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Blue Nile, Inc. (NASDAQ:NILE)

Q2 2008 Earnings Call Transcript

August 5, 2008 5:00 pm ET

Executives

Eileen Askew – Manager, IR

Diane Irvine – CEO and President

Marc Stolzman – CFO

Analysts

Lorraine Maikis – Merrill Lynch

James Sanford [ph] – Citi Investment

Matt Nemer – Thomas Weisel Partners

Douglas Anmuth – Lehman Brothers

Herman Leung – Deutsche Bank

Jim Friedland – Cowen & Co.

Operator

Good afternoon. My name is Christie and I will be your host operator on this call. Your lines will be placed on a listen-only mode. At the end of the presentation, management will be available for questions. (Operator instructions) At this time, I would like to introduce Eileen Askew, Manager of Investor Relations of Blue Nile.

Eileen Askew

Thanks, Christie. Good afternoon and thank you for joining us on our conference call today to review our second quarter 2008 financial results. With me today are Mark Vadon, Executive Chairman; Diane Irvine, Chief Executive Officer; and Marc Stolzman, Chief Financial Officer.

Before we begin, I would like to remind you that some of the comments we will make on this call are forward-looking, including without limitation statements regarding expectations of future financial performance, net sales, gross margins, expenses, net income, operating cash flow, capital expenditures, international growth, stock-based compensation expense, and other financial statement or balance sheet items, as well as statements about our future plans and objectives, beliefs, expectations, targets, goals, outlooks, or predictions for the future.

These statements are only predictions based on assumptions that are believed to be reasonable at the time they are made and are subject to significant risks and uncertainties. You should not rely on these forward-looking statements as representing our views in the future and we undertake no obligation to publicly update or revise these statements.

Our actual results may differ materially and adversely from any projections and forward-looking statements discussed on this call. Our quarterly report on Form 10-Q, our Annual Report on Form 10-K, and other forms on file with the SEC identify important risk factors and uncertainties that you should consider when making an investment decision regarding Blue Nile and that may affect whether our forward-looking statements prove to be correct.

Also, please note that during the course of this conference call, we may discuss certain non-GAAP financial measures as we review the company’s performance. We will discuss non-GAAP free cash flow, which is defined as net cash provided by or used in operating activities, or operating cash flow, less outflows for purchases of fixed assets, including internal use software and website development.

We will also discuss non-GAAP adjusted EBITDA, which is defined as earnings before interest and other income, taxes, depreciation and amortization adjusted to exclude the effects of stock-based compensation expense. Please refer to the Investor Relations section of our website to obtain a copy of our earnings release, which contains reconciliations of non-GAAP measures to the nearest comparable GAAP measures.

At the conclusion of this call, we will conduct a question-and-answer session. And now I would like to turn the call over to Diane Irvine.

Diane Irvine

Thank you, Eileen. Good afternoon, everyone. During our call today, I want to share with your our thoughts on the economic environment and our second quarter performance. I will review our international business and give you an update on the progress we’ve made on our 2008 initiatives. Marc Stolzman will then take you through a review of our second quarter results and our financial goals for the year. Following our prepared remarks, Mark Vadon, our Founder and Executive Chairman, will join us for Q&A.

With that overview, I’d like to start by reviewing our thoughts on the economic environment. Since the beginning of 2008, our industry and retail in general has faced an extremely challenging economic environment in the US. When we first spoke to you February about the health of the US economic and general consumer confidence, we stated that the luxury sector, including jewelry, could perhaps be more impacted by an economic downturn than other retail categories.

As we entered the second quarter, we had just experienced 3.8% sales growth in Q1 and saw slight improvements in sales trends in April and May. However, we have seen clear signs of further weakness in the economy in the past two months. We believe that the US economic environment and consumer sentiment have declined since the beginning of June and are now weaker than the conditions we discussed with you on our calls in February and May.

We are well aware of the significant impact of consumer discretionary spending that has been driven by rising oil and food prices, the severe decline in housing prices, and tight credit markets. As economic uncertainties have influenced consumers in the US, consumers appear to have pulled back on discretionary spending and the purchase of high ticket items. We believe that the severe tightening in credit markets has impacted the ability of consumers to access credit for the purchase of high ticket items such as jewelry.

