right now. It's incredibly small relative to what the long-term opportunity is. All of the distinct and unique elements of our diamond supply chain that has helped us get to a 4% market share in the United States selling engagement rings, that resonates in China. It's the same unique exclusive supply chain. So I think that we're in the very early stages and the investments that we made are just starting to bring us to market.

Paul Swinand - Morningstar Inc., Research Division

Okay, great. Just a question on -- I know you guys do a lot of analytics. And I guess you've made a good case that your customers on the engagement side are loyal and then loyal subsequently when you try to sell them something else. Can you give us any color or give us any analytics that suggests that somebody that comes in as a non-engagement or as a fashion customer in the first place, can we assume that they are loyal as well because some people would say that they aren't?

David B. Binder

Yes, and that's a good question. The non-engagement customers tend to have a greater repeat value to Blue Nile, which means the revenue that they generate in subsequent purchases is significantly higher than the revenue they generate in their first, and it over-indexes versus the engagement customers. So we have always seen them as great lifetime value and worthy of greater investment to acquire customers. In 2012, we used that thesis to drive more marketing dollars to acquire customers specifically in non-engagement. The result of that was we acquired customers at a rate equal to our historic high, which was great. And the customers that we brought in, they actually had a better lifetime performance that we could measure in the first year. So the attachment rate, which we define as the frequency of their second and third purchase was increasing versus historic levels and the values in their subsequent purchases were greater than we had seen with customers we acquired in prior years. So the thesis for us and the data still supports that acquiring non-engagement customers has a great lifetime value. For us, we're really focused on now getting the product assortment and the website experience compelling so that we can go deeper to reaccelerate growth there and to even raise the level of the customers to a higher level.

Paul Swinand - Morningstar Inc., Research Division

Okay, that's very helpful and interesting. Just a follow up on that, is the -- is that new segment of customers predominantly female, whereas the old engagement customers starting more with the male?

David B. Binder

There is definitely that dynamic. So engagement is going to be more male based than female based. Non-engagement is going to be more female than our engagement customers. We still are generating a lot of male customer purchases, both engagement and in non-engagement. And I think that speaks a lot to how well we sell high-value diamond jewelry. That's typically going to be an item that's purchased by a husband for a wife, a boyfriend for a girlfriend to mark a life occasion. And so we're still generating a lot of orders coming in the non-engagement segment for men, but more and more we're shifting that to females. And that's -- I think that's going to be an ongoing evolution for the business.

Operator

Your next question comes from Mark Miller with William Blair.

Mark R. Miller - William Blair & Company L.L.C., Research Division

I wanted to get your perspective on seasonality of the business in your outlook. It's a similar percent of sales first half versus what you've had in the first half of the year, say, for the last 5 years. But you have a higher percent of profitability in your plan in the second half. So how much of that does reflect an evolution of the business with your plans for more non-engagement jewelry and that being bigger in the fourth quarter? And how much of it does it reflect improvements that you're looking for as we move through the year? I know you're doing a lot with assortment changes and innovations around visualization and whatnot. But to the extent we have some key changes coming in the second half, if you could just highlight which of those are most critical to your plans. And then finally, in terms of the margin outlook, is it coming more through improved gross margins as we move through the year or leverage on expenses? I know that was a lot.

David B. Binder

That certainly was. I don't know how much of that I can answer, but I'm going to do my best. The seasonality is still a part -- a big part of our business, and the fourth quarter is going to over-index any of the prior 3. With our strategy, if we execute as we expect, we should be accelerating the growth in non-engagement at a greater rate, which starts to create improvement in your gross margin. We've said historically that non-engagement products tend to sell at twice the margin rate as engagement. And frankly, over the last 5 quarters, engagement growth has been so strong that we haven't seen a mix shift towards non-engagement. We think that eventually that happens as we evolve our strategy. And it happens in large part because it's so much more of a large addressable market. Throughout this year, the things that are really important for us are improved assortment, continued refined marketing, but we're really looking at improving the user experience on the website. Harvey mentioned that mobile is a big issue for us. We think it's a big issue in a very significant way in the non-engagement business. That if we can create a much more compelling user experience and greater visualization, your conversion rates improve and your non-engagement sales pick up. And that's part of the plan that we have this year. And in part, it's what we expect to drive some greater efficiency and profitability. We're also expecting the size of this business to be materially greater at the end of the year than it was last year or even at the beginning of this year. And with that, we continue to gain scale in our operating expenses and will continue to be very efficient there. We're a $400-plus million business with about 250 employees, and we expect that efficient model to continue even as we continue to grow and scale.

