UNITED STATES SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ended April 3, 2005

OR

For the transition period from                      to                     

Commission file number 000-50763

BLUE NILE, INC.

(206) 336-6700
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of May 1, 2005, the registrant had 17,643,045 shares of common stock outstanding.

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Cautionary Note Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains forward-looking statements that involve many risks and uncertainties. These statements relate to future events and our future performance that are based on current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. In some cases, you can identify forward-looking statements by terms such as “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “targets,” “seek,” or “continue,” the negative of these terms or other variations of such terms. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business and other characterizations of future events or circumstances, are forward-looking statements. These statements are only predictions based upon assumptions made that are believed to be reasonable at the time, and are subject to risk and uncertainties. Therefore, actual events or results may differ materially and adversely from those expressed in any forward-looking statement. In evaluating these statements, you should specifically consider the risks described under the caption “Factors that May Affect Future Operating Results” and elsewhere in this Form 10-Q. These factors may cause our actual results to differ materially from any forward-looking statements. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

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BLUE NILE, INC.

INDEX

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

BLUE NILE, INC.

The accompanying notes are an integral part of these consolidated financial statements

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BLUE NILE, INC.

The accompanying notes are an integral part of these consolidated financial statements

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BLUE NILE, INC.

The accompanying notes are an integral part of these consolidated financial statements

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BLUE NILE, INC.

The accompanying notes are an integral part of these consolidated financial statements

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BLUE NILE, INC.

Note 1. Description of the Company and Summary of Significant Accounting Policies

The Company

Blue Nile, Inc. (the “Company”) is a leading online retailer of high quality diamonds and fine jewelry in the United States. In addition to sales of diamonds, fine jewelry and watches, the Company provides guidance and support to enable customers to more effectively learn about and purchase diamonds as well as classically styled fine jewelry. The Company, a Delaware corporation, based in Seattle, Washington, was formed in March 1999. The Company maintains its primary web site at www.bluenile.com. The Company also operates the www.bluenile.co.uk and www.bluenile.ca web sites.

Change in Fiscal Year

On January 1, 2004, the Company’s fiscal year-end changed from December 31, to the Sunday closest to December 31. Each fiscal year consists of four 13-week quarters, with an extra week added onto the fourth quarter every five to six years. As a result of this transition, the first fiscal quarter of 2004 consisted of two additional shipping days as compared to the first fiscal quarter of 2005. These additional days contributed approximately $0.3 million to net sales for the quarter ended April 4, 2004.

Reclassifications

Certain reclassifications of prior period balances have been made for consistent presentation with the current period. These reclassifications had no impact on net income or stockholders’ equity as previously reported.

Basis of Presentation

The accompanying unaudited consolidated financial statements should be read in conjunction with the Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K filed for the year ended January 2, 2005. The same accounting policies are followed for preparing quarterly and annual financial statements. In the opinion of management, all adjustments necessary for the fair presentation of the financial position, results of operations and cash flows have been included and are of a normal, recurring nature.

Due to a number of factors, including the seasonal nature of the retail industry and other factors described in this report, quarterly results are not necessarily indicative of the results for the full fiscal year.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Some of the more significant estimates include the allowance for sales returns and the reserve for estimated fraud losses. Actual results could differ materially from those estimates.

Intangible Assets

Intangible assets represent the consideration paid for licenses and other similar agreements with finite lives. Amortization is calculated on a straight-line basis over the estimated useful life of the related assets, which range from 10 years to 17 years. Amortization expense for the quarter ended April 3, 2005 was approximately $8,000.

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BLUE NILE, INC.
Notes to Consolidated Financial Statements

Stock-Based Compensation

The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25.” The Company has elected to apply the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock Based Compensation.” Had compensation cost for the Company’s stock options been determined based on the fair value of the options at the date of grant, the Company’s pro forma net income would have been as shown below (in thousands, except per share data):

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123R (Revised 2004), “Share-Based Payment” (“SFAS 123R”). This statement addresses the accounting for share-based payment transactions in which a company receives employee services in exchange for the company’s equity instruments or liabilities that are based on the fair value of the company’s equity securities or may be settled by the issuance of these securities. SFAS 123R eliminates the ability to account for share-based compensation using APB 25 and generally requires that such transactions be accounted for using a fair value method. The provisions of this statement are effective for financial statements issued in the first annual reporting period commencing after June 15, 2005. Therefore, the Company will adopt the provisions of SFAS 123R in its first quarter of 2006. The stock-based compensation the Company will recognize after the adoption of SFAS 123R will be affected by the number and type of stock-based awards granted in the future and the pricing model and related assumptions the Company decides to use to estimate the fair values of options.

