Pre-Holiday Interview With Blue Nile's CEO

Brendan Byrnes sat down with Blue Nile  (NASDAQ: NILE  ) CEO Harvey Kanter on Cyber Monday to get some more color on the company's recent third-quarter results, discuss trends in the online marketplace, and see what the company has in store for the holiday season.

A full transcript follows the video.

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Brendan Byrnes: Hey folks, I'm Brendan Byrnes and I'm joined today by Harvey Kanter, who is the CEO of Blue Nile. Thanks again for sitting down with us today.

Harvey Kanter: Hey, Brendan, it's great to be here today and kick off Cyber Monday.

Byrnes: Definitely, and we'll get to that in just a second, but I want to go backwards, just for a second. Your third quarter, great results, and actually now expecting record sales for the full year in 2013; tell us a little bit about some drivers there, and tell us about what we can expect going forward, as far as fourth quarter, which is always your biggest.

Kanter: Great question. You know, the reality is, last year in Q3 we had a 20% increase and in Q4 we had a 21% increase, so we're up against some pretty tough comps, driven last year by engagement. The good news is that engagement continues to be really successful. We had a double-digit increase on top of last year Q3, and the success of that is being driven -- as I said by engagement -- but also non-engagement is starting to come online.

We had a double-digit increase in the second quarter in non-engagement. In the third quarter we almost had a double-digit -- we were plus 9.4 -- and our expectation for Q4 is to see real acceleration of the non-engagement category, and continue to drive engagement. When it all comes together, it just makes great music.

Byrnes: I think a lot of people are still surprised that a lot of people actually buy engagement rings online, which is the biggest part of your business, of course. What is the breakdown, roughly, versus traditional?

Kanter: About 70% engagement and 30% nonengagement. Non-engagement is actually wedding bands, diamond jewelry, and fashion jewelry, so it's kind of an aggregation of a couple different categories.

Byrnes: I think some people say, "Why would I make this big purchase online?" But at the same time we've also seen a huge shift toward mobile from desktop, etc., so there are a couple of different factors at play here. What are some of your competitive advantages, first of all, against the brick-and-mortar stores, especially, as they come increasingly online as well?

Kanter: You're right, there are two real distinct elements to our business. One is, the fact of the matter is we've been around since 1999 and we've created such strong education, counsel, and guidance, with value that's 20%-40% below traditional brick-and-mortar stores, and the quality that is certified by the GIA, that they just have a great deal of trust and confidence in what they're buying.

Quite honestly, we sell every day -- regularly, at this point -- $40,000 purchases on a mobile device, and upwards of $200,000 purchases with some degree of regularity; certainly not at the same level of the $40,000 purchase. That, to us, is a really strong part of why we've had 14 years of success.

Rolling all the way forward to today, mobile. Mobile, mobile, mobile. We almost delivered 60% of our traffic last week in the mobile business, and had about 25% of our revenue last week driven by a mobile device. I think that's driven by our leading industry customer experience that we've rolled out, which is really agnostic device interaction, simplified experience across every device, that is seamless and exactly the same -- so it's really easy for the younger, more affluent, really well-educated consumer to come to Blue Nile and buy.

Byrnes: You mentioned one of the things I wanted to hit on, which is across retail, which is a lot of traffic via mobile, but it's also harder to close the deal on mobile. Some people are afraid to give their credit card information on mobile, some people just think it's a lengthy process. What are some things that Blue Nile can do as we go increasingly mobile from PCs and desktops, to try to get that up and get people buying on mobile?

Kanter: Great question. The reality is, our core customer buying engagement is around 30 years old. They're more affluent and more educated, and they've literally grown up with the iPhone as their PC. We're coming into this incredible sweet spot where more and more consumers are just totally comfortable with buying online.

The fact of the matter is, as more and more customers move and see the easy way -- over Thanksgiving weekend, you never had to leave your home. You could eat your turkey and have your cake, so to speak. You could just be shopping at home, with your friends and family all around you. In the engagement business, that's really critical, because the number one way people determine where to buy is based on friends and family's recommendations, and our net promoter score drives an incredible level of customer service advocacy for the brand.

Long story short, it's just more and more people experiencing how easy and simple online purchasing is -- and when you're 20%-40% below traditional brick and mortar stores, why would you buy anywhere else?

