Blue Nile, Inc. (NASDAQ:NILE)
Q2 2016 Earnings Conference Call
August 8, 2016 5:00 PM ET
Nancy Shipp – Director-Investor Relations
Harvey Kanter – President and Chief Executive Officer
David Binder – Chief Financial Officer
Ryan Domyancic – William Blair
Ed Yruma – Pacific Crest Securities
Good afternoon, ladies and gentlemen. My name is Ian, and I will be your host operator on this call. Your lines will be placed on a listen-only mode. At the end of the presentation, management will be available for questions. [Operator Instructions] At this time, I would like to introduce Nancy Shipp, Director of Investor Relations of Blue Nile.
Good afternoon and thank you for joining us on our conference call today to review our Second Quarter 2016 Financial Results. With me today are 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 make forward-looking statements during this call regarding the Company's future performance. These statements are only predictions based upon 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 Reports on Form 10-K, and other forms on file with the SEC, identify important risk factors and uncertainties that you should consider when making an investment decision regarding Blue Nile, and that 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 internal 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 reconciliation of non-GAAP measures to the nearest comparable GAAP measures.
Now, I would like to turn the call over to Harvey, our President and CEO. Harvey?
Thanks, Nancy. Good afternoon and welcome to Blue Nile’s second quarter 2016 earnings conference call. Today we announced second quarter sales slightly above last year at nearly $140 million, and on an EPS basis we delivered of $0.18 per share. We have some meaningful wins but I will acknowledge upfront that these results are short of what we expected. We’re making improvements to the user experience and made a strategic decision within the quarter to increase our pace of investment. This creates pressure on earnings in the short-term, but we believe is the right move for long-term results and shareholder value.
Now I’ll provide some details and insights into what drove our results as well as an update on the user experience initiatives both online and off-line to improve the business. Sales in the overall U.S. engagement category decreased by 4%, in large part due to a continuous struggle with lower ASP in core price points. Engagement ring sales were actually strong for the quarter, and until we hit June, where we saw a deceleration in total unit sales, which significantly impacted the quarter. We are still assessing what happened, but the drop-off was broad across geography and product categories, such that we can't discount macro issues, given that June was an exceptionally volatile month for the U.S. and the world.
Regardless, we believe the steady-state of the business is one of growth though we are still cautious due to macro volatility. Conversely, the high-end of our business, which we define as greater than $25,000, performed better than it has over the last several quarters, and while it is still not where we wanted to be, we are encouraged.
Next is our U.S. non-engagement business in the U.S., which continues to grow overall. Our wedding band business had another quarter of double-digit unit growth, which makes 12 out of the last 14 quarters. Investments we've made to the user experience and our supply chain continue to pay off. Additionally the diamond jewelry units grew by double-digits, while sales grew in the mid-single digits. This is the second quarter of accelerated unit and sales growth. And lastly, our fashion jewelry margin rate grew moderately in spite of a small falloff in year-over-year revenue.
As previously communicated, we made a strategic decision to be less promotional overall. And we have fine tuned that strategy during the Mother's Day period, which was successful and provided further proof that this decision is a good one. Our designer partnerships continue to remain strong and are adding a significant and growing percentage of our business. What's more is that we are able to effectively utilize them in marketing activities designed to increase our brands awareness.
In fact, we are pleased to have hosted Colin Cowie just a few weeks ago, who spoke to the media and even built a ring at our fulfillment center. You can check out video on YouTube to see Colin building this ring. Outside of U.S. both Europe and China had double-digit growth during the quarter. Despite macro conditions including Brexit. This is the third quarter of accelerated growth in China and the fourth quarter of double-digit sales growth for Europe. Again, similar to our band business, this is largely due to the investments we continue to make in the user experience that are paying off. We will continue to refine our marketing, our assortment and our local presence to take advantage and accelerate growth.
