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Blue Nile, Inc. (NASDAQ:NILE)

Q3 2007 Earnings Call

November 6, 2007 5:00 pm ET

Executives

Nancy Shipp - IR

Mark Vadon - CEO, Chairman

Diane Irvine - President

Robin Easton - CFO

Analysts

Mark Mahaney - Citi Investment Research

Doug Anmuth - Lehman Brothers

Jim Friedland - Cowen

Malindi Davies - CIBC World Markets

Jaime Sheinheit - Merrill Lynch

Kristine Koerber - JMP Securities

Analyst for Imran Khan – JP Morgan

Operator

(Operator Instructions) At this time, I would like tointroduce Nancy Shipp, Director of Investor Relations of Blue Nile.

Nancy Shipp

Good afternoon andthank you for joining us on our conference call today to review our third quarter2007 financial results. With me today are Mark Vadon, Chief Executive Officer;Diane Irvine, President; and Robin Easton, Chief Financial Officer.

Before we begin, I would like to remind you that some of thecomments we will make on this call are forward-looking including, withoutlimitation, statements regarding expectations of future financial performance,net sales, gross margin, expenses, net income, operating cash flow, capitalexpenditures, international growth, stock-based compensation expense and otherfinancial statements or balance sheet items, as well as statements about ourfuture plans and objectives, beliefs, expectations, targets, goals, outlooks orpredictions for the future.

These statements are only predictions based on assumptionsthat are believed to be reasonable at the time they are made, and are subjectto significant risks and uncertainties. You should not rely on theseforward-looking statements as representing our views in the future, and weundertake no obligation to publicly update or revise these statements.

Our actual results may differ materially or adversely fromany projections and forward-looking statements discussed on this call. Ourquarterly reports on Form 10-Q, our annual reports on Form 10-K and other formson file with the SEC identify important risk factors and uncertainties that youshould consider when making an investment decision regarding Blue Nile and thatmay affect whether our forward-looking statements prove to be correct.

Also, please note that during the course of this conferencecall, we may discuss certain non-GAAP financial measures as we review the company'sperformance. We will discuss non-GAAP free cash flow, which is defined as netcash provided by or used in operating activities or operating cash flow, lessoutflows for purchases of fixed assets, including internal-use software andwebsite development.

We will also discuss non-GAAP adjusted EBITDA, which isdefined as earnings before interest and other income, taxes, depreciation andamortization, adjusted to exclude the effect of stock-based compensationexpense. Please refer to the investor relations section of our website toobtain a copy of our earnings release, which contains reconciliations ofnon-GAAP measures to the nearest comparable GAAP measures.

At the conclusion of the call, we will conduct aquestion-and-answer session. Now, I would like to turn the call over to MarkVadon.

Mark Vadon

Good afternoon, everyone, and welcome to today's conferencecall. The third quarter was another strong quarter for Blue Nile.Throughout this year, we have been focused on driving profitable growth for thebusiness, building on our clear leadership position in the industry wepioneered more than eight years ago. Through the first nine months of the year,those efforts have been successful, with year-to-date revenue growth of 28.9%and year-to-date operating income growth of 46.3% compared to the first threequarters of 2006.

This year, we have had two overriding priorities. First, wehave sought to drive innovation of the purchasing experience on our website inorder to maximize customer satisfaction. This objective is grounded in ourbelief that building an Internet brand that resonates with consumers is notdone primarily through marketing or technology. Building a great brand,especially on the Internet, is accomplished through a focused obsession onoffering a superior customer experience. It is done by focusing on every singlecontact point with the customer and improving those contact points every singleday.

Second, during 2007 we have invested significant effort inexpanding our business to new markets. Earlier this year, we relaunched ourCanadian and UKbusinesses and opened our Dublinoffice. These efforts have led to accelerating growth in our non-US business. Weare still in the early stages of our international expansion, but I have been veryhappy with our progress to-date. Diane will be sharing more color on oursuccess in these and other areas.

Before turning the call over to Diane, I would like to takea moment to introduce you to Robin Easton, our new CFO. Robin joined Blue Nile a little less than two months ago, and he has been a greataddition to our team. We are happy to introduce Robin today to the investmentcommunity, and I know that Robin looks forward to working with all of you inthe future. Robin will provide more details about our financial results laterin the call.