We saw a significant decline in our third-party financing program during the second quarter as a result of the substantial decrease in credit approvals to consumers, consistent with what is happening throughout the credit markets. In addition to the difficulties in the economic environment, we have seen significant inflation in our costs this year. Diamond prices have been steadily rising in 2008 and there was single dramatic increase in wholesale diamond prices that took place in late May.

Specifically diamond prices rose by an unprecedented 7% to 25% overnight as we entered the month of June. This diamond price increase impacted our sales in the month of June and thus our second quarter results. Sudden changes in diamond prices can have a significant impact on our business because we purchase diamonds on a just-in-time basis from our suppliers in our virtual inventory model. Because we have real-time pricing from our suppliers, our costs for diamonds and thus our retail prices change immediately, up or down, as wholesale diamond prices change. These price increases were therefore passed on to consumers on a real-time basis, which had a negative impact on demand for the month of June. In addition to increases in diamond prices, the price of metals has risen substantially over the last year.

On a year-to-date basis through the end of the second quarter, prices for gold increased 9%, silver prices rose 17%, and platinum prices were up 33%, significantly impacting our merchandise costs. As a result of these dynamics, our overall inventory costs have increased dramatically this year, at the same time that we faced significant headwinds from the consumer environment.

Despite this challenging environment, our second quarter sales growth of 2.2% was within our expectations and we achieved profitability of $0.20 per diluted share, which was well above our guidance. Due to our keen focus on profitability and our expansion into new international markets, we have been successfully navigating this difficult environment.

Despite the disruptions in the jewelry industry and the economic uncertainty facing US consumers, we generated profitable growth in the first half of 2008 with sales up 3% over the first six months of 2007. While the overall retail jewelry environment in the US remains very difficult, Blue Nile has a strong business model that is differentiated from our brick and mortar competitors.

As we discussed on our first quarter call, a number of large jewelers in the US have filed for bankruptcy protection this year, while other large chains have announced significant store closures and are liquidity inventory at heavy discounts. While we cannot predict the extent of the US economic downturn, we are extremely well positioned in this environment. Blue Nile is financially and competitively strong. We believe that the strength and benefits of our unique business model allow us to navigate through these challenging conditions so that we can emerge as an even stronger business when the economy begins to improve.

In our earnings announcement today, we’ve provided an update to our sales and EPS goals for the full year. As we discussed in early May, our revenue and earnings goals for the year assumed an economic environment consistent with what we had experienced through the first four months of the year. Given the significant increase in the cost of diamond we experienced in June and our belief that the economic environment has weakened further, we believe it is prudent to revise our financial goals downward for 2008.

While we are obviously disappointed with the impact that the current economic environment and the rapid rise in diamond and metal prices are having on our results and on our expectations for the year, Blue Nile remains as strong, growing and profitable business. In today’s environment, we are executing on our initiatives for 2008 and are committed to delivering an exceptional experience and value to our customers.

As we are now half way through the year, I would like to update you on our progress against our key initiatives for 2008. Those initiatives are, one, enhancing the customer experience; two, focusing on an efficient and lean cost structure; and three, driving international growth. Investing in the customer experience is paramount to building a lasting brand. This year we are focusing on every customer touch point, exploring the many ways that we can improve our interaction with our customers.

For example, on the website, we are enhancing usability and product navigation. In customer service, we have implemented new training that focuses on our communication with our customers, using one voice that champions the quality of our brand and emphasizes our commitment to service that exceeds our customers’ expectations.

We are excited about the enhancements we’ve made to our website this year and the additional changes we have planned for the second half of the year. In early July we launched a service called Diamond Alerts within our diamond search functionality. This service alerts customers by email or RSS feed when diamonds matching their search criteria have been added to the website.

Last week we launched Live Help [ph] on our website, which provides one more way for customers to interact with Blue Nile. Now in addition to our award-winning customer service by phone or via email, customers may engage in a live chat with an expert diamond and jewelry consultant to answer any questions arise as customers shop our website.