The Company is currently evaluating which pricing model it will use to estimate the value of its options and which transition method it will use to implement SFAS 123R.

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BLUE NILE, INC.
Notes to Consolidated Financial Statements

Note 2. Inventories

Inventories are stated at cost and consist of the following (in thousands):

Note 3. Marketable Securities

The Company’s marketable securities are classified as available-for-sale as defined by SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). At April 3, 2005, marketable securities consisted of U.S. government and agencies’ securities maturing within one year. The securities are carried at fair value, with the unrealized gains and losses included in accumulated other comprehensive income (loss). Realized gains or losses on the sale of marketable securities are identified on a specific identification basis and are reflected as a component of interest income or expense. The cost, fair value and unrealized gains and losses of marketable securities as of the quarter ended April 3, 2005 are as follows (in thousands):

There were no realized gains or losses on sales of marketable securities for the quarter ended April 3, 2005.

Note 4. Net Income Per Share

Basic net income per share is based on the weighted average number of common shares outstanding. Diluted net income per share is based on the weighted average number of common shares and equivalents outstanding. Common share equivalents included in the computation represent common shares issuable upon assumed exercise of outstanding stock options and warrants and mandatorily redeemable convertible preferred stock, except when the effect of their inclusion would be antidilutive.

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BLUE NILE, INC.
Notes to Consolidated Financial Statements

The following tables set forth the computation of basic and diluted net income per share (in thousands, except per share data):

For the quarter ended April 3, 2005, there were 547,298 stock option shares excluded from the computation of net income per diluted share due to their antidilutive effect. For the quarter ended April 4, 2004, there were 728 stock option shares excluded from the computation of net income per diluted share due to their antidilutive effect.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with Blue Nile, Inc.’s (“Blue Nile,” the “Company,” “we,” “our,” “us,”) Consolidated Financial Statements and the related Notes contained elsewhere in this quarterly report on Form 10-Q and annual report on Form 10-K filed for our fiscal year ended January 2, 2005. All statements in the following discussion that are not reports of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the factors that may affect operating results set forth herein.

Overview

Net income in the first quarter of 2005 was $2.6 million, or $0.14 per diluted share. In the first quarter of 2004, net income and net income per diluted share were $1.9 million and $0.12, respectively. The 36.6% increase in net income for the quarter was primarily driven by the growth in net sales.

In August 2004, the Company launched a website in the United Kingdom, www.bluenile.co.uk through which the Company offers a limited number of products. In January 2005, the Company launched a website in Canada, www.bluenile.ca. In the first quarter of 2005, international sales were immaterial.

Results of Operations

Comparison of the Quarter Ended April 3, 2005 to the Quarter Ended April 4, 2004

Net Sales

Net sales increased 23.3% to $44.1 million in the quarter ended April 3, 2005 compared to $35.8 million in the quarter ended April 4, 2004. The increase in net sales was primarily due to an increase in net sales of engagement rings, customized diamond jewelry and loose diamonds.

The Company transitioned to a four-four-five retail fiscal calendar on January 1, 2004. As a result of this transition, the first fiscal quarter of 2004 consisted of two additional days of operations as compared to the first fiscal quarter of 2005. These additional days contributed approximately $0.3 million to net sales for the quarter ended April 4, 2004.

Gross Profit

Gross profit increased 18.0% to $9.7 million for the quarter ended April 3, 2005 from $8.2 million in the quarter ended April 4, 2004. The increase in gross profit resulted primarily from increases in sales volume. Gross profit as a percentage of net sales declined to 22.0% for the quarter ended April 3, 2005 from 22.9% in the quarter ended April 4, 2004. The decrease in gross profit as a percentage of net sales resulted primarily from changes in product mix.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased 15.4% to $6.1 million for the quarter ended April 3, 2005 from $5.3 million in the quarter ended April 4, 2004. The primary reason for the increase is additional costs associated with being a public company. These costs amounted to approximately $700,000 in the first quarter of 2005 as compared to approximately $250,000 in the first quarter of 2004. The remaining increase was primarily due to increased advertising costs related to higher sales volume.

As a percentage of net sales, selling, general and administrative expenses were 13.9% in the year to date ended April 3, 2005 compared to 14.8% in the quarter ended April 4, 2004. The decrease in these expenses as a percentage of net sales resulted primarily from our ability to grow sales at a greater pace than selling, general and administrative expenses.

Interest Income

Interest income was approximately $501,000 for the quarter ended April 3, 2005, compared to approximately $42,000 in the quarter ended April 4, 2004. The increase in interest income is primarily due to an increase in our cash and cash equivalents and marketable securities as a result of our initial public stock offering completed in May 2004, which resulted in net proceeds of $42.5 million.