Byrnes: Right. Let's talk about international. I think about 17% of your sales in the third quarter came from international, as opposed to the U.S. What are some trends there? Where do you expect that balance to be in the future, and what are some challenges and opportunities you see there?

Kanter: That's a great question. Historically, if you look backwards, about a third of our business was Canada, a third of our business was U.K., and a third of our business was Asia-Pacific. Asia-Pacific has grown to be 50% of our international revenue, and China specifically is sort of ground zero for us. It's really important to drive that business.

We're making significant investments. We have now two offices in Shanghai. We're planning to import diamonds directly into the country. We have a small call center there, situated to talk in the traditional and simplified Chinese language, and to interact with consumers. While we don't know exactly when, we expect the Chinese market to be about $100 million or more.

We're going slow enough to not be bleeding, but fast enough to really make sure our infrastructure is in place to maximize the opportunity there.

Byrnes: Could you talk about the model in China? It's a little bit of a different model than in the U.S. You have issues, I guess, in China with delivery; it's not as easy to get things to people, so you're using some kind of storefronts there. Could you talk about that?

Kanter: Yeah, we actually have a partnership there, and that partnership has storefronts, to your point, in major markets. He provides the ability to do fulfillment and payment, so consumers can come in and make a payment, consumers can come up ... FedEx is not as easy to deliver in China, so that's one of the challenges.

But consumers actually like to come into a storefront in China. There are interesting, unique elements of the culture there, that are distinctly different, but the fact of the matter is we're still bringing great value. We bring very quick service, and we bring incredible quality. That is the DNA of Blue Nile, and that's why we're continuing to make great success there.

Byrnes: Jump back to the 30,000-foot view; what are some competitive advantages that you see over traditional brick-and-mortar stores? Obviously, the overhead is one, but it goes a little bit deeper than that.

Kanter: Yeah, it actually does go deeper than that. We have $1.3 billion worth of diamond inventory. We actually look at 25% of the world's loose stones, and put about 15% of the world's loose stones on our website, and that's incredible. And those stones are available worldwide -- the exact same inventory worldwide.

We don't, also, pay for those stones until they're purchased by the consumer, so it's a virtual inventory and it gives us a great negative working capital structure and great cash flow metrics. Those are really important and, as we've already mentioned, fundamentally we have a different cost structure.

When you put it all together, that's why we can create such competitive value to our "competitive set," if you will. Any competitor would be hard-pressed to have $1.3 billion worth of stones, which typically equates to about 140,000 units of loose diamonds, on our website.

Byrnes: You think that's the main thing that insulates you -- we talked about this earlier -- from competitors increasingly coming online, be it Tiffany, Zales, or even an Amazon?

Kanter: Yeah, I think that, and part of that sourcing model is the fact that our suppliers create virtual inventory, and that is only available on Blue Nile. For lack of a better way to say it, we have contractually obligated a lot of suppliers. Because of our volume, they recognize that we are really the core place to sell loose stones, and they turn their inventory so much faster than traditional brick-and-mortar jewelry stores would.

Byrnes: We can't ignore this table, here. Could you walk us through what we have here, and maybe some of the price ranges that we have here?

Kanter: Yeah, you have an incredible assortment and breadth. You have, most importantly, today's biggest item, which is up to 40% savings on diamond studs -- and they're our premier quality stone so it's a really incredible value -- as low as $499.

Byrnes: You expect that to be your biggest seller on Cyber Monday?

Kanter: Yeah, by far. That is a great track record for us. We ran a promotion similar to that last year, and it's just a great gift. No better value, no better quality.

Then we also have something more opening price-oriented starting, for precious stones and semiprecious, at $100. Probably more exciting, though, are things like our traditional loose stones, mounted in a solitaire, or in fact here in a double halo for Monique Lhuillier. These are really, really incredible products.

Byrnes: Wow.

Kanter: Last but not least, you might look at our extraordinary. Our extraordinary is typically $20,000, $30,000, $40,000 pieces of jewelry that are bench watermarks. They're really incredible, not just in the quality but the value -- even here -- is as compelling as in our loose stones.

We have just a great deal to offer. We're really excited about what the next three or four weeks will bring to the market, and we're hopeful that it will be a great season.

Byrnes: Harvey Kanter, thank you so much for your time. Better keep your eye on me, I don't swipe any of these on my way out here!

 Kanter: Brendan, thanks so much. I really appreciate your time.

Byrnes: Appreciate it, thank you.


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