Blue Nile 050809

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Equity Mkt. Cap. $64

Net LT Debt./

Mkt. Cap. 0.

Total EV $59

10 Yr. Treasury 3.

08 FCF Yield N

Financial Statistics

EPS P

2006A $0.76 3

2007A $0.90 3

2008A $0.75 3

2009E $0.66 6

EPS

FCF/

Share P/F

2006A $1.73 16

2007A $1.53 18

2008A -$0.85 N

2009E $1.32 3

Free Cash Flow

May 8, 20

Brian Bo(312) 345-15

bbolan@sturdivant-co.

Important disclosures appear on the inside cover and back of this publication.

Blue Nile (NASDAQ: NILE $44.58)

Long Term Rating: Market PerformLong Term Target Price: $54

Mid-Atlantic Institutional Research

EXECUTIVE SUMMARY

Investment Summary: Blue Nile performed admirable in a difficult economic environment. Or-ders fell 13% but average price increased driving a top line beat. Gross margins expanded due tolower diamond and precious metal costs and improved sourcing. We have increased our earnings

expectations and expanded our multiple to reflect the better than expected results. We maintainour market perform rating and increase our target price to $54.

Key Points

Gross margins increase. We were pleased with the increase in gross margins due to lowerdiamond and precious metal costs as well as improvements in sourcing. We modeled in fur-ther improvements to gross margins throughout the remainder of the year.

Earnings expectations rise. Earnings per share of $0.13 were better than expected despite ahigher than expected operating expenses. We have increased our FY09 earnings estimates to$0.66, up from $0.55.

Average order size increases, number of orders decreases. The increase in order size was

a significant surprise considering the consistent downward trend in diamond pricing. As ex-pected, the number of orders dropped 13%, slightly more than we expected. We expect ordersto fall by 12% in 2Q09 and average order size to decline by roughly 5%.

Margin expansion drives multiple higher. The increase in gross margin leads us to believethe market will assign a higher multiple for shares of Blue Nile. We have increased our earn-ings estimates and increased our target price to $54 per share, based on a multiple of 81x our2009 earnings estimate of $0.66.

1Q09 Earnings better than expected

Source: BigCharts, CompanyReports and Sturdivant & Co. Estim

Relative Daily Price 5/8/09

Price 3/24 $29

52 Wk Lo-Hi $18.34-55

Div Yield

Avg. Volume 32

Insiders Own

S&P 500 907

Share Information

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Mr. Bolan does own shares of Blue Nile

Disclosures

Rating System Definitions

Sturdivant & Co.s stock ratings system reflects the investment decisions our clients face every day, and is meant to assist clients in making these decisions by recommending aspecific action to take with each stock we cover. All of the ratings correspond to a specific investment action that we recommend taking on the date the research is published. Thus,Outperform (equivalent to Buy) ratings are reserved only for stocks that we would be actively buying at the time the research is published. Marketperform (equivalent toHold) ratings are reserved for stocks that we believe are in line with the markets anticipated performance and we recommend holding. Underperform (equivalent to Sell)ratings are assigned to stocks where the analyst anticipates stock price declines relative to the market. Please note also that the price expectations that determine the rating are inabsolute dollar terms, not in terms of relative performance to a sector or an index. Therefore, analysts will not use the Outperform rating for stocks that are expected to performwell relative to their sector but only for stocks that are expected to appreciate in actual dollar returns.Research Analyst Compensation

Analyst compensation is based on: (1) the analysts productivity, including the quality of the analysts research and the analysts contribution to the growth and development of ouroverall research effort; (2) ratings and direct feedback from our investing clients, our sales force and from independent rating services. Sturdivant & Co.s Compliance and Re-search Departments are responsible for establishing these compensation guidelines and for reviewing and approving senior analyst compensation. Analyst contribution to our

investment banking business is not a factor in determining analyst compensation and compensation is not, directly or indirectly, related to the specific recommendations or viewsexpressed in the report.Research Analyst Certification