At this time, I would like to turn the call over to Diane.

Diane Irvine

Thank you, Mark. The third quarter was an excellent one for Blue Nile and a great start to the second half of the year. During thethird quarter, we delivered strong sales growth and exceptional profitability. Oursales increased 26.5% to $67.4 million. Net income in the third quarter totaled$3 million or $0.18 per diluted share. Our EPS of $0.18 increased 63.6% fromthe prior year, and was $0.03 above the top end of our guidance range.

We performed well across all areas of the business, and wesaw strong sales in virtually all product categories during the third quarter.Growth continued to be strong at the high end, with more than 50%year-over-year growth in price points above $25,000.

During the quarter, our marketing efforts were veryeffective in driving increased levels of high quality traffic to our website.Traffic grew 20% year over year, the highest third quarter traffic growth wehave experienced since 2004. We saw excellent growth across all marketingvehicles, and we continue to be very focused on efforts to improve conversionthrough website and operational enhancements. These efforts, combined with ourability to drive high-quality traffic, have been key contributors to our rapidgrowth.

Our results reflect how well the Blue Nilebrand and experience resonate with our customers. We firmly believe that ourongoing strategy and business initiatives are having a sustainable and positiveeffect on our business.

Over the past few years, we have talked repeatedly aboutstriving for the perfect customer experience. Throughout Blue Nile'shistory, we have made many enhancements to our business that improved theoverall shopping experience for our customers. Every business decision we maketakes into account its effect on the customer, and we strive to makeimprovements each and every day. We believe that this intense customer focus iswhy we are the category leader and the only way to build a lasting brand.

I'd like to talk about a couple of key initiatives thatspeak to our commitment to invest in and enhance the Blue Nileshopping experience. Last month, we introduced free priority shipping on allorders. This means that for all orders of non-customized products that areplaced by 3 pm Eastern time, thecustomer will receive the product the following morning. This is a tremendousoffering for our customers, and one that is truly differentiated within theecommerce landscape. While it is too early to assess the impact, we believecustomers will react positively to this offer and that it will help us convertnew and repeat customers during the holiday shopping season.

In addition, last Thursday we launched a new and improvedwebsite in preparation for the holiday season. We have updated the look andfeel of our website and have increased the focus on one of the key tenets that Blue Nile stands for: education and guidance. Our prior website was oneof the best in all of ecommerce in its ability to monetize shopping traffic,and we believe our updated website will take this capability to a new level.

Efforts such as these, which continue to innovate and improvethe consumer experience, help build brand loyalty and trust, and thereby helpus grow that important repeat and referral business.

As Mark mentioned, another key initiative for Blue Nile is the expansion of our international business, taking thecustomer experience we have created in the USand expanding to other parts of the world. While our international sales arestill a relatively small part of our overall business, international growth wasstrong in the third quarter. We generated approximately $4.5 million in netsales through our Canadaand UKwebsites, representing year-over-year growth of 105%.

We are very happy with the growth we're seeing in thisbusiness following the second quarter opening of our operations center in Ireland,which serves our UKcustomers, and the launch of our localized websites in the UKand Canada. Itis an especially exciting time for the business as we prepare for our firstholiday season in Europe. International growth willremain a priority for us going forward.

So far this quarter, we have continued to see strong salesmomentum and as we gear up for the important holiday season, we feel greatabout our competitive position. We have an integrated marketing plan in placeto continue to drive record levels of qualified traffic to our website. As Imentioned earlier, we are driving this traffic to a brand new website, whichwas built to incorporate our years of learning about how to convert our targetconsumer. Early indications are that the new website is converting very well.

On the merchandising front, we are extremely well positionedfor the upcoming holiday season. We have many exciting new offerings gearedtoward the holiday that include beautiful sterling silver and pearl items toone of a kind diamond jewelry pieces. Our product assortment, while beingcarefully edited by our merchants to provide a distinct viewpoint, is thelargest and deepest assortment in the company's history. We are confident thatour customers will enthusiastically embrace our product offering this holidayseason.