Overall, international sales increased by 9% on an adjusted constant currency basis and increased by 6% in the quarter before the adjustment. With category results set. I'll next turn to our focus on user experience to improve the business. It is important to note that today's consumer doesn't care if you're online or off-line, they demand a great experience no matter how they choose to shop and on their terms. Enter the Blue Nile Webroom. We now have three Webrooms up and running with one over a year old, which is Roosevelt Field. This location continues to grow and exceed our expectations.
Importantly, our goal is to achieve financial metrics that are equal to or better than the overall Company's performance, and this is happening at Roosevelt Field. The initial performance from the two additional Webrooms is promising and we believe will accelerate as Roosevelt Field has over time. The performance has encouraged us for our fourth launch in Portland and a fifth launch, which we have accelerated and will hopefully open by Thanksgiving. The Webroom experience is fundamentally different than any traditional jewelry store and it's becoming clear that a segment of our customers want our easy, educational and pressure free experience in a physical environment.
Combining that with our online experience, we are bringing the online and offline worlds together. We called this retail re-imagined and we are running hard on both pillars to meet the customers demand for choice and shopping on their terms. In addition to the Webroom openings I discussed, we're also making significant and user-focused enhancements online that will help emulate the experiential element of the Webroom to continue to build trust for buying online.
We expect this to be in place in the fourth quarter. As good stewards of business, we continue to balance the higher spend on these pillars with profitability. However, we believe a potential trade-off in short-term financial performance will create long-term value for shareholders and we like our forward-looking direction. We are excited for the future. There's a lot of work ahead to create the best possible experience for customer but I know they're up to task. Why? The employees here at Blue Nile. They are passionate about the customer, they know that they play a part in most special moments of our customers lives and it is something they take extremely seriously. They have my deepest admiration and thanks. And now I'll turn the call over to David and he will discuss the details of our financial results. David?
Thanks, Harvey, and welcome to everyone on the call this afternoon. As Harvey mentioned earlier, our results demonstrate relative flat financial performance versus last year. In a period of low revenue growth and heightened investment, we yielded a modest decline in earnings by carefully managing the balance between gross margin, marketing and overhead fixed operating expenses. For the second quarter we generated sales of $113.8 million, a slight increase from the same period last year. We drove an increase in gross margin rate equal to 30 basis points of sales and $300,000. We also improved marketing efficiency, increasing traffic to the site while reducing spend by over $700,000.
The combination of higher gross margin and lower marketing spend delivered greater contribution in excess of $1 million versus last year, which is a great outcome. While performance increased at this level, we also increased investments in key initiatives that we believe will re-accelerate growth and profitability in the long run. The balance between higher spend on these investments, with improvements in gross margin and marketing efficiency, yielded a relatively flat bottom line, with adjusted EBITDA of $5.6 million, net income of $2.1 million, and earnings per diluted share of $0.18.
Now turning to the details; sales from our engagement products in the U.S. generated $62.6 million in revenue, decreasing by 4.4%. The majority of the decline is from lower selling prices as we continue to see relative weakness from orders at higher price points. On the positive, we generated growth in the number of rings sold which is the core of this category and a positive trend. I should also note the cadence of growth in the quarter. As Harvey mentioned, the first two months of April and May were relatively strong and we saw a market slowdown in June.
Looking forward, we are cautious about the short-term volatility while remaining committed to the investments we’re making to further improve the user experience with the goal of accelerating growth in the core of the business. Sales of non-engagement products in the U.S. generated $30.4 million, an increase of 5.9%. Wedding band performance was the biggest contributor growing at a double-digit rate and continuing with its solid growth for the past four quarters.
Sales of diamond jewelry grew, while fashion jewelry posted a small decline. Now shifting to performance outside the U.S., our international business drove $20.8 million in sales growing by 64% and representing 18.3% of total sales. The U.S. dollar continues to be relatively strong versus foreign currencies and on a constant currency basis international sales grew by 9.4%.
