Blue Nile's CEO Presents at Morgan Stanley Technology, Media & Telecom Conference (Transcript)

Blue Nile, Inc. (NASDAQ:NILE) Morgan Stanley Technology, Media & Telecom Conference February 26, 2013 5:30 PM ETExecutivesHarvey Kanter President & Chief Executive OfficerDavid Binder Chief Financial OfficerAnalystsAndrew Reid Morgan StanleyAndrew Reid Morgan StanleyHi, my name is Andrew Reid. Im Morgan Stanleys Small Cap eCommerce Analyst and Im joined by Harvey and David, CEO and CFO respectively of Blue Nile. Were very excited to have them today. Thanks for coming.Harvey KanterOh great to be here, thank you.Andrew Reid Morgan StanleySo I guess Id just like to start off by asking a little bit about kind of how 2012 went kind of relative to your expectations coming in. Harvey, you joined in March of 2012 so its not a full year for you so some of the things that went right, some of the things that you feel like you could improve on here in 2013.Harvey KanterSure. Well, it may not be a full year but it feels like a couple I can tell you. We covered a lot of ground. Were actually pretty excited about our results. An interesting dichotomy if you will is we are excited about our results and yet we fell, relatively speaking, short of guidance. And so thats the dichotomy. But we had a pretty big plan. What were most excited about is the sequential acceleration of our results. So for those of you who are not truly familiar, in round figures we went from 3 to 13 to 20 and accelerated into Q4.Our core business, which is I think the most exciting element accelerated the most. We had a really meaningful result and engagement and in fact it was the highest level of success both in absolute performance and relative growth in over five years. And we also had a pretty big initiative to grow new customer accounts, and we almost met the highest level of absolute customers in the history of the company within literally a stones throw but it was the highest level of growth in over five years as well.So those are really meaningful results. We ended the year at plus 15%; we ended Q4 at 21%. We had a 16% increase in net income and so theyre really meaningful results. My reference to feeling like two years is I came in in March, we reorganized a little bit some of the team. We ran pretty hard at resorting parts of our business and then we spent three months trying to get set for Q4, and Q4 as many of you know wasnt quite the Q4 everyone expected. And so it was kind of a challenging environment to have executed all that. And then we ended the year in a really great place. So our inventory was leveraged to last year. It actually came out measurably less liable if you will which was really exciting and we thought we were well-positioned for 13. And weve authored pretty meaningful growth in that category. Last but not least I would say that some of you have heard us talk about non-engagement, and were really excited about continuing to build upon the core of engagement. But in non-engagement, it didnt work out all as we had anticipated. Having said that, we still think strategically where were headed, which is to grow the customer count to engage the female part of our consumer at a higher level and to grow the repeat business inherent in non-engagement in the female consumer is still strategically absolutely the right direction.Were evolving how we execute that at a tactical level but its important that you know the consistency with which we continue to move forward in terms of really driving that is the strategic, for lack of a better word directive. And I would qualify it as timing more than a change in strategy.Andrew Reid Morgan StanleyThank you. So if we take a look at where you are in terms of the customer base in both the engagement and non-engagement business as well as the merchandising mix, can you talk a little bit about how you see that evolving? I guess in engagement it sounds like things are going just fine. In non-engagement, is it going to be that you want to spend more marketing dollars to market to a wider group of potential customers or is it that you want to take the current customer group you have and just merchandise to their preferences more?Harvey KanterIts actually both. Its comical when you ask a question you cant answer it directly, but its comical because quite honestly there are initiatives underway that I can reference which specifically address really optimizing the core customer we have, that old colloquial of The best customer is the one you have. We believe theres a lot more business in both addressing his needs after he gets engaged, which is our core customer as well as her, and shes already coming to the website. 