In operations, we have built the capacity to handlesignificant growth this holiday season and deliver on our commitment to ourcustomers to provide high quality jewelry products with unmatched levels ofservice. During this holiday quarter, we will continue to be focused onprofitably growing our business while executing with excellence. First andforemost, we will do this by providing an unbeatable purchase experience to ourcustomers. We believe that if we do this well, we will certainly continue togain share in the jewelry market.

Now, I would like to turn the call over to Robin.

Robin Easton

Thank you, Diane and good afternoon, everyone. I am veryexcited to be here at Blue Nile and to be meeting all ofyou on this call today. Since joining Blue Nile justunder two months ago, I have spent my time immersing myself in the business,and I can say that I am even more enthusiastic about the future opportunitiesfor Blue Nile's growth.

In the third quarter, we posted net sales of $67.4 million,representing an increase of 26.5% over the third quarter of 2006. In Q3, total orders increased16.3% as compared to a year ago. Our average selling price per order was $2,093in the third quarter, compared to $1,884 in Q3 2006. Gross profit for thequarter was $13.4 million, an increase of 28.4% year over year. As a percentageof net sales, our gross margin for the quarter was 19.8%, compared to 19.5% ayear ago. The growth in gross profit was the highest third quarter growth ratewe have delivered as a public company.

Net income for the quarter was $3 million. Net income perdiluted share was $0.18, representing EPS growth of 63.6%; again, the highestthird quarter earnings growth we have experienced as a public company.

We performed well on costs during the third quarter. OurSG&A totaled $9.7 million for the third quarter and included $1.4 millionin stock compensation expense. As a percentage of net sales, SG&A declinedto 14.5% in Q3 compared to 15.5% in the third quarter a year ago. Operatingincome showed exceptional growth in the third quarter to $3.6 million, anincrease of 67.3% compared to Q3 of 2006. This operating income growth was alsoour highest third quarter growth rate as a public company. In Q3, incrementaloperating income as a percentage of incremental revenue was 10.3%.

Non-GAAP adjusted EBITDA, which we define as earnings beforeinterest and other income, taxes, depreciation and amortization, adjusted toexclude the effects of stock-based compensation expense, increased 38.3% forthe quarter to $5.4 million. This demonstrates our ability to continue todeliver leverage as the business grows. Interest income was $947,000 for thequarter, compared to $670,000 in last year's third quarter.

Our effective tax rate for the quarter was 35%, compared to35.6% a year ago.

Turning to the balance sheet, we ended the quarter with$74.3 million of cash. Inventory, at $15.3 million, grew 20.7% compared to lastyear, resulting in improved inventory turns of 16.3 times compared to 15.9times a year ago.

Accounts payable grew 35.1% from last year to $40.3 million,with days payable expanding nine days compared to last year.

Now, let's turn to the cash flow statement. Operating cashflow for the trailing 12 months increased 9.6% to $33.2 million. I think it'simportant to note that we have posted excellent cash flow results, despitehaving fully utilized the tax benefit of our cumulative net operating lossesfor federal income tax purposes.

Free cash flow, which we define as free cash flow fromoperations, including cash costs for taxes, tax benefits from stockcompensation and changes in working capital less capital expenditures, increased4% to $29.4 million on a trailing 12-month basis. Our free cash flow resultsinclude higher capital expenditures of $3.8 million for the trailing 12-monthperiod, compared to $2 million for the previous trailing 12-month period.

The year-over-year increase was primarily related toinvestments in our domestic fulfillment facility and the establishment of ourinternational operation in Ireland,investments that are important for our future growth.

I would now like to discuss our guidance for the fourthquarter and full year of 2007. Inthe fourth quarter, we expect net sales to be between $109 million and $115million. Net income is expected to be $0.40 to $0.45 per diluted share. We areincreasing our financial guidance for the year 2007. For the year, we expectnet sales to be between $316 million and $322 million. We expect net income perdiluted share to be between $1.00 and $1.05 for 2007.