We are constantly evaluating and developing features and functionality for the site that will elevate the shopping experience for Blue Nile customers and assist them in navigating our merchandise offering more efficiency. One of our most exciting projects is the re-launch of our diamond search functionality that will take place in the third quarter. Our new Diamond Search will provide an enhanced experience for consumers who come to Blue Nile looking for the perfect diamond.

Following this innovative launch, in Q4 we will releasing a new version of our build-your-own ring functionality that will offer consumers greater flexibility and visualization capability as they build customized engagement rings. Today our customers tell us that the usability of an information provided on our website far exceeds that of other options online.

Our goal is to further extend our lead in the online jewelry category by continuing to raise the bar in all aspects of our website experience. In today’s marketplace, we are even more focused on providing an exceptional customer experience and a compelling value proposition in order to capture market share.

On the product side, we are focused on offering more of the beautiful, high quality products for which we are known. A specific area of focus is our collection of settings, which is being expanded with new fashion designs. We are enhancing our selection with settings that include more intricate designs such as pave diamonds and milgrain detail.

Additionally, we have extended our offering in diamond eternity bands, beautiful rings that consumers love as engagement and wedding jewelry. Later this year, we will be re-launching our assortment of settings as a series of collections, each of which will showcase distinctive styling and points of view in order to assist customers in their selection process.

In non-engagement jewelry, we continue to add selectively to our assortment in order to offer more modern looks while maintaining a classic feel to our overall selection. We will continue to broaden our offering in the product areas where we see consumer demand and where we believe we have the greatest potential for growth.

Our initiatives to enhance our customer experience are paying off. We see this everyday in increasing customer feedback scores as well as in customer comments that highlight our success. I would like to share with you a couple of recent comments so you can hear from our customers in their own words.

The first comment. The ring is amazing and way more than we expected for the price. The quality is superior to that offered by any other local jeweler. Thanks to Blue Nile we could afford to buy my dream ring. I would have cost us double elsewhere for the exact same quality diamond. And the second comment. Blue Nile made my engagement ring process about as pleasant as it could be from the education to the browsing to the building to the buying. A great experience is one thing, but Blue Nile also ended up with the most competitive price among the other major retailers I researched. How can you not go with the retailer that has the best service and experience, but also the best price?

Our second key initiative for the year is to focus on an efficient and lean cost structure. As top line growth has slowed in the current macro environment, we are aligning our cost to the level of demand that we are currently generating. Last year we invested in fulfillment capacity in Seattle and Dublin that will enable us to efficiency scale to roughly $1 billion in sales. This investment in capacity has prevented us from realizing cost leverage in the short-term, but will enable us to realize scale benefits as we anniversary these investments in the coming quarters.

Our third initiative for 2008 is to drive international growth. Our international business started with limited offerings to Canada in 2003 and the UK in 2004. Over time, we improved the offering with greater product selections, and in May of 2007, we launched new websites that transact in local currency in those markets. Since the beginning of 2008, we expanded our shipping capability to new markets in Europe and Asia Pacific and are now serving over 25 markets globally.

In the second quarter, the sales growth in Canada and the UK continued to be strong. Combined, these markets grew over 100% in the quarter and accounted for the majority of our international revenue. With the addition of our new markets, the growth in our international business has been exceptional. For the second quarter, net sales for markets outside the US totaled $8.1 million, representing 179% year-on-year growth and increasing to 11% of total sales.

We continue to evaluate the new international markets we’ve entered during 2008 and are excited by the level of activity that has been generated through the attraction of consumers to the Blue Nile brand and compelling proposition. As a remainder, customers who are purchasing from the new international markets we’ve opened up in Asia Pacific and European countries are shopping through either our US or UK website and they are paying in US dollars or British pounds.

We are very excited about the potential of our international business and we’ll continue to learn about what works in these markets and continue to improve the customer experience as we move forward. At halfway point in the year, we are as confident as ever in the strength of our business model. Now more than ever, we believe our value proposition and our commitment to superior customer service set us ahead of our competitors.