60% of our traffic is generated by a female consumer and so we believe theres an opportunity to engage her in a more concrete way. And were doing a lot of things which we can certainly talk to to engage and maximize the opportunity with her in terms of revenue. The flipside of it is our acquisition pursuits, we have an expectation that well have as many new customers coming to us this year through our acquisition priority as we did last year on an absolute number, and thats pretty meaningful. So if I could Ill just segue a little bit. I want to talk about what were doing to basically optimize the current customer is two really big strategic things. One is enhancing the level of feature functionality that is critical for us as an internet player to create as much of a, for lack of a better way to say it a brick and mortar environment as possible in a way that makes sense; so site visualization or product visualization, 3600 video, photographs of our diamonds, band matcher which is basically the ability to attach more and more bands to every engagement transaction by literally showing which bands go with which engagement rings. Those seem rather rudimentary on one level but the fact of the matter is were not as advanced in all those elements as we want to be. The other one which will engage the current customer but really engage her or him where they want to be when they want to be engaged, which is begun by creating parity of our PC across all mobile environments. So we like to think we coined the term [phablet] although we know we really didnt, but phablet is basically phone and tablet. And one of the challenges is a lot of the really robust feature functionality on the PC doesnt translate today to the browser-based environment of the mobile.And so a lot of what were doing is literally bringing those all the way through the, for lack of a better way to say it, channel agnostics and to have the same browser experience. At that point youll be able to build your own jewelry, advanced diamond search and a lot of elements that will then address the core customer where they want to be addressed, when theyre willing to access our business. But that will grow the core customer, the one we have today.And then obviously as we evolve the engagement business, continue to invest in our marketing elements, we believe that well continue to grow the brand of Blue Nile creating a better level of awareness for what we stand for and actually engaging a new customer. And so thats ultimately why I said both.Andrew Reid Morgan StanleyOkay. So if we look at what youve kind of just gone over, I think one of the interesting opportunities that you guys have is to make inroads into the non-engagement side of the business. I think to your point it didnt go as well as you would have liked it in 2012 but that potentially could have been because of the fiscal cliff towards the end of the year.How do you think about your strategy going into that because youre obviously marketing to a different consumer whos going to be making the purchases and so a lot of people may think that thats going to necessitate either a brand or you going out and acquiring jewelry from name brand designers.Harvey KanterYou know, theres three really big things were trying to accomplish. One is just plain and simple awareness. I would tell you that a perfect example, for Valentines Day I bought my daughter who is not our target customer, but I bought her some jewelry for Valentines Day and she literally asked me where I got it. And it was kind of mesmerizing that she could ask that about a jewelry store but she thought it was really great. It was for Valentines Day and the fact of the matter is she told me she had an experience where a lot of people said Where did you get it?That in and of itself is one of our challenges, that we start with a male customer, hes approximately 30 years old and in the engagement business. We dont transition him through lifes great events and so thats one of the challenges, which is after you buy that engagement ring theres birthdays, theres anniversaries, theres Bar Mitzvah gifts, theres 75-year-old mother gifts. Theres all those things that we can do and we dont do a good enough job, so thats one element.The second element, what were trying to do is as we think about evolving the non-engagement side of our business is evolve our perspective. So some of you have heard us talk about fashion and one of the things that hindsight is 20/20, we went a little too far in fashion and we didnt have enough data to understand when we initially went through the resorting process the degree to which we needed to evolve. And for us, non-engagement is bands, diamond jewelry and what we call other fashion which is gems, silver, pearls, gold, and Im forgetting one. That other side of the business, that other fashion we went too far, and basically the customer said Which was great learning, but basically we went too far in terms of the level of fashion in the mix. And conversely, after we went through a deeper dive of five years of data we actually understood that part of what we didnt do was grow some of our businesses that made more sense using the data that we have historically in-house that said diamond jewelry was a bigger opportunity than we anticipated.So when we grew fashion, non-engagement we went after things like gems. We went after diamond jewelry but our style count was not growing in diamond jewelry at the same level as the fashion side of the business; i.e., gems and things of that nature. And so hindsight 20/20, we had the customer tell us they wanted more diamond jewelry. The velocity of diamond jewelry was better, the productivity was better. The style count wasnt as robust.Conversely, we went after the gem side of the business