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Liquidity and Capital Resources

As of April 3, 2005, we had working capital of $81.0 million, including cash and cash equivalents of $53.5 million and marketable securities of $26.9 million, partially offset by accounts payable of $17.6 million. We believe that our current cash and cash equivalents and marketable securities as well as cash flows from operations will be sufficient to continue our operations and meet our capital needs for the foreseeable future.

Net cash of $19.7 million was used for operating activities in the quarter ended April 3, 2005, compared to cash used in operating activities of $11.0 million in the quarter ended April 4, 2004. Cash was provided by earnings of $2.6 million and $1.9 million in the quarter ended April 3, 2005 and April 4, 2004, respectively. This was offset by net payments of payables totaling $20.1 million for the quarter ended April 3, 2005 and $14.5 million for the quarter ended April 4, 2004. The increase in net payments of payables in 2005 relates primarily to the payment of suppliers in the first quarter for inventory sold in the fourth quarter. The volume of sales in the fourth quarter of 2004 was much greater than the volume in the fourth quarter of 2003, resulting in an increase in the net payment of payables in the first quarter of 2005 compared to the first quarter of 2004. This payment cycle reflects what we believe to be the beneficial working capital characteristics of our business model, wherein we collect cash from customers within several business days following a related sale while we typically have longer payment terms with our suppliers.

Net cash provided by investing activities was $14.7 million for the quarter ended April 3, 2005 and $238,000 for the quarter ended April 4, 2004. Cash provided in 2005 was primarily from net sales of marketable securities of $14.9 million. Cash provided in 2004 was primarily the result of transfers of restricted cash.

Net cash used in financing activities for the quarter ended April 3, 2005 was $1.0 million resulting primarily from repurchases of Blue Nile, Inc. common stock. In February 2005, our board of directors authorized the repurchase of common stock with aggregate total value of $30.0 million within the 12 months following the date of approval of such repurchase. The timing and amount of any shares repurchased will be determined by our management based on their evaluation of market conditions and other factors. During the quarter ended April 3, 2005, we purchased 39,000 shares of our common stock for approximately $1.1 million. Cash provided by financing activities for the quarter ended April 4, 2004 was $59,000 and was related to the exercise of common stock options and warrants.

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Risk Factors

You should carefully consider the risks described below and elsewhere in this report, which could materially and adversely affect our business, results of operations or financial condition. In those cases, the trading price of our common stock could decline and you may lose all or part of your investment.

Our limited operating history makes it difficult for us to accurately forecast net sales and appropriately plan our expenses.

We were formed in March 1999 and have a limited operating history. As a result, it is difficult to accurately forecast our net sales and plan our operating expenses. We base our current and future expense levels on our operating forecasts and estimates of future net sales. Net sales and operating results are difficult to forecast because they generally depend on the volume and timing of the orders we receive, which are uncertain. Some of our expenses are fixed, and, as a result, we may be unable to adjust our spending in a timely manner to compensate for any unexpected shortfall in net sales. This inability could cause our net income in a given quarter to be lower than expected.

We expect our quarterly financial results to fluctuate, which may lead to volatility in our stock price.

We expect our net sales and operating results to vary significantly from quarter to quarter due to a number of factors, including changes in:

	•	demand for our products;
	•	the costs to acquire diamonds and precious metals;
	•	our ability to attract visitors to our web sites and convert those visitors into customers;
	•	our ability to retain existing customers or encourage repeat purchases;
	•	our ability to manage our product mix and inventory;
	•	wholesale diamond prices;
	•	consumer tastes and preferences for diamonds and fine jewelry;
	•	our ability to manage our fulfillment operations;
	•	general economic conditions;
	•	advertising and other marketing costs;
	•	our, or our competitors’, pricing and marketing strategies;
	•	conditions or trends in the diamond and fine jewelry industry;
	•	conditions or trends in the Internet and e-commerce industry; and
	•	costs of expanding or enhancing our technology or web sites.

As a result of the variability of these and other factors, our operating results in future quarters may be below the expectations of public market analysts and investors. In this event, the price of our common stock may decline.

As a result of seasonal fluctuations in our net sales, our quarterly results may fluctuate and could be below expectations.

We have experienced and expect to continue to experience seasonal fluctuations in our net sales. In particular, a disproportionate amount of our net sales has been realized during the fourth quarter as a result of the December holiday season, and we expect this seasonality to continue in the future. Over 38%, 38% and 42% of our net sales in 2004, 2003 and 2002, respectively, were generated during the fourth quarter. In anticipation of increased sales activity during the fourth quarter, we may incur significant additional expenses, including higher inventory of jewelry and additional staffing in our fulfillment and custo