Asia-Pacific represents nearly 60% of the international sales with the vast majority coming from Greater China. Sales from Greater China grew by 11% continuing its acceleration from the previous three quarters. Additionally, sales to Europe increased by over 20%, led primarily by the UK. While we’re pleased with this result, we recognize that the volatility in currency rates in June was extreme and presents a challenge going forward. Our expectation is that sales in Europe and most specifically in the United Kingdom will be a headwind in the short-term.
For the overall business, gross profit increased by $300,000 to $22.4 million. Gross profit as a percentage of sales increased from 19.4% to 19.7% up by 30 basis points, which is primarily due to a mix shift from engagement to non-engagement products. Our engagement category made up 70.5% of our overall sales compared to 71.9% in the prior year. Going forward, we see opportunities to continue to increase gross margin through our initiatives to use analytics to drive pricing decisions as well as through further strengthening our product sourcing.
SG&A expense totaled $19.1 million for the quarter compared to $18.7 million last year, an increase of $400,000. This level of spend equals 16.8% of revenue, which is 40 basis points higher than prior year. The majority of the increase is associated with investments we’re making to enhance the user experience both through online features, as well as the build-out and operation of our Webrooms.
During the second quarter, a greater opportunity developed to accelerate user experience initiatives on our website to help drive more qualified traffic and convert visitors to engagement purchasers. Through this work, we identified approximately $300,000 of previously capitalized software that was no longer consistent with this opportunity. The decision resulted in the charge equal to $0.02 share in the second quarter and the incremental investments we continue to make are factored into our guidance.
Marketing in absolute dollars decreased by approximately $700,000, and as a percentage of sales decreased by 65 basis points. We continually work to strike the right balance between marketing spend and the opportunity to generate revenue growth and are encouraged by the higher level of traffic we’re driving with this level of spend. Net income totaled $2.1 million decreasing by $200,000 versus last year. And non-GAAP adjusted EBITDA for the second quarter was $5.6 million decreasing by less than $100,000. As a percentage of net sales adjusted EBITDA was 4.9%, versus 5% last year.
Second quarter earnings per diluted share equaled $0.18 versus $0.20 last year. Stock-based compensation expense equaled $0.07 a share, which is flat from the prior year. Again I should mention that the decision to write off internally developed software yielded an expense of $0.02 per share. Our inventory balance equaled $43.4 million compared to $36.8 million last year. A large part of the increase is from loose diamonds, which are in the process of delivery to customers, or held for future sale and carry favorable margins.
We ended the quarter with $36.6 million in cash compared to $39.7 million last year. Cash flow from operations over the trailing 12 months equaled $9.3 million, over this period we used $8.1 million to fund a special dividend and $800,000 to buyback shares of which $300,000 was spent in the second quarter this year. Now I'll conclude this portion of the call with our guidance for the third quarter and full year of 2016.
For the third quarter we expect net sales between $107 million and $111 million and earnings per diluted share between $0.11 and $0.14. For the full year, we are maintaining our previously provided guidance of net sales to be between $465 million and $495 million in earnings per diluted share of between $0.88 and $0.95.
Now I’ll turn the call back over to the operator and we will be happy to take your questions.
[Operator Instructions] And our first question comes from the line of Ryan Domyancic from William Blair.
Hi. Good afternoon. On the U.S. engagement, you said you saw the trend slow in June, has there been a noticeable reversal in trends during July and August?
Hey, Ryan, this is David. The cadence was really interesting and obviously it was something we felt we should call out in our comments, June was markedly tough versus the prior couple of months and July started equally tough. We've since seen an improvement and we have cautiously included that improved performance within our range of guidance for the third quarter.
Okay, helpful and then during June, again, nothing on the marketing side that Blue Nile did differently and nothing it saw in the marketplace that its competitors were doing differently?
No. I mean that's a great question. Nothing markedly changed in the cadence of our marketing spend even the traffic to the site and what was interesting about the cadence of growth was how broadly felt the slowdown in June was. So it wasn't just the United States, it was international. It wasn't contained just to the U.S. engagement part of our business, but it was broadly across categories. So the competitive position versus others in the marketplace, that continues to be very active, but we wouldn't say that June was markedly different.