not only did some of the fashion not sell but we were over-sorted, it was not as productive as it needed to be. So were regrouping in that and over the course of time we expect that our non-engagement business will evolve. So again, I said before strategically were still pursuing the same things but tactically how we execute it is the learning weve had out of this year. And honestly, the Board, we feel really good about that learning because had we not learned and the business just not worked if it was more homogenized, our results, we wouldnt have seen the ability, the roadmap to steer into the new place.David BinderI think its also interesting, if you look at the market sizes so when we look at non-engagement, the addressable market in the United States its about $50 billion in total. That comprises wedding bands which we already are speaking to those customers, and wedding bands is probably $4 billion to $5 billion of that total addressable market. So its sizable and its also an audience that were already addressing.Diamond jewelry is about $25 billion and thats an audience that in part were already speaking to because were talking to a guy whos coming to the site, whos trying to understand the attributes about diamonds that can tell him to make a purchase. It speaks to the unique elements of our supply chain, that weve got deep competitive advantages. So some of the addressable market, the largest pieces of that addressable market were already speaking to those customers through what were doing on the engagement side.The extension into some of the more fashion elements that are outside of diamond jewelry or outside of wedding bands is a great opportunity for us and we can broaden the audience we speak to, in part because its off of the back of the brand that were building in engagement and wedding bands and diamond jewelry. Theres a lot more frequency there, its a bigger audience but its something that we can grow into gradually while were really exploiting large opportunities within diamond jewelry and wedding bands.Andrew Reid Morgan StanleyWould that strategy necessitate you to really focus on you appealing again to that male demographic? Or how do you make that transition from selling the engagement ring to the guy, the fianc, and then getting him to essentially get his wife toHarvey KanterTheres probably at least a couple different ways. One is our marketing is evolving. So personalization, lifecycle marketing we have definitely not maximized that opportunity. So I mentioned when hes 30 years old and buys that engagement ring, all the lifecycle events happening after that we really havent maximized that. The other thing is, you asked the question do we have to address her differently we dont look at her as like a distinct customer that is like Blue Nile and some other business. Shes already coming to the site. Shes buying a lot of elements that are on the site. Were not maximizing that through all of the offer. Weve been fairly finite. The bulldog part of our business is new customers that dont know us as opposed to different customers, so the way youve characterized the question a little bit at least our perspective is that we dont have a different customer. We have to engage her in a different way.Andrew Reid Morgan StanleyOkay. And Dave, you were speaking about data and going through five years of data before. What sort of technology do you bring to your merchandising strategy? Or when you think about how to optimize your business, how do you use data to help make better decisions?Dave BinderSo Blue Nile has been founded as an online retailer with very rich data analytics and tools. It really started with selling what was 20,000 or 30,000 loose diamonds now up to 150,000 loose diamonds, and understanding how to optimize the velocity, the conversion rates; and when customers decide to buy and when they dont so that we can optimize margins versus sales. So theres a deep set of analytic tools thats spread pretty deeply throughout our organization to understand what works and what doesnt.Whats happened over the past three or four years is weve extended those tools to really understand how to optimize marketing spend for customer acquisition and how to optimize the merchandising of non-engagement jewelry. And thats something thats been relatively new to us: adapting those tools and empowering the people who run the company to really use that analysis to figure out what is the right product and what is the right pricing.I would say that with all of that deep, rich analytic tools at the foundation of Blue Nile we didnt necessarily have deep merchandising capabilities. And so when we re-launched our strategy at the beginning of 2012 we in part recognized that we are a merchant, and as we broaden the products that we sell we need retailers. We need people, merchants who can use that data in a different way to broaden the assortment, and then came Harvey.Andrew Reid Morgan StanleyOkay. And I guess taking that one step further in terms of bringing retail experience, whats your view in terms of trying to go out and create more partnerships, relationships like you have with Monique Lhuillier to really kind of drive brand awareness at Blue Nile?Harvey