JACKSON SECURITIES, LLC

Research for the Prudent Investor

Date 2/13/07 Blue Nile (NILE): Earnings

Current Price $38.60
review, maintain hold
52WK HI $42.45 • Industry: Internet Services
52WK LO $24.10 • NILE: NASDAQ; $38.60 HOLD initiated 2/7/07: $39.18
EPS (TTM) $0.78 Target: $40.00
• 12-month price target: $40.00
Shares Outstanding 16.6M
Market Cap. $618M
Dividend Yield NA
Price/Earnings (TTM) 54X
Price/Sales (TTM) 2.8X
EV/Revenue (TTM) 2.3X
EV/EBITDA (TTM) 25.8X
EBITDA (TTM) $20.8M

Brian Bolan
Director of Equity Research
Company Description
Blue Nile is a leading online retailer of high quality diamonds and fine
Technology jewelry. Blue Nile specializes in the customization of diamond jewelry with
Jackson Securities, LLC a “Build Your Own” feature that offers customers the ability to customize
300 S. Wacker Dr., Suite 2450 diamond rings, pendants and earrings. While not providing the lowest
Chicago, IL 60606 cost diamonds, the company believes its formula of no pressure sales,
Ph: (312) 253-0578 high quality educational material and reasonable prices will result in higher
Fax: (312) 986-0560 profits.
bbolan@jacksonsecurities.com
Valuation and Recommendation:
Blue Nile reported a good quarter and full year 2006, and released
guidance for 2007 that is below our estimates. We believe that the pre
earnings sell off was an obvious example of the old standby “buy the
rumor and sell the news”. The recalibration of the stock price was
warranted and we believe the stock is now priced for perfection.
Jackson Securities, LLC seeks to do business with companies covered in its
research reports. As a result, investors should be aware that the firm may have a
conflict of interest that could affect the objectivity of this report. Investors should
consider this report as only a single factor in making their investment decisions.
Please also refer to the important disclosures found on page numbers 7 and 8.
Analyst Certification is found on page number 7.
Blue Nile (NILE)

Earnings Release

Blue Nile (NILE) announced revenue of $90.7M for the forth

quarter of 2006. This represents an increase of 23.9% from the
same period a year ago, but below our estimate of $94.2M and the
Wall Street consensus of $91.9M.

The company posted earnings of $0.35 per share beating our

estimate of $0.32 and Wall Street consensus of $0.31 per share.
The out performance in earnings was due to better than anticipated
operational efficiencies. Please refer to the table at the end of the
report that highlights the margins for the quarter and the difference
from our estimates.

During the quarter, the company said that they saw strong growth
in all product categories and singled out sterling silver charm
bracelets, the journey diamond pendant line and diamond eternity
necklaces up to $70,000 as the best sellers during the Christmas
season. They noted that the quarter was very back end loaded, as
shoppers likely procrastinated. Reacting quickly to this, the
company offered express shipping for customers who had the
intention of buying a diamond engagement ring in time for
Valentine’s day. This certainly could have been a factor for all the
positive momentum the stock had seen prior to the day of the
earnings release.

Orders and ASP’s

The average sales price (ASP) was $1,314, up 2.3% from a year
ago, but down 30% from the prior quarter. The 2005 ASP saw a
quarter over quarter decrease of 27%. Orders were up 21% from a
year ago, inline with our expectations of around 69,000. We have
modeled in assumptions for next quarter of an ASP of $1500 and
total orders just shy of 40,000. Those assumptions give us a
topline number that is below guidance, and accordingly, we will be
raising topline estimates soon.

JACKSON Brian Bolan 2

SECURITIES, Director of Research – Technology
LLC
Blue Nile (NILE)

Blue Nile posted 40 transactions that were priced at $50,000 or

more, an increase of 74% from the year ago period. The company
believes that this is a signal that there is more faith in the online
model, and their brand in particular.

Traffic, Margins and the Mix

On the conference call, management noted that they continue to

see increases in traffic and conversions. The goal is to get the right
traffic, not just traffic growth for growth’s sake, but looking to get
the right customers to the site that have the impetus to make
purchases.

The product mix helped margins this quarter, and the company
passed on some metal price increases. Historically, about 80% of
the customers on Blue Nile were first time buyers, while around
20% were repeat customers. This quarter the company noted that
they ticked over 20% for the first time. This is a positive sign that
customer satisfaction is real and beginning to show in a meaningful
way. We expect to see this metric climb in the coming quarters.

Shares outstanding and the buy back

During the quarter, Blue Nile repurchased 92,000 shares of its

common stock for about $3.2M. This works out to an average
price of $34.78. The company noted they wanted to repurchase
more shares in the quarter but were confined due to short open
windows. They noted, however, that their strategy of planned
purchases is giving them a benefit of 6% ahead of an open market
purchase plan. They also noted that $93.2M of the repurchase plan
is still available.

Guidance and our Model

In the earnings release, Blue Nile guided Wall Street to topline of

between $61M - $63M and a bottom line number between $0.14 -
$0.15 per share for the first quarter of 2007. The company also
guided a tax rate of 35.4% for the quarter.