We expect capital expenditures for the year of approximately$5 million, which includes the investments I just mentioned related to theexpansion of our USfulfillment center and our new European facility. The effective tax rate forfinancial statement purposes for the fourth quarter is expected to beapproximately 35%.

Consistent with prior years, we will not be providingguidance for 2008 until our Q4 2007 earnings call in February. This is becausewe have the ability to provide much more informed guidance following thecompletion of the fourth quarter, the most important quarter of the year forour business.

Now, I would like to turn the call back to Diane.

Diane Irvine

Thank you, Robin. Insummary, we are pleased with our Q3 results and the excellent performance wehave had so far this year. We have made good progress on our strategicinitiatives in 2007, and we are optimistic about the upcoming holiday season.

This is the end of our formal presentation. Before we beginthe Q&A session, I would like to take a moment to thank Nancy Shipp for allof her work over the past three-and-a-half years. Nancyhas done a wonderful job in establishing our investor relations program sincewe became a public company, and in interacting with investors and analysts. Nancywill be leaving us soon to spend more time with her family. Nancy,thank you for all of your work on behalf of Blue Nile.We will miss you.

I would also like to welcome Eileen Askew, who has joined Blue Nile and is taking over our investor relations program. Eileenlooks forward to meeting our investors and analysts in the coming days andweeks.

We would be happy to take your questions now.

Question-and-AnswerSession

Operator

Your first question comes from Mark Mahaney - CitiInvestment Research.

Mark Mahaney - Citi Investment Research

Thank you very much. Two questions, please. On theinternational expansion, are there any trends you're seeing in terms of theproducts that sell in the UKand Canada, theprice points and how that's different from the USmarket to date?

Then a quick question just on the gross margins; they wereup year over year, down sequentially. Was there anything unusual in thatpattern? That 90 bips sequential decline may have been just a touch bit greaterthan we would have expected, but not out of the ballpark. Just checking to seewhether there was anything unusual about the comp last year. Thank you verymuch.

Diane Irvine

Thank you, Mark. In terms of 2Q margins, I'll take that onefirst. As you know, the third quarter is much more driven by engagementproducts as opposed to the non-engagement category because there is nogift-giving holiday in Q3 so we would expect the margins to be lower than Q2,and then from that point it just depends on the mix, particularly withinengagement, whereas to the extent we have larger sales the gross marginpercentage might be a bit lower, but we're looking to optimize, really, thedollars per unit. I think we felt great about the margin performance during thequarter. Certainly, as we look at the year-on-year trends, that gross profitgrowth is exactly what we have been looking for and expecting so that wasterrific.

Then in terms of our international markets, what we'reseeing there is great growth and development in those markets where I wouldsay, we're starting to sell much larger diamonds there and higher quality thanperhaps have been in those markets in the past. We don't sell an entire rangeof products, as we do in our USwebsite yet today in those markets, but we're adding more and more productofferings all the time, so we're very pleased with our progress there.

Operator

Your next question comes from Doug Anmuth - Lehman Brothers.

Doug Anmuth - Lehman Brothers

Thank you, a few questions for you. First, I knew you had atough year-over-year comp in terms of the number of orders, but do you thinkthat there was anything else in particular that did drive the deceleration inorders during 3Q?

Secondly, can you talk a little bit about your checkoutpayment process, in terms of the fact that you had Google Checkout early on inthe year? Now Google Checkout seems to be gone, and PayPal is on the site.Thank you.

Mark Vadon

On Checkout, we accept both Google Checkout and PayPal. Bothof those are on our shopping cart. We've been very pleased with the results ofboth of those. We just released PayPal probably less than a month ago, so it'sstill very early there. But overall, we're just trying to provide more optionsfor our customers, and I think both of those are appealing to their ownaudience, and we think they're useful for our business.

On the number of orders, I think overall we're seeing greatgrowth in traffic to the website, and that traffic is converting really well butwe don't manage the business to a number of orders. We're managing the businessmore, we're looking at traffic coming into the website, and we're trying tomonetize it as well as we can irregardless of how many orders it drives. Justas you look at our business, it's relatively unique because of the range ofprice points. Our price points this quarter went from $35 up to I think ourlargest order was something like $190,000. So when you've got that range ofprice points, your average ticket can move around, just based on what types oftraffic you are driving. Different marketing channels drive different mix.Things like what you put on an e-mail as it goes out, what you're featuring onthe homepage, all of those things can move the mix.