Okay, that's very helpful and that one more. On the Webroom, I think your first Webroom opened about a year ago, can you speak to the revenue productivity of that Webroom and how it's doing against your long-term goals?
Yes, this is Harvey. The way we have typically characterized it is fundamentally maintaining the model of the business and that's based in the $1.4 million of revenue per FTE equivalent we have as a business and a Company. And so a typical Webroom has between five and six employees, a GM and typically five collaborative selling people, so if you think about it in that way and $1.4 million of revenue you kind of get sense of where the overall revenue of the store is. And what we are looking to fundamentally achieve is that kind of revenue base in the store that's typically 500 to 700 square feet and then flowing through to the bottom line in a way that's similar or even accretive to the overall business.
Okay. Great and then finally, I promise last one – you've got the second class of Webrooms, are they performing in line with the first Webroom on a relative basis of where they are at in their lifecycle so far?
Well, I would say again. This is Harvey, I would say that one is performing slightly ahead and one is somewhat behind and I would say somewhat being more slightly than materially. But the dynamics are different, we are learning a lot as we go. Our expectations, obviously with really accelerating a fifth Webroom and trying to get it in this year certainly would imply that we are comfortable with where we are in the development of the concept and the ability to actually build trust and convert customers, albeit online, in a Webroom environment.
Great, that makes a lot of sense. Thanks for the additional color.
And our next question is from Ed Yruma from Pacific Crest Securities.
Hi, good afternoon guys. Thanks for taking my question. I guess first on the Webroom again, I understand, thank you very for much for the helpful FTE commentary; but just maybe looking at it differently, if you look at the sales in that market with that catchment area versus maybe where you were last year, are you seeing a market lift in performance there when you do put the Webroom in?
Hey, this is David. What we are seeing is a pretty contained area around the Webroom is outperforming versus how it would have performed given the historic trends. So we're seeing the market lift by an amount that's pretty much comparable to what we are attributing to direct sales coming out of the Webroom. So it is improving the overall performance for that geography.
I know you also indicated that you made some changes or enhancements to the user experience, you called out a write-down of some software. I guess could you kind of characterize how the user experience has been changed and kind of maybe if you've seen better results out of some of these changes?
Sure. This is David. The enhancements that we are making are really in progress. What we have seen is some of the features that we've launched haven’t worked well enough across devices, so being able to work well on the phone, tablet and PC equally, and we've got early readings on some development that we're doing that works much better. It is an ongoing initiative, we'll always be investing to make the user experience better, but what we saw was a specific opportunity to accelerate development in an area that we believe can have a good impact as early as the fourth quarter this year and that's factored into our guidance range.
Got it. And one final if I may. You noted the improved performance of the above $25,000 price point, can you segment what may be driving that? Do you have any international consumers that may be turning the needle there or what changes have you made that will improve that business? Thank you.
Sure. This is David again. I think if anything, the improvement at the very high and may be a comp issue where we've now gone almost two years with it softening and we may have reached a new baseline and hopefully can grow from here. We don't see – there is material additional actions we can take to make that part of the business perform better. I think that we do well in that segment in part because we have great assortment, incredibly compelling prices and great quality. To add onto that incremental marketing or an additional element to the user experience, I don’t think in a targeted way, would help improve performance at the very high and. If anything, that part of the business seems to move with macro conditions and historically we have felt that it's moved a little bit ahead of the rest of the purchasers.
Got you. Thanks so much.
[Operator Instructions] At this time, I'm showing no further audio questions. I’ll now turn the call back to David.
Thank you, Ian, and thanks everybody who joined the call today. We look forward to giving you an update after our third quarter results.
Ladies and gentlemen, this does conclude today’s conference call. We thank you for your participation. And you may now disconnect.
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