JACKSON Brian Bolan 3

SECURITIES, Director of Research – Technology
LLC
Blue Nile (NILE)

For the fiscal year 2007, the company guided to $290M - $300M
on the topline and between $0.80 - $0.85 per share on the bottom
line. The expected tax rate for 2007 is 35.4%.

Our model is calling for $58.9M on the topline and $0.17 per share
in earnings for the first quarter of 2007. A modest 19.5% gross
margin is also assumed by our model which might even be too
low. We will likely be moving our revenue estimate higher to
catch up with guidance, but at the same time we expect that higher
marketing costs will offset the increase in revenue.

For the year, we had modeled total revenues of $304M, just

slightly above the top end of the guided range. We do not
anticipate that number to move too much from where it is now.

We also should note that we were expecting more aggressive share

buy backs in both this quarter and throughout the fiscal year. As a
result we will be recalibrating our model to reflect this and
anticipate publishing a much higher shares outstanding number.

Recent Price action on the Stock

Over the last several weeks, shares of Blue Nile have advanced in
anticipation of strong earnings. We view this mostly as a
momentum play which ended the day of the earnings
announcement. As in most cases of ‘Buy the rumor and sell the
news’, the momentum inevitably switched sides as the stock lost
6.8% the day of the earnings announcement. In the after hours
market the stock showed little movement suggesting that it has
been recalibrated and once again priced for perfection.

JACKSON Brian Bolan 4

SECURITIES, Director of Research – Technology
LLC
 Blue Nile (NILE)

4Q06 Earnings Recap

4th Qtr. 3rd Qtr. 4th Qtr. 4th Qtr. year Quarter / Diff from
Blue Nile In Thousands of U.S. Dollars /year Quarter estimate
(except for per share items) 1/1/2006 Estimate actual
Total Revenue 73,231 53,248 94,199 90,729 23.9% 70.4% -3.7%
Cost of Revenue 57,009 42,817 75,454 72,024 26.3% 68.2% -4.5%
Gross Margin 22.2% 19.6% 19.9% 20.6% -6.9% 5.2% 3.6%
Sell/General/Admin 8,739 8,271 11,304 10,575 21.0% 27.9% -6.4%
SG&A as percent of sales 11.9% 15.5% 12.0% 11.7% -2.3% -25.0% -2.9%
Total Operating Expense 65,748 51,088 86,758 82,599 25.6% 61.7% -4.8%
Operating Income 7,483 2,160 7,442 8,130 8.6% 276.4% 9.2%
Operatin Margin 10.2% 4.1% 7.9% 9.0% -12.3% 120.9% 13.4%
Other Income
Interest Income 776 670 500 787 1.4% 17.5% 57.4%
Other 5 1 0 -1

Net Income Before Taxes 8,264 2,831 7,942 8,916 7.9% 214.9% 12.3%

Provision for Income Taxes 2,975 1,007 2,859 3,163 6.3% 214.1% 10.6%
Tax Rate 36.0% 35.6% 36.0% 35.5% -1.5% -0.3% -1.5%

Net Income 5,289 1,824 5,083 5,753 8.8% 215.4% 13.2%

Basic/Primary EPS Excl. Extra. Items 0.31 0.11 0.32 0.36 17.8% 215.2% 13.1%
Basic/Primary EPS Incl. Extra. Items 0.31 0.11 0.32 0.35 13.1% 202.7% 9.3%

Basic/Primary Weighted Average Shares 17,324 16,014 16,000 16,011 -7.6% 0.0% 0.1%
Diluted Weighted Average Shares 18,433 16,670 16,100 16,673 -9.5% 0.0% 3.6%

Source: Company Reports and Jackson Securities

JACKSON Brian Bolan 5

SECURITIES, Director of Research – Technology
LLC
Disclosures:

Analyst Certification
I, Brian Bolan, hereby certify that the views expressed in this research report accurately reflect my personal views about
the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly,
related to the specific recommendations or views expressed in this research report. I may be compensated in part based
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securities described herein.

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subject company in the last 12 months.
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the company/companies mentioned in this report.

Market Making:
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Explanation of Ratings:
Buy - Expected 12-month absolute performance of +10% or higher than the market price at which time the rating was
issued.
Hold - Expected 12-month absolute performance of +5% to –5% from the price at the time the rating was issued.
Sell - Expected 12-month absolute performance of –10% or lower than the market price at which time the rating was
issued.

Distribution of Ratings:
Jackson Securities, LLC has a distribution of ratings among its coverage universe as follows:

Buys – 54.6% (18 of 33 active recommendations)

Holds – 42.4% (14 of 33 active recommendations)
Sells – 3.0% (1 of 33 active recommendations)

Jackson Securities has provided investment banking services within the previous 12 months with the following percentage
of the companies they have rated:

Buys – 3.0% (1 of 33 active recommendations)

Holds – 0% (0 of 33 active recommendations)
Sells – 0% (0 of 33 active recommendations)

Risks: General economic conditions, economic slowdown/recession, adverse industry news.

Other Important Disclosures and Disclaimers

Disclaimer: This communication is neither an offer to sell nor a solicitation of an offer to buy any securities mentioned
herein. This material should not be construed as an offer to sell or the solicitation of an offer to buy any securities

Brian Bolan
Director of Equity Research – Technology
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Brian Bolan
Director of Equity Research – Technology