We are relentlessly focused on enhancing the Blue Nile customer experience across every touch point of our brand, paying close attention to the hundreds of details that matter to our customers. While growing our business in this environment is challenging, we will continue to be guided by our long-term financial objective of rapid growth rates in a normalized US economy. We believe that the long-term growth opportunities for our business, both here in the US and internationally, are tremendous.

I’d now like to turn the call over to our CFO, Marc Stolzman. Marc joined Blue Nile about two months ago and we’re very excited to have him onboard. He brings a wealth of experience to our team and has a true passion for building the Blue Nile brand. Marc will now provide more details on our quarterly results.

Marc Stolzman

Thank you, Diane. And good afternoon, everyone. As Diane mentioned, in the second quarter we posted net sales of $73.7 million representing an increase of 2.2% over the second quarter of 2007. International sales grew 179% year-over-year, while the US sales declined 5%. It is important to note that our second quarter last year, a quarter in which we grew 27%, was influenced by our Google Checkout promotion and one large order of $1.5 million, both of which impact the year-over-year the comparisons.

Looking at the sales trends during the quarter, we had modest year-over-year growth in April, better growth in May, and a reversal of that trend in June. We continued to see weakness at the very high price points, over $100,000 throughout the quarter. We saw pockets of strength within the $50,000 to $100,000 price points and under the $5,000 level. Price points between $5,000 and $50,000, which we believe are the most reliant on credit and are prone to consumers trading down, were weak.

Gross profit for the quarter was $15.1 million, an increase of 1.2% year-over-year. As a percentage of sales, gross margin for the quarter was 20.5%. Our reported gross margin in the second quarter of last year was 20.7% and included a shipping refund that benefited our margin by 30 basis points. Excluding this shipping refund, our gross margin of 20.5% for the quarter improved 10 basis points over last year. The year-over-year improvement in gross margin is a result of mix shift and price increases.

Customers in the second quarter of 2008 on average bought smaller carat stones compared to a year ago. These smaller carat stones carry a higher average gross margin so this shift in product mix had a favorable impact on overall margins. In addition, selective retail price increases helped offset the increase in our product cost in the face of rising diamond and metals prices.

For the quarter, total orders were down 7% as compared to a year ago, and our average selling price per order increased 9.7% to $1,787 in the second quarter. However, it is important to note that our order total a year ago included a Google Checkout promotion that drove a significant number of low ticket orders. In addition, last year we had one order for $1.5 million. Excluding this Google promotion and the $1.5 million sale from last year’s total, orders in the second quarter of 2008 increased 13% over last year and our average ticket declined 5.5%. This trend of lower average ticket is indicative of how consumers are currently shopping for their jewelry purchases.

During the quarter, traffic to the website was up versus a year ago. Recently, third party data sources have estimated that traffic to our website has declined significantly. These reports have shown little correlation to actual traffic data. We would encourage analysts and investors to be very cautious in their use of third-party traffic data.

Net income for the quarter was $3.2 million. Earnings per diluted share were $0.20, exceeding the high-end of our guidance range by $0.02. Net income per diluted share for the quarter includes stock-based compensation expense of $0.08 compared to $0.05 for the second quarter of 2007.

SG&A totaled $10.8 million for the quarter. SG&A included $1.9 million in stock compensation expense in the second quarter of 2008 compared to $1.4 million in the second quarter a year ago. Excluding stock-based compensation expense, SG&A as a percentage of sales was 12.1% compared to 11.8% in the second quarter of 2007.

Second quarter results include higher cost associated with our expanded domestic fulfillment center and our international operations. Additionally, the second quarter includes legal costs primarily related to intellectual property defense. These costs were offset by legal settlements received during the quarter, reported in the other income line of our P&L.

Operating income for the second quarter totaled $4.4 million, representing an operating margin of 5.9%. Non-GAAP adjusted EBITDA, which we define as earnings before interest and other income, income taxes, depreciation and amortization, adjusted to exclude the effects of stock-based compensation expense, was $6.8 million for the quarter, flat with second quarter of 2007.

Interest income totaled approximately $280,000 for the quarter compared to approximately $800,000 in last year’s second quarter. The decrease in interest income is due to lower interest rates and lower average cash balance compared to the second quarter of 2007 as a result of our share repurchases. Our other income in the quarter rose to $285,000 compared to $12,000 a year ago due to legal settlements received during the quarter.