The senior research analyst(s) certifies that the views expressed in this research report and/or financial model accurately reflect such senior analyst's personal views about thesubject securities or issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in theresearch report. Mr. Bolan does owns shares of Blue Nile. This is not a complete analysis of every material fact regarding any company, industry or security. The opinions ex-pressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee theaccuracy. The Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are examples of unmanaged common stock indices used to measure and report performance ofvarious sectors of the stock market; direct investment in indices is not avai lable. A complete listing of all companies covered by Sturdivant & Co., Inc. and applicable researchdisclosures can be obtained from the Company. Price Target Risks

Investment risks associated with the achievement of the price target include, but are not limited to, the companys failure to achieve our earnings and revenue estimates, unforeseenmacroeconomic and/or industry events that adversely impact demand for the companys products or services, product obsolescence, changes in investor sentiment regarding thespecific company or industry, intense and rapidly changing competitive pressures, the continuing development of industry standards, the companys ability to compete for talent,and adverse market conditions. For a complete discussion of the risk factors that could affect the market price of the companys shares, refer to the most recent form 10-Q or 10-Kthat the company has filed with the SEC.

Source: BigCharts.com

RELATIVE STOCK PRICE PERFORMANCE

Rating and Price Target History for Blue Nile (NILE )

STURDIVANT & CO., INC.

OP: Outperform MP:Marketperform MU: Market Underperform

5/8/09MP: $44.58

T: $54.00

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Table of Contents

Earnings Overview 4

Valuation Margin Analysis 5

Valuation Stockholders Equity to Market Value 6

Valuation Price to Earnings 7

Conclusion 8

Income Statement 9

1Q09 Income Statement review 10

Institutional Contacts 11

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Earnings Overview

Blue Nile reported revenue of $62.4M and earnings per share of $0.13. Although revenues were down11% from the year ago period, they were still much stronger than our estimates. The strength in thetopline came from higher than expected average selling prices (ASPs). Orders were in line with our

expectations.

Gross margin of 21.2% was well ahead of our expected rate of 19.5% due to lower diamond pricing,lower metal input costs and improved sourcing. Going forward, we believe that margins will improveas diamond pricing may continue to see weakness and the improvements in sourcing will also serve as atailwind to gross margins.

High end purchases, those at or above the $25,000 price point continue to suffer due to weak economicconditions. This seems to be more of an industry concern that a Blue Nile specific issue. We believethat when the economy turns around, the higher price point items will resume sales.

The company moved to reduce inventory to $16M down from $19.4M. This 17% reduction is partiallydue to the company moving to better manage inventory and the lower number of orders compared tothe same time last year. The read through in lower inventory leaves us with the idea that orders willcontinue to face pressure.

For 2Q09, we are expecting orders to fall by 12% from the year ago period and ASPs of $1,700. Ourestimated ASP is roughly 5% below the year ago level. The company noted on the call that the secondquarter, which contains Mothers Day, is slightly weaker than the first quarter (with any growthremoved from the equation).

IDEXDiamond Index

Source: IDEXONLINE.com

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ValuationMargin Analysis

Our initiating coverage report carried a theme of Blue Nile facing declining margins and lower sales.With lower sales baked in the stock, the increase in margins comes as a welcome surprise. We haveupdated our model to reflect stronger gross margins, which provide a boost for net margin as well.

Gross Margin

The increase in gross margin was attributed to three factors, lower diamond pricing, lower precious

metals costs and improved sourcing. We believe that diamond pricing is likely to continue on adownward path and gross margins should continue to benefit. Our model has been revised to reflectstronger gross margins for the remainder of the year.

Source: Company reports and Sturdivant & Co research


1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09E 3Q09E 4Q09E

Total Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%Cost of sales 80.5% 79.3% 80.2% 81.0% 80.2% 79.5% 79.7% 79.4% 78.8% 79.2% 79.6% 80.0%SG&A 14.1% 13.7% 14.5% 12.1% 15.5% 14.6% 15.3% 14.4% 16.5% 14.8% 15.1% 14.5%Operating Margin 5.4% 7.0% 5.4% 6.9% 4.3% 5.9% 5.0% 6.2% 4.7% 6.0% 5.3% 5.5%Net Margin 4.1% 5.2% 4.4% 4.9% 3.6% 4.3% 3.6% 4.1% 3.1% 4.1% 3.7% 3.7%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%


NetMargin

17.5%

18.0%

18.5%

19.0%

19.5%

20.0%

20.5%

21.0%

21.5%


GrossMargin

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ValuationStockholders Equity to Market Value