KanterYeah, Monique Lhuillier has been a really phenomenal success story. We actually hit our numbers and I joked with David, he was the one who thought we were reaching too high but we had a really good result. We were very happy with it. The interesting thing is part of what shes done for us is shes bringing us cache as a designer, shes bringing us fashion orientation. Her average price points are higher than our current price points; her margin is slightly higher than our current margins but what shes done for us is exposed lots of further opportunity. Its interesting her fashion, to the extent its understandable, has sold better than her highest level of fashion which actually correlates well with our non-engagement history in Q4. But what shes also done is created the ability to understand that shes not just a bridal company. So I was telling some of the folks earlier in the day that when she hit, the very first week she hit we sold 21 units and that doesnt sound like a lot. But when her average price point is $8000, $9000 its a meaningful number. The 21 units were comprised of 13 units of bridal engagement settings and 8 units of bands, and that in and of itself is normally a one- to three-month process. But customers knew she was on the site and the minute she hit it sold.The second element thats really exciting about that is that bands historically dont sell at that level of ratio for us thats why I referenced the fact that we believe we have a band opportunity to grow attachment rate. But what we perceive is that many women in the beginning were buying bands that basically were for jewelry, not necessarily to be a wedding band to go with your wedding ring. And so we believe the opportunity to grow fashion jewelry with Monique is relevant and well actually launch some small level of fashion jewelry with Monique in the second half of this year.But then also if you think about all those data points that I just suggested, we believe that if we can land another what we would define as cache, industry-leading really relevant designer that will augment our business And were not looking to just bring brands in with nameplates because Blue Nile wants to have exclusivity just like in diamonds, with something really rich and meaningful. But when a brand creates a fashion umbrella for us, heavily engaging with the women consumer because we know women were directing that purchase that first week, not men; and has already an orientation to jewelry we believe theres an upside and more a brand offer. And were exploring that but I would tell you its a very slow burn. Were not looking to just add names for the sake of names.Andrew Reid Morgan StanleyOkay. So do you think that as you look to, and I dont want to say create a portfolio of brands or designers but is that going to be enough to essentially offset what you have offline, your competitors there? Because I think if you just look at, whether it be department stores or specialty retail jewelers, they are spending a whole lot more on marketing. So how do you get some sort of asymmetric leverage out of your business to compete with them?Harvey KanterYeah, I would say first and foremost we are not looking to become, no ill intent, but a portfolio of brands. We will be very selective in what we bring into the Blue Nile business, number one. Number two, what we really are looking at is, and Moniques a perfect example she literally was labeled as one of the top 50 most powerful women in 2011. Shes one of the top They say shes the 14th most well-respected designer in the world out of the top 15. She really brings us an element thats an adjunct to what we do, and as we look to bring in more fashion or more elements of what she does, what well try to do is evolve the perspective that its not about literally more its about the viral nature of what she does and the unique elements of what she does. So if you dont know much about Monique, the other elements that support that is she has a special occasion dress line today. She just launched Italian shoes. She is well-known in the red carpet Oscars, What are you wearing? Shes one of the people that people say theyre wearing, now theyre wearing her jewelry as well as her gowns.And theres a viral element she has a huge Facebook following, a Twitter following, a Pinterest following and that aligns really well to our own social media practice where we are literally the worlds leading jeweler on Pinterest and I do mean that literally. There is no jeweler larger than us on Pinterest and we are one of the worlds leading jewelers on Facebook. And so theres a viral element of that where we wont push branding in terms of offline marketing programs a la Macys because were just not a general merchant. Its really about dialog, engagement and the viral effort and what Monique brings to us is so many elements of that in a social media presence.Andrew Reid Morgan StanleySo just really quickly and then well go to questions in the audience, your stock price has come down since reporting Q4 earnings. And youve put a credit facility in place. Youve bought back $40 million of stock in each of the past two years. Is there an opportunity here to do something in terms of a leveraged recap or something