What we're always doing at any given time is we're justtrying to maximize the revenue generated from the traffic, and that can lead toa lower order, higher ASP type of quarter or the opposite. Truthfully, I nevereven look at that number of orders number until you guys bring it up. I'm amuch more interested in, how much revenue are we driving out of this?

The two numbers we're watching most closely to understandconversion are what's the traffic inbound to the site? I think Diane mentionedthat that was plus 20% this quarter, which we thought was a great, great number.And then, how many dollars of gross margin are we generating per person we aredriving onto the website? That also is doing quite well.

Operator

Your next question comes from Jim Friedland – Cowen.

Jim Friedland - Cowen

Thanks. Some questions relating to gross margin. First, onthe international business, are there any cost of goods that are non-locallydriven coming out of the UK,or are you buying diamonds in pounds and euros?

In terms of the free overnight shipping across all theitems, FedEx I think, is raising their prices pretty meaningfully. How shouldbe think about gross margin in 2008 interms of the various trends? Because you have a positive anniversary whichyou've already experienced on the price cut.

Basically, my question is, could the FedEx price increaseweigh on gross profit at all?

Diane Irvine

Thanks, Jim. In terms of gross margins in the internationalbusiness, I think you were asking specifically about purchasing diamonds. Diamondsare denominated in dollars globally, and those sales are being reflected indollars here. The only thing that would happen there, for example, in the UKa customer is buying in pounds and then we'll be converting that into dollars. Soyou have a few days of different currency, but that's really the only thingthat's happening. At this point, that operation is a very small number in termsof any conversion impact from currency.

In terms of shipping, really the priority overnight shippingwe look at that as an investment in the customer experience. As you know, as wealways talk about, we're putting value out there for customers. We believe theyfind it, so we certainly think that's going to be a tremendous offering thatcustomers will embrace.

As you look at next year, I think what you would see more ofis, as our mix shifts a little bit towards more non-engagement product whichcarries a higher gross margin percentage because it's a lower ticket, you'dexpect to see stable to possibly upward margin movements. We're doing a greatjob across the board in the company in terms of costs, whether it's in ourproduct purchasing or whether it's in any of the other line items that go intocost of goods. I think we feel like we have healthy trends there going forward.

Mark Vadon

When you look at that free shipping, the priority overnight,our average ticket is so high that the shipping cost as a percentage of revenueis relatively minor. I think our beliefvery much is this is not a cost; it's an investment that will pay outrelatively quickly, because we think we're going to see the lift necessary topay for that change in shipping.

Overall, you start looking as we are shipping everything onpriority overnight on FedEx, we're becoming a decent-sized customer for FedExand we're seeing some leverage as we continue to ramp the business. Focusingall of our efforts and our buying power on one form of shipping helps us whenwe need to negotiate our pricing.

Jim Friedland - Cowen

One quick follow-up on pricing. I think last quarter yousaid that you were in a position where you even experimented a little withraising prices. Can you talk a little bit about pricing trends on the site inengagement and non-engagement this quarter?

Diane Irvine

I think in terms of pricing,I would say we're relatively stable, to use that term, where as you know, ourpricing is really driven by the price point of the product. So we're looking atthe gross margin dollars as we can go up from as Mark said, a $35 product tosomething in the hundreds of thousands of dollars.

So there are always times, for example, within diamondswhere we might see certain pockets where prices either get raised or loweredduring a quarter, but it's not a structural change in our pricing. Then as youlook at metal products, whether it's something containing platinum or gold,over time as those prices have gone up, we might have periods when we areraising our prices by a bit, but nothing significant in terms of changes, justkind of here and there, based upon supply and demand. We'll make changes on acontinuous basis.

Mark Vadon

You're seeing our margins creep up more from mix than anything.We're keeping relatively stable pricing within product lines, but then the mixis slowly shifting over time. I'd just say that in Q3, that's when the mix isthe most geared toward engagement of any time period during the year. Thatshift will be lightest during Q3, I guess I'd say.