In measuring the value of Blue Nile, we looked closely at the company from a both a growth and valueperspective. Our model is calling for significant top line decreases, thus forcing us to focus ourvaluation on more value based metrics. One metric we analyzed is Stockholders Equity (SE). Ourtable above denotes the dramatic changes in stockholders equity over the last year. We looked at theeffect of SE being divided by market capitalization (MC) to see if value investors would be rewardedby investing in Blue Nile in a period that saw SE increase as a percentage of MC. This is not afoolproof method, as the growth in shareholder equity in 4Q07 was coupled with a 46% decline inmarket capitalization and reached the high water mark for SE/MC over the past two years. This was

followed by a more than 50% decline in market value.

Our analysis indicates that the market looks ahead of the changes in stockholders equity.



$

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09

StockholdersEquity(SE)

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09

Stockholders Equity (SE) 39,617$ 49,112$ 59,500$ 63,478$ 26,630$ 32,365$ 15,194$ 19,308$ 23,040$

Market Capitalization (MC) 914,600 1,578,615 1,378,497 742,281 755,160 629,800 388,208 287,573 660,720fully diluted shares 16,617 16,617 16,912 16,617 16,275 15,694 15,200 14,831 14,821

Reported 5/7/2007 8/6/2007 11/6/2007 2/12/2008 5/6/2008 8/5/2008 11/4/2008 2/18/2009 5/7/2009

Stock PriceDay of report 47.35 82.00 74.68 53.85 45.18 39.52 28.25 21.03 44.58

Day after 55.04 95.00 81.51 44.67 46.40 40.13 25.54 19.39 44.58

SE/ MC 4.3% 3.1% 4.3% 8.6% 3.5% 5.1% 3.9% 6.7% 3.5%

Year over Year

Change in SE -33% -34% -74% -70% -13%Change in Price -16% -58% -69% -57% -4%

Qtr over Qtr

Change in SE 24% 21% 7% -58% 22% -53% 27% 19%

Change in Price 73% -14% -45% 4% -14% -36% -24% 130%

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ValuationPrice to Earnings

Blue Nile has seen a steady decrease in its multiple over the last two years. We see that the marketprices the stock off of trailing earnings. There is a high degree of correlation between the movementsof the trailing twelve months earnings multiple and the change in price.

The falling price of diamonds and news in the quarter that production mines would slow helped themultiple expand. The falling price of diamonds allowed the company to boost the gross margin linewhich will also serve to expand the multiple. We believe that the multiple could continue to expand.



Price to Earnings and Price to Forward Earnings

Price to Earnings Valuation Table

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09

Price to Earnings 71 116 94 49 51 43 27 21 6Price to Forward Earnings 62 111 102 64 75 63 43 29 6

Price 914,600 1,578,615 1,378,497 742,281 755,160 629,800 388,208 287,573 660,72Earnings 12,932 13,581 14,730 15,019 14,776 14,776 14,200 13,563 10,99

Forward Earnings 14,776 14,200 13,563 11,630 10,051 10,011 8,967 9,824 9,82

Variance (1,844) (619) 1,167 3,389 4,725 4,765 5,234 3,739 1,17

Qtr over QtrChange in Price 73% -14% -45% 4% -14% -36% -24% 130

Change in PE 64% -19% -47% 3% -17% -36% -22% 183Change in Forward PE 80% -9% -37% 18% -16% -31% -32% 130

20

40

60

80

100

120

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09

Priceto

Earnings

PricetoForwardEarnings

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Conclusion

The falling price of diamonds and improvements in sourcing have helped boost gross margins. Thisexpansion of margins is likely to continue and will boost the multiple on the stock. We have updatedour model to reflect our expectation of higher gross margins.

We are maintaining our rating of market perform and increasing our target price to $54 based on amultiple of 81x 2009 earnings.