maybe even more substantial?Dave BinderSo well our stock came up a little after our earnings release, I just wanted to clarify that. So I mean we continue to view the share repurchase as a good way to provide shareholder value. Our business is cash flow rich; we have a negative working capital model which Im sure most people are aware of. With growth we generate significantly greater levels of cash flow than our net earnings, and so we believe deploying that cash to repurchase shares if the opportunity presents itself is still a good way to benefit our long-term shareholders.I wouldnt say that its necessarily our design to then leverage that into a cap or to do anything thats bigger or more transactional in nature. Its really to enhance the yield if we dont feel like were getting the right valuation in the market on our stock. And I think its a very fair thing to point out our stock tends to be very volatile, and so if its in a volatile cycle where the price is relatively low given what we think the fundamental valuation is of even the engagement part of our business as a standalone we think using excess cash to buy back shares is the right thing to do for shareholders.Question-and-Answer SessionAndrew Reid Morgan StanleyLets turn to the audience to see if you have any questions. AnalystIn the example of Monique, if you hit it out of the park how many brands, how many names could you sign up like that over a period of time? And if Im, let me inject an internet word I guess are you kind of building a marketplace inside Blue Nile with these brands?Harvey KanterIm going to not really totally answer your question, but the first answer is I dont know. We dont have a vision that well be 20 or 30 brands, we dont have a vision that its only two or three. In answer to your second question is kind of a hybrid of that: we have a belief that content and being a website that is more than just a, for lack of a better way to say it, a website that hawks goods, that sells stuff we can become a really highly-engaging place to spend time. I say this a lot but my wife is a perfect example. I reference that a lot she sits on the couch at night, she watches TV with her tablet and what my vision, my hope for our business is we will be one of the places she just goes to for content. And so at that point if Blue Nile is such an important part of her life, whenever she thinks about jewelry shell come to Blue Nile. And she does Huffington Post or things of that nature where shes just looking at whats the buzz. If we drive content vis--vis designers and its not just what the designers selling but whats on the runway, where theyre showing, whats relevant, whats fashionable that collision in a positive way of commerce and content will make the Blue Nile brand a really rich part of consumers lives and thats really what were ultimately trying to do. And at that point, when shes sitting on the couch with the tablet well have the best avenue to convert her and really have that incredibly loyal customer.And more designers by default doesnt make that incredibly loyal customer. And more designers by default doesnt make that happen. The right designers creating the right content is really the dialog were trying to create.AnalystAnd on that point you have some very nice jewelry in your store, and obviously they come from people who design these items very well for a big price tag. So I guess what we dont quite understand is how many designers are you actually working with now as a total? And when you market someone like Monique, how does that change that channel that you already have in place? And where are you going with that too, because I think part of it is we dont understand how many designers youre working with already.Harvey KanterYeah, we actually dont truly have an array of designers. We actually brought in, since the merchandising evolution in the organization, a Design Director. She is literally an educated Philadelphia School of Jewelry Design, and shes an educated 45-year-old woman whos been in the business a fairly long time. Shes in our in-house kind of design director, and thats her title Design Director. Beyond Monique there is no design entre if you will to a host of designers. We work with a pretty defined set of suppliers and those suppliers have in-house design and they design exclusively for us, but theyre not cache designers. Theyre just what they are theyre in-house designers, and that is for both our jewelry business as well as our setting business. Its a pretty narrow supplier base, so we have long-term relations with these people. But they are part of their design company and theyre designing for their broad company, and then a subset of what they design is specifically for us.Andrew Reid Morgan StanleyIll just interject with another one here. So in 2012 you guys benefited at least in the earlier part of the year with easier comps in the year-over-year diamond price decreases. As were into 2013 now you guys have guidance in the market that includes kind of an estimate of a 5% to 10% increase if I remember correctly. Where does it start to get difficult to continue to grow your engagement business as diamond prices are increasing?Dave BinderSo historically, well before 