So overall, I think you should expect to continue to seegross margins edge up as the mix continues over the quarters and years to come.

Operator

Your next question comes from Malindi Davies - CIBC WorldMarkets.

Malindi Davies - CIBC World Markets

I was hoping you could elaborate on your top markets. Arethey still growing at 20% plus, as you've said on previous calls? Do you seeany difference in terms of engagement versus non-engagement split in thosemarkets versus the rest of your markets?

Mark Vadon

Yes, we continue tosee really strong growth from our top markets. I think what we have been seeingfor the entire history of the business is our most mature markets are growingslightly slower than the business at large. We keep watching those markets, andas long as those markets are showing healthy growth, we think that's kind of aforward indicator of the upside revenue potential of the business.

Our belief is eventually the whole country shops online theway people do today in markets like San Franciscoor Northern Virginia or Bostonor those types of markets. But we're seeing no change and we're seeing thosemarkets continue to grow.

Those markets tend to have a little broader range ofproducts in the mix. I think what we're seeing is there are more repeat buyersin those markets, and so the mix is a little bit geared towards thenon-engagement. So those markets along with that have slightly higher grossmargin levels. They just look like as we would expect, the overall business tomore and more look over the years as the rest of the country sort of matures inits purchasing behavior.

Operator

Your next question comes from Jaime Sheinheit - MerrillLynch.

Jaime Sheinheit - Merrill Lynch

You've talked about significant strength in thehigher-ticket items. I was wondering if you could talk a little bit about thetrends you're seeing in the lower-priced items?

Diane Irvine

Over time, we really find that the tails are growing. Thehigh end is growing very nicely. We also see, as you look at price points thatat the lower price points in engagement, that is growing as well. So I thinkyou are finding just a broader range overall in the business. That looks veryhealthy to us.

Jaime Sheinheit - Merrill Lynch

Just quickly on international,I was wondering if you could expand a little bit more on how you're drivingtraffic to the international sites?

Diane Irvine

We may have talked in the past in terms of international.I'd say we are just in the early stages of marketing there. We're doing onlinemarketing search and just started an affiliate program. I'd say we've built a reallygood business there albeit, at this point, a smaller one without doing a lot ofmarketing. So I think that's very encouraging to us. We're doing more and moreas we see the revenue build and we see the momentum there.

Mark Vadon

The marketing in those markets looks a lot like what the USBlue Nile marketing looked like in 1999. We've just layered in the verybeginning of a marketing program. So there's paid search happening, there'snatural search. There's a lot of referral happening in those markets. We justintroduced an affiliate program in the UK.I think what you're going to see over the next year or so is we're going tostart launching a complete integrated marketing program, more similar to whatwe have in the US.

I think that's one of the things we're most excited about.Even with pretty limited marketing, those businesses are growing well. If youlook at our UKand Canadian businesses combined, our belief is that combined business islarger in the sale of diamond engagement rings than any competitor we have inthe United States.

So I think again, that just points to competitively the leadwe have on anybody is immense and is just getting stronger over time.

Operator

Your next question comes from Kristine Koerber - JMPSecurities.

Kristine Koerber - JMP Securities

A couple of questions. First of all, how should we look atinventory growth going forward, especially as the mix shift changes towardsnon-engagement jewelry? Any risks associated with that?

Diane Irvine

In terms of inventorygrowth, as you look at mix shifting over time, it's a slow shift. I think inthe past several years it's been 2 percentage points a year, where the mixshifts towards non-engagement. In terms of what happens there, a portion ofthat non-engagement business is also driven by diamonds, where we're notholding those in inventory, so obviously very favorable working capitalcharacteristics there.

Then as you look at other items that we are holding ininventory, we have great payment terms and very fast turns of that inventory,such that really across the board for any product at Blue Nile,we have negative working capital.

I think the inventory growth is not always able to bepredicted based upon the revenue growth. But I think we feel that we have veryfavorable dynamics there and that will continue.

Kristine Koerber - JMP Securities

Lastly on theexpenses, the SG&A margin, can you just elaborate on what really drove themargin so much lower this quarter? Thank you.