Valuation MatrixValuation Matrix

Price 50 51 52 53 54 55 56 57 58

P/Sales

CY08 2.6 2.7 2.7 2.8 2.8 2.9 2.9 3.0 3.0CY09 2.8 2.7 2.7 2.8 3.0 3.0 3.1 3.1 3.2

P/Operating Income

CY08 48.5 49.4 50.4 51.4 52.3 53.3 54.3 55.2 56.2

CY09 51.2 52.2 53.3 54.3 55.3 56.3 57.4 58.4 59.4

P/Net before tax

CY08 43.4 44.3 45.1 46.0 46.9 47.7 48.6 49.5 50.3

CY09 48.9 49.9 50.9 51.9 52.8 53.8 54.8 55.8 56.7

P/Net Income

CY08 66.6 68.0 69.3 70.6 72.0 73.3 74.6 76.0 77.3CY09 75.3 76.8 78.3 79.8 81.3 82.8 84.3 85.8 87.3

Multiple

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BlueNile

IncomeStatement

Source:Companyreports,Sturdivant&CoResearch

BlueNile

InThousa

ndsofU.S.Dollars

1stQtr.

2ndQt

r.3rdQtr.

4thQtr.

2008

1stQtr.

2ndQtr.

3rdQtr.

4thQtr

.

2009

(exceptforpershareitems)

Estimate

Estimate

Estimate

Estimate

TotalRevenue

70,460

73,70

6

65,376

85,787

295,329

62,403

61,704

58,745

85,474

268,325

CostofRevenue

56,536

58,58

3

52,114

68,100

235,333

49,200

48,894

46,731

68,379

213,204

GrossMargin

19.8

%

20.5

%

20.3

%

20.6

%

20.3

%

21

.2%

20.8

%

20.5

%

20.0

%

20.5

%

S

ell/General/Admin

10,898

10,758

9,980

12,369

44,005

10,299

9,101

8,894

12,39

4

40,688

SG&Aaspercen

tofsales

15.5

%

14.6%

15.3

%

14.4

%

14.9

%

16

.5%

14.8

%

15.1

%

14.5

%

15.2

%

Total

OperatingExpense

67,434

69,34

1

62,094

80,469

279,338

59,499

57,995

55,625

80,773

253,892

OperatingIncome

3,026

4,36

5

3,282

5,318

15,991

2,904

3,708

3,119

4,701

14,433

OperatinMargin

4.3

%

5.9

%

5.0

%

6.2

%

5.4

%

4

.7%

6.0

%

5.3

%

5.5

%

5.4

%

OtherIncome

InterestIncome

835

280

184

121

1,420

67

200

200

20

0

667

Other

91

285

95

-26

445

13

-15

5

1

0

13

NetIn

comeBeforeTaxes

3,952

4,93

0

3,561

5,413

17,856

2,984

3,893

3,324

4,911

15,113

ProvisionforIncomeTaxes

1,381

1,72

5

1,226

1,894

6,226

1,044

1,363

1,164

1,719

5,289

TaxRate

34.9

%

35.0%

34.4

%

35.0

%

34.9

%

35.0

%

35.0

%

35.0

%

35.0

%

35.0

%

NetIncome

2,571

3,20

5

2,335

3,519

11,630

1,940

2,531

2,161

3,192

9,824

Basic/PrimaryEPSExcl.

Extra.Items

0.16

$

0.2

1

$

0.16

$

0.24

$

0.78

$

0.13

$

0.17

$

0.15

$

0.22

$

0.68

$

Basic/PrimaryEP

SIncl.Extra.Items

0.16

$

0.2

0

$

0.15

$

0.24

$

0.75

$

0.13

$

0.17

$

0.15

$

0.22

$

0.66

$

Basic/PrimaryWeightedAverageShares

15,601

15,01

8

14,621

14,493

14,496

14,500

14,450

14,400

DilutedWeightedAverageShares

16,275

15,69

4

15,200

14,831

15,500

14,821

14,820

14,800

14,700

14,785

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Source: Company Reports

Blue Nile 1Q09 Earnings review

Blue Nile In Thousands of U.S. Dollars1st Qtr. 4th Qtr. 1st Qtr. 1st Qtr.