2011 which was when it became really volatile in the market, diamond prices would tend to increase 5% to 10% gradually, and there was a pretty well-managed gradual inflation in prices. Thats an environment where in the past Blue Nile has grown the engagement side of its business in the double-digit range. And so we feel like that is still a comfortable environment where the value proposition that we have resonates.If we see heightened volatility going forward and we start to see growth in diamond prices that are materially above 10% well probably get a little bit concerned that we will be in a rough period like we were in 2011. But historically speaking with moderate inflation Blue Nile is well positioned to grow.Andrew Reid Morgan StanleyAnd so if we look at 2013, can you just maybe highlight the top three opportunities or low-hanging fruit? You mentioned band attachment-Harvey KanterYeah, I would say theres no question the three biggest opportunities are to evolve merchandising and marketing, and that has been part of the reason I was hired and part of the reason I joined. The second one is the mobile parity mobile parity and bringing PC functionality to the mobile-based environment and adding feature functionality across all environments is a critical technological requirement. And then the third one which we really havent spoken about at all but its international. We believe the Asia-Pacific market is a really, really meaningful market. Some of you have seen we announced a partnership with [Sho], we have invested in a partner a year ago, [Vay] that has brick and mortar storefronts. Our President of International literally has been to Asia three times already this year I head over next week. Its a critical priority and we believe that the Asian market in totality will for certain be this years biggest international market for us and the growth is long-term the biggest opportunity we have. So those are our three big, big ideas.Andrew Reid Morgan StanleySo any opportunity to chip away at those, you referenced maybe 1.7 million to 2.0 million weddings or marriages each year, to grow market share in the core engagement?Dave BinderYeah, well with 2012 growth around 20% in our engagement business just in the US were clearly gaining share and that is the plan. We see the market as potentially growing at a moderate pace, so for us to grow significantly were taking share and that is the plan. We think that were over 4%, approaching 5% of the market in the US its about a $5 billion market for people spending on engagement rings. And weve always felt that we should be a double-digit market share player and thats the path that were on.Harvey KanterA lot of reference points to mobile parity and bringing the PC feature functionality to mobile will actually materially grow the engagement side of the business. Just the fact that consumers are looking to engage in mobile environments and we have rich feature functionality on the PC that cant always be accessed in the mobile we think will really materially change engagement for us and support part of continuing to prop up that in spite of what transpires with pricing. And the tailwinds we had last year, whether we have them or not we probably wont have them at the same level, but theres other pretty linear data points that should prop up and continue to drive the engagement side of the business.Andrew Reid Morgan StanleyOkay. As you continue to grow in the non-engagement side, do you believe that thats going to become much more capital intensive and is that going to have an effect on your free cash flow?Dave BinderSo I mean we do take on inventory primarily for the sale of non-engagement products. The design of our terms and our cash flow should yield neutral or negative working capital. If we can turn products four times a year our terms are such that we would be in a negative working capital position. Over time, it would be even better if we can figure out more of a consignment model. So we can strive for negative working capital in non-engagement with good execution but with risk, and if we can get to a consignment model its with much less or no risk.Harvey KanterOne of the interesting data points, and in absolute dollar volume its meaningful in millions but its not meaningful in tens of millions but if you look at our website today we have the Red Carpet Selection and that was actually offered specifically around the Oscars. But in Q4 we tripled what we call our extraordinary business and its exclusively consignment. Its much more upper-end price points - $10,000, $20,000, $30,000 price points or more but its what David alluded to in terms of trying to transition a bigger piece of our business to consignment.In the lower price points its harder to get the jewelry manufacturers to put consignment for $100 items so we dont have a vision for that, but as we continue to migrate our business the ability to move that model more and more into jewelry is a really rich component of the model that would work well financially.Andrew Reid Morgan StanleyAnd so is the consignment model just pure margin after the marketing you put behind it?Dave BinderPretty much. We dont own the inventory.Andrew Reid Morgan StanleyAny other questions?