Diane Irvine

I think if you look across the board at SG&A, we arevery efficient. I think we tend to run lean and really are disciplined in ourcost management. So if you look there in terms of people, professionalservices, everything there; our marketing, very efficient. I think it is acrossthe board throughout the business. We have been really great at managing ourcosts and as Mark talked about, getting more purchasing power. I think that'sin a lot of areas, not just in that cost of goods area. I think that's reallywhat you're seeing there. Obviously, in terms of profitability, the grossmargin growth that we're seeing is an additional benefit there.

Operator

Your next question comes from Imran Khan – JP Morgan.

Analyst for ImranKhan - JP Morgan

A quick question just about holiday sales. Are you expectingnon-engagement sales to trend, given the tightening economy? Have you seen anychanges in competition domestically from people such as Amazon for holidayseason?

Diane Irvine

In terms of holiday trend, I think as we had mentioned inour comments earlier, as we have started the quarter we're seeing very strongmomentum so that is great. I think in terms of consumer spending or what yousee more broadly, I think we have always said we don't exactly know. I thinkthere's a very strong argument that when you look at engagement, that is lessdiscretionary. I can only point to what we're seeing, which is great strengthin the business, even stronger at the beginning of Q4 I'd say than what we sawin Q3. Of course we are taking share, so I think we're a bit different than yousee in retail broadly. But I think we feel very optimistic today in that we'rewell positioned for the holiday season.

In terms of competition, I would really just point to whatMark talked about earlier, that I feel every quarter we get ahead of thecompetition and really expand our lead. Mark mentioned our internationalbusiness as being larger than any of the UScompetitors in terms of engagement online. I think we need to continue to get better and better at what we'redoing, which is why we focus so heavily on the customer experience. I think yousee that happening.

Operator

Your final question comes from Mark Mahaney – CitiInvestment Research.

Mark Mahaney - Citi Investment Research

Could you provide a little bit more detail on that trafficgrowth year over year? Could you give us some context versus what the trafficgrowth was the last couple of quarters, or maybe divide that between UStraffic growth and international traffic growth?

Then real quickly, on the share buybacks, you seem like youalmost have a cash problem. You're generating so much cash. You haven't boughtback stock the last two quarters. You have something of a CapEx ramp this yearfor international expansion. You probably don't need that kind of CapEx levelnext year. What you do with all the cash? Do you want to be back committing tobuying back more stock?

Mark Vadon

I'll take the traffic part, then Diane can answer thequestion about what we're going to do with our cash. On traffic, theinternational really doesn't come much into play there. The amount of trafficcoming off the international sites is very, very small right now.

Overall, I think the traffic we're seeing is very strong. Wehave been experiencing traffic levels in the mid-teens and up all year long.There's months when it's higher, months when it's lower, but overall it's beenvery, very strong. Those rates of traffic growth are stronger than we saw thelast couple of years.

So if you go back to 2005 and 2006, we were driving growthin the business more from the conversion side than the traffic side. Now Ithink that has flipped over where we are now able to drive a lot strongertraffic than we have previously.

We continue to work on improving our conversion. So one ofthe things we've been very excited about, we've been working hard behind thescenes on the new website. That just launched just days ago. Overall, whatwe're going to try to be doing here is just continuing to drive that level oftraffic growth and convert it better and better. I think if we do that, we willdo really well. But as far as the top level of traffic that we're driving itseems like, if anything, in the marketing environment out there, it's gettingeasier to drive qualified traffic instead of harder right now.

Diane Irvine

Mark, in terms of our cash position and buybacks, wecertainly plan to continue to use the buyback program as a strategic means todeliver value to shareholders. As you know, we've bought back 15% of ouroutstanding shares to date, and we have operated that program to try to beopportunistic. What I would tell you is that we'll continue to be thoughtfulthere and do the right thing for shareholders, and we will clearly look at thatas a program through which to do that.

Mark Vadon

Thanks, everybody for participating on the call today. Welook forward to updating you after our fourth quarter.

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Source: Blue Nile Q3 2007 Earnings Call Transcript
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