(except for per share items) 2008 Estimate Actual Yr/Yr Qtr/Qtr Estimate

Total Revenue 70,460 85,787 57,460 62,403 -11% -27% 9%

Cost of Revenue 56,536 68,100 46,255 49,200 -13% -28% 6%

Gross Margin 19.8% 20.6% 19.5% 21.2% 7% 3% 9%

Sell/General/Admin 10,898 12,369 8,763 10,299 -5% -17% 18%

SG&A as percent of sales 15.5% 14.4% 15.3% 16.5% 7% 14% 8%

Total Operating Expense 67,434 80,469 55,018 59,499 -12% -26% 8%

Operating Income 3,026 5,318 2,442 2,904 -4% -45% 19%Operatin Margin 4.3% 6.2% 4.3% 4.7% 8% -25% 9%

Other Income

Interest Income 835 121 150 67 -92% -45% -55%

Other 91 -26 -15 13 -86% -150% -187%

Net Income Before Taxes 3,952 5,413 2,577 2,984 -24% -45% 16%

Provision for Income Taxes1,381 1,894 902 1,044 -24% -45% 16%

Tax Rate 34.9% 35.0% 35.0% 35.0% 0% 0% 0%

Net Income 2,571 3,519 1,675 1,940 -25% -45% 16%

Basic/Primary EPS Excl. Extra. Items 0.16$ 0.24$ 0.12$ 0.13$ -19% -45% 14%

Basic/Primary EPS Incl. Extra. Items 0.16$ 0.24$ 0.11$ 0.13$ -17% -45% 14%

Basic/Primary Weighted Average Shares 15,601 14,493 14,300 14,496 -7% 0% 1%

Diluted Weighted Average Shares 16,275 14,831 14,600 14,821 -9% 0% 2%

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Sturdivant & Co.s

Businessmans Approach to Value Philosophy

Sturdivant & Co. uses the businessmans approach to evaluating stocks. This philosophy is predicated on looking at a

company as a prudent man would were he to consider making a reasoned investment in a business. We focus on acompanys strategy, the competitive position a company has versus its peers, quality of management, risk factors, itsprospect for growth, as well as critical catalysts and milestones as evidence of progress. Finally, of course, we look at acompanys valuation to determine where we feel the stock is priced attractively.


Beth Ann Loewy, [email protected]

856-751-1331 ext. 114Food

Consumer Staples

Retail

Fundamental Research

Institutional Trading

Debra L. [email protected]

800-486-1515 or856-751-1331 ext. 110

Harvey R. de [email protected]

800-486-1515 or856-751-1331 ext. 112

Albert A. [email protected]

856-751-1331 ext. 108

James [email protected]

800-486-1515 or856-751-1331 ext. 115

Institutional Sales

Carl R. Gibbs, [email protected]

856-751-1331 ext. 107

Terry [email protected]

856-751-1331 ext. 101

Richard A. [email protected]

856-751-1331 ext. 109Industrials

Chairman

Brian [email protected]

312-345-1534Technology

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Member: FINRA and SIPC

This material is for your private information and we are not soliciting any action based upon it. This reportshould not be construed as, or the solicitation of an offer to buy any security in any jurisdiction where such anoffer or solicitation would be illegal. The material is based upon information that we consider reliable, but we donot represent that it is accurate or complete, and it should not be relied upon as such. Opinions expressed are our

current opinions as of the date appearing on this material only. While we endeavor to update on a reasonablebasis the information discussed in this material, there may be regulatory, compliance or other reasons thatprevent us from doing so. We and our affiliates, officers, directors, partners and employees, including personsinvolved in the preparation or issuance of this material, from time to time, have long or short positions in, andbuy or sell, the securities, or derivatives (including options) thereof, of companies mentioned herein. Sturdivant& Co. has not received compensation from this company in the past 12 months and this company is not aninvestment banking client.


Date Price Rating Target

NILE 3/24/095/8/09

29.6144.58

MPMP

$24.00$54.00

Total Technology Group

Outperform Marketperform Underperform

40% (2) 60% (3) 0% (0)

Outperform Marketperform Underperform

0 0 0

Investment Banking Relationship

US-Technology Group

Investment Rating Company Ticker Symbol Initial Coverage Date Research Analyst

Market Outperform

Google GOOG 10/7/2008 BrianBolaneBay EBAY 1/22/2009 BrianBolan

Market Perform

Yahoo YHOO 12/10/2008 BrianBolanBlueNile NILE 3/25/2009 BrianBolan

Amazon.comInc. AMZN 11/17/2008 BrianBolanMarket Underperform

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Blue Nile 050809