Mark R. Miller - William Blair & Company L.L.C., Research Division

This is a follow-up, David. Do you feel like the changes that are required for you to achieve this improvement in the second half that those will be largely in place by the second quarter? Or how much of this needs to be still iterative and learning about what the customer is really responding to?

Harvey S. Kanter

It's actually Harvey. The changes are less changes and more about an evolution and additions. And so it's - they're kind of increment us in many respects. They're not in replace of. So that's an important qualification, if you will, or articulation of what really we're doing. The other thing, which I would say is they're evolutionary in an iterative way so that you will actually start to see them roll out. Some will literally roll out in days ahead of us. Some will roll out in weeks and some will roll out in months ahead. The good news is that we feel really strongly about what we're doing. And the reality is things are moving pretty quick. Mobile is a perfect example where that whole space is moving at an accelerating pace and we recognize how important that is. And so what we're doing is rolling things out as they come online. We're not waiting for a big, ta-da, so to speak. We have multiple deployments. They will -- as I said, in literally days ahead, you will see some element of that. And our expectation is by the end of September, in front of the critical Q4 period, we will lock down the site and then just drive through Q4 status quo. And that's across everything from visualization to what we refer to as phablet, which is mobile and tablet, to some of the changes in how we bring product to market and the way we actually create the breadth of offer increases on the site. Because it's not literally just putting more product on the site, it's actually the way we're doing that, which is an iteration and evolution of what we can see today.

Operator

Your next question comes from Rick Patel with Stephens.

Rick B. Patel - Stephens Inc., Research Division

Can you talk about fashion jewelry within your non-engagement business? I'm curious if you're more confident with the assortment you have now versus what you have for holiday. And are you seeing any pockets of strength within that, that you can look to monetize as you go into the next few quarters and holiday?

Harvey S. Kanter

Great question. It's Harvey again. I would tell you that the way you characterize the question, inherently what we've already defined at our Q4 and what we've made in opening comments today, it's going to move forward and each month it will move farther forward. But basically coming out of Q4, we made some, what I would call, good adjustments. But they were adjustments given the 6-week time frame. And we will continue to evolve further. Without telling you specific product categories, you will see coming online in the next couple of weeks an evolution of one of the specific categories. And each month going forward, you will see either a change in the product mix, increments to a product mix or the evolution which we referred to. And specifically in fashion jewelry, and our fashion jewelry is obviously defined as everything other than diamond jewelry. But diamond jewelry, in addition, will also move forward. And so that was the place we actually were able to get the greatest traction in the first quarter, and you would have seen things. Coming out of Q4, we talked about some of the diamond jewelry that was most accessible in Q4, the most understandable element of fashion, which is really what you saw for Valentine's Day. And then as we roll into Mother's Day, you should have been able to see extensions of that, plus the other products that I referred to. And again, without -- if you're on the website, you would see it. If you're not on the website, I don't want to share for the world exactly what that product is that the consumers are responding to. But if you're spending enough time on the website, you would see that. The short answer, though, is that there's not -- until Q4, it won't all roll up, for lack of a better way to say it. So we're chasing it hard. We're trying to make sure we don't go too fast, which is what we really -- moved really fast for Q4 last year and what we said is we're going to allow this runway to be a longer runway and not chase something. With the new learning we have, we're going to let the customer be more, if you will, involved in the process by basically voting through their wallet, if you will, where they're purchasing. And so as that process happens, what we said is we'll accelerate the business, but that really will move into the end of '13 and quite honestly, into '14. And we've shifted our orientation, as we've already mentioned, with respect to diamond jewelry and bands, as we continue to learn about what the consumer believes is understandable fashion and how they actually are buying into that.

Rick B. Patel - Stephens Inc., Research Division

And you made some investments to last year as it relates to local language capabilities in China, and it looks like your sales grew very nicely in the first quarter. So can you delve a little bit more deeply into your international strategy for improving the user experience? Are you looking to add more local language websites or is it about improving functionality? Just help us think about that?

David B. Binder

This is David. You're right, we launched a couple of local language websites, in China and we also the Japan -- Japanese site. And we have diamond jewelry consultants who speak local language, and those are absolutely catalysts for growth. Looking forward, we are exploring a couple of languages that might enhance further markets that we are serving. But I think that there's a lot of investment potential and pickup in just bringing more product in distinct country-based pricing to each of these markets. By sourcing product closer to the customers in those markets, we are providing a better assortment. We're also giving a better ability to spend marketing dollars. The better the product, the better the ability to market and to generate awareness, and we're also looking at partnerships. Marketing partnerships like we announced with Xiu recently is a great way for us to leverage the language sites that we've launched and drive more traffic to it and sell more products through it.

Operator

And we have no further questions at this time. Thank you, everyone, for your participation. And that concludes today's program. You may now disconnect.

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