Our effective tax rate for the quarter was 35.0% compared to 35.4% a year ago. We ended the quarter with a cash balance of $47.2 million. During the quarter we repurchased 10,500 shares of our common stock for a total of $0.5 million. Following the quarter-end, we continued our share repurchases buying 466,400 shares for a total of $18.2 million. Since the inception of the buyback program in the first quarter of 2005, we have repurchased 4.3 million shares for a total of $155 million. This amount represents 24% of the shares outstanding at the inception of the program. Our share repurchase program continues to be a priority for our uses of cash, and we will continue to look for opportunities to strategically execute our repurchase program.

Looking at the statement of cash flows, our trailing 12-month non-GAAP free cash flow for the second quarter totaled $20.5 million, down from $33 million in the year ago period. Due to our slower growth rate in 2008, we have generated less cash from our negative working capital model as compared to prior years.

I’d now like to discuss our guidance for the third quarter and full year of 2008. As a reminder, we operate on a 52/53-week fiscal calendar. Our fiscal year 2008, which will end on January 4, 2009, will include 53 weeks rather than the normal 52 weeks. The additional week will occur in our fourth quarter ending January 4, 2009. The addition of this week occurs once every five or six years under a 52/53-week fiscal calendar.

As we announced in our press release, we have revised our expectations for the full year to more modest growth levels as a result of the indications we have seen of further weakening in the US economy. For the third quarter, we expect net sales growth to range from 0% to 5% compared to the third quarter of 2007. Net income is expected to be $0.15 to $0.17 per diluted share. Q3 2008 is expected to have higher stock compensation expense compared to the prior year that equates to an incremental $0.03 of EPS.

For the full year, we are revising our expectations for 2008 to grow net sales and non-GAAP adjusted EBITDA in the mid-single digits. Our goal with respect to earnings per share is to achieve EPS that is consistent with levels achieved in 2007 when we reported $1.04 per diluted share. For 2008, our stock compensation expense is approximately $0.30 per diluted share, which is $0.08 higher than stock compensation expense in 2007. Our capital expenditures for the year are still expected to approximate $2.5 million.

Now I’d like to turn the call back to Diane.

Diane Irvine

Thank you, Marc. In summary, we are confident that our initiatives will allow us to enhance the Blue Nile customer experience and to continue to gain share in the large world market for diamonds and fine jewelry. We are passionate about building an iconic consumer brand and extending the Blue Nile brand globally. And we have firm conviction in our ability to capture the significant long-term opportunities that lie ahead for our business.

With that, we would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Lorraine Maikis from Merrill Lynch. Your line is open.

Lorraine Maikis – Merrill Lynch

Thank you. Good afternoon. I was just curious about the cost control strategy and if there is anything else you can do going forward to continue to cut your SG&A as sales trends don’t meet your initial expectations?

Diane Irvine

Well, I think obviously cost discipline has been a hallmark of our performance over the years and it’s something that we’re very, very focused on. And we continue to be – clearly over the long-term of our business, you’ll continue to see great leverage there. And so I think for now it’s making the wise investments from everything from marketing to all the business. So – I don’t think there is any one thing in particular but just a very disciplined focus on our cost management.

Lorraine Maikis – Merrill Lynch

And could you give us an update on your non-engagement jewelry strategy, if there are any changes that you need to make to the assortment given the environment or how you expect growth to trend there?

Diane Irvine

In terms of non-engagement, as we’ve talked about in the past, over time we’ll see more and more of the business become non-engagement, certainly as we have repeat customers coming back to purchase from us. We will in the next month be launching our fall collection in advance of holiday. So that is something that is very exciting for us as we approach the holiday season. So we’ll introduce some new styles there. But I think for us, that category is one that is very important for that repeat customer. We want to keep an edited assortment of classic styles, but also mix in new fashion. So we have some exciting products coming up in the next couple of months.

Lorraine Maikis – Merrill Lynch

Thank you.

Diane Irvine

Thank you, Lorraine.

Operator

Your next question comes from the line of Mark Mahaney with Citi Investments. Your line is open.

James Sanford – Citi Investment

This is James Sanford [ph] for Mark Mahaney. Just a couple of quick questions. It looks like inventory turns are at their lowest at this point. Should we expect any kind of build-up going into the quarter? Are you at a level that you are comfortable with? And given the pricing increases in the raw materials, any additional trend that we should expect in terms of impact on inventory there?

Diane Irvine

Sure. James, in terms of inventory, as we approach the fourth quarter and get into the fourth quarter, certainly we will build inventory for the holiday season, and so we’ll be doing our planning based upon what we’re seeing in Q3 and plans for Q4. So that will be what happens normally on a seasonal basis. In terms of the raw material increases, some metal prices have started to come back a little bit in the past month. So we’ll see what happens there. I think the significant moves have happened, so hopefully there will be some easing off there. And then there will be a point at which if there is an easing off, then we’ll start to see benefit in our pricing. And that would be true for metals. In terms of diamonds, there hasn’t been any easing, if you will, in prices since the significant increase that we saw at the end of May, but we manage that area very carefully and that’s what we need to do.

James Sanford – Citi Investment

Thank you.

Operator

Your next question comes from the line of Matt Nemer with Thomas Weisel Partners. Your line is open.

Matt Nemer – Thomas Weisel Partners

Good afternoon everyone. My first question is on the guidance, it looks like your revenue and EBITDA guidance for the back half is coming down, but your EPS guidance is not. In addition to share repurchase, is there anything else going on there that we should be aware of that would be boosting EPS?

Marc Stolzman

Hi, Matt. I think in terms of the second half of the year, certainly we plan our expectations based on the current share level and not taking into account share repurchases. That’s not an item that we can predict in advance of market conditions. You are correct about the expectation on sales. And what we’ve done in terms of evaluating earnings per share is to look at the current environment and then the strategy that Diane outlined earlier in cost management to make sure that we can balance the current expectation of our sales growth and achieve our goals for earnings per share. So I do believe that in the past we have not been as specific about how that sales level would impact our earnings per share, but we do anticipate that within this range we would achieve the level that we’ve described.

Matt Nemer – Thomas Weisel Partners

Okay. And then in terms of the fourth quarter, have you disclosed the impact of the extra week and I’m just wondering if there are any other specific drivers or comparisons from the year ago that help boost the implied Q4 growth rate?

Diane Irvine

In terms of the extra week, Matt, we have not disclosed the impact there. And I think because you have the holiday season and what’s happening in the economy, I think all of that gets mixed together. So I think it would be probably false precision if we were to try to come with a number and say here is the impact there. And in terms of Q4, the other dynamic that we’ve seen currently, at these sales levels – for example, in engagement, we’ve had probably a bit of a trading-down phenomenon on the part of the customer. And as that happens if the ticket is slightly lower, then that drives a little bit higher gross margins. So, clearly the mix of products will then be driving what happens in gross margin in the second half of the year, especially Q4.

Matt Nemer – Thomas Weisel Partners

Okay. And then lastly, thanks for the detail on the customer behavior in terms of price points. Is there anything else you can share with us that you’ve noticed from your customers in terms of abandonment rates or return rates, or maybe even some incremental detail on the finance approval rates?

Diane Irvine

In terms of customer behavior, return rates have been steady over time to slightly declining, so nothing new happening there. What we do in engagement category is somewhat of a trading-down whether it’s in terms of price points. There is also a bit of substitution, if you will, where diamond bands did very well. So we believe that there is some use of eternity bands and other diamond bands as an engagement jewelry item. In terms of financing, that is a third-party program that we have and there was a very clear tightening of credit in the second quarter so that fewer customers were being approved there. And that is certainly no surprise if we all look at what’s happening in the overall market, but that had an impact on us as well. It’s a smaller part of our business, but certainly any change there can have an impact. At these prices, credit is very important to many customers, especially that engagement customer where they have high income potential but not necessarily high asset. So we continue to believe there's probably some element of deferral as well in terms of these purchases.

Marc Stolzman

Yes, and we can see that very clearly in the financing program where you see a step-down in the approval rates at different credit scores. But across the board at different credit – at almost every credit score we’re seeing the credit provider stepping down. So we can see it there, but our feeling is that that’s also happening within people’s credit card limits. That’s a target for us to see people’s credit card limits, but our suspicion is that people have just less access to credit. You can hear that anecdotally if you listen to customer phone calls coming into our call center or chats going on with our call center. We see a lot of requests for more credit options out there. We feel like we can just see – especially when you look at that $5,000 to $50,000 of our price point, we can see customers just trying to figure out ways to finance this purchase.

Matt Nemer – Thomas Weisel Partners

Are you locked in with that – is that an exclusive with that third party provider or – obviously this is not an opportune time to be looking for financing. But are there other folks that you can potentially use for financing?

Diane Irvine

It’s not an exclusive program, Matt, and certainly payment options are very important to our customer and so something that we’re focused as well.

Matt Nemer – Thomas Weisel Partners

Great. That’s all I’ve got. Thank you.

Diane Irvine

Thank you.

Operator

Your next question comes from the line of Douglas Anmuth with Lehman Brothers. Your line is open.

Douglas Anmuth – Lehman Brothers

Thanks for taking my questions. A few things. First, can you comment on the impact of taxes in New York since the recent rollout and then if you have any view on the impact if taxes are to roll out more broadly to the other states online? And then secondly, was there any particular reason that you waited to buy back stock so heavily until 3Q as opposed to in 2Q? And then I have one more follow-up. Thanks.

Diane Irvine

Sure. In terms of New York, I would say it’s just [ph] a comment, but I think our feeling there is we charge sales taxes in jurisdictions where we are required to. Obviously we have charged sales taxes since inception in the State of Washington. And here in Washington, Seattle is a fantastic market for us. So we believe that our great consumer proposition is what really speaks to the customer and that will continue to see that consumers find that value regardless of their location. So – but to your point, we did start collecting sales taxes in the State of New York in June. In terms of our buyback, we look for the right opportunity. We generally run that in a 10b5-1 program, and so we find our points to purchase and we’ll continue to be opportunistic and intend to use that program to deliver value to our shareholders over the long-term.

Douglas Anmuth – Lehman Brothers

And then if I could just follow up, in terms of the payment cycle with vendors, obviously a big benefit for your business in terms of working capital. Any change that you are seeing in this environment or are suppliers at all demanding their payments any sooner?

Diane Irvine

No, I think, as we’ve talked over time, Doug, we have extended our days payable consistently through time on a quarterly and annual basis. That continues. What you do see and what Marc talked about in terms of the free cash flow and the cash flow statement is with slower growth and you don’t have the same power from the buildup of the payables. But the model hasn’t changed and so we’ll continue to see nice benefit from working capital, although it’s currently not what you see a year ago with higher growth rates.

Marc Stolzman

Yes, I think in general our vendors are just excited that we’re purchasing because we’re with the most jewelers right now, when the sales aren’t coming in, what they are trying to do is sell within the case rather than buying new. They’re trying to lean more heavily on their vendors for consignment merchandise. So in general, because we continue to buy on a regular basis, and that’s driven by the faster inventory turn we have than normal jewelry store which is turning once a year, our vendors are pretty excited with our business and our – especially the strong ones are being flexible as they can to help us continue to grow the business.

Douglas Anmuth – Lehman Brothers

And I may have missed it, but did you mention what percentage of sales were finance?

Diane Irvine

We didn’t mention that, Doug. We haven’t disclosed that percentage.

Douglas Anmuth – Lehman Brothers

Okay, great. Thank you.

Diane Irvine

Thank you.

Operator

(Operator instructions) Our next question comes from the line of Herman Leung with Deutsche Bank. Your line is open, sir.

Herman Leung – Deutsche Bank

Hi, thanks. Couple of questions. First question is, just wanted to see if you can quantify the impact on the diamond price increases you talked about, 7% to 25% increases as you entered June, were there impacts on specific sizes of diamonds? And second question I have is inter-related as well, is whether or not some of these competitors that you are seeing that are liquidating inventory, is there an opportunity for you guys to basically pick up some of their inventory that’s kind of going out? And if you’re also seeing diamond prices, can you increase the frequency in terms of price increases on your side? I know you guys do that like two times a year or so. I was wondering if you can use that as a hedge on the diamond pricing.

Diane Irvine

Thanks, Herman. In terms of the impact of the diamond pricing, as you are saying, the price changes were specific by category and by shape. As we’ve seen for sometime, probably four years or more, at the high end primarily 2.0 or 2.5 carats and up, those had the highest percentage increases, so up to 20% and 25% in the large carat sizes. But across the board, very significant changes. And as I mentioned, for us that has been an immediate impact on our pricing because we are buying on a real-time basis. So, as our costs change, then in diamonds that gets passed on to the consumer. If you look offline and you’re talking about a lot of the liquidation that's happening, the rest of the industry is very troubled, and that continued to worsen as we’ve gone through the year. In terms of picking up inventory from any liquidation, with respect to loose diamonds as an example, we do opportunistically purchase diamonds when we see that there are opportunities for us to capture more of the economics with the lot of the liquidations that are happening. Some of that inventory looks very different from what we sell. It’s not same quality spectrum. But having said that, I think we’re – if something fits our quality, then we see an opportunity to gain more of the economics and we would look at that. But that tends to not be the case in what you’re seeing today offline in terms of very heavy liquidations taking place.

Herman Leung – Deutsche Bank

And in terms of the frequency of price increases, could you pass some incremental kind of price increases on your site, just given the increase in your raw material cost?

Diane Irvine

You’re referring to metals there, is that right?

Herman Leung – Deutsche Bank

Metals and diamonds.

Diane Irvine

With respect to diamonds, it works a little bit differently where because we have our virtual supply of diamonds, if you will, that we’re purchasing everyday, and that’s one reason when Marc talked about that vendors are happy that we’re purchasing. We’re probably the only people in the industry that are buying from diamond suppliers everyday. But an increase or a decrease in wholesale diamond pricing will then immediately pass through to consumers unless we’re changing our margin structure. With respect to metals, that’s I guess a bit of a separate area for us where – take platinum wedding bands as an example. Those are products we’re holding in our inventory and so those platinum prices, which I mentioned had increased in the first six months of the year by 33%, that’s something where we certainly try to hold our prices. We want to have fantastic value to our consumers. But after a period of time, if we had a little bit of margin compression, we then will pass those prices onto consumers. So that was taking place in the first half of the year where as those prices increased, we did reach points where on various products with metal whether it's platinum, gold or silver, we have had to take some retail price increases, not to the same extent that our costs have gone up. But we have raised those retails as well.

Herman Leung – Deutsche Bank

Got it. And then last question is – I guess this is for Marc as well. On your assumption on guidance, I was wondering if you can quantify the back half specifically for US and international kind of growth. You continue to expect the US to decline in the kind of low-double digit range, considering internationals ramping up much more significantly?

Marc Stolzman

I think in terms of the second half, we have seen where the US business is now and I think Diane’s comments and mine combined, looking at what we expect from the holiday season and the year-over-year with the 53rd week, certainly that has a large impact on the US growth rates. We do continue to expect strength from the international growth, but in terms of laying it out more specifically of either international growth or impacts in the US business, we haven’t disclosed that at this time and don’t think we want to be more specific in our overall guidance.

Herman Leung – Deutsche Bank

Yes. Thanks.

Operator

Our last question comes from the line of Jim Friedland with Cowen & Co. Your line is open.

Jim Friedland – Cowen & Co.

Hi, thanks. If you look at the adjusted order growth number of 13%, is that – should we use that as a proxy for the year-over-year site visits to Blue Nile from your internal logs?

Marc Stolzman

Yes, well, I mean – we had – I think what we said in the script is we had positive growth in traffic. We also had positive growth in conversions. So we saw the increase in orders coming from both traffic increases and conversion increases. I think that’s about as specific as we want to get. I do want to say, we see increasing reliance from the analyst community on the comScore data that’s being released out there. And I’ve just got to caution you guys that when we look at that data, it has very little correlation with the actual numbers we’re seeing on our servers. And I’d even want to caution, we saw somebody recently using the international traffic data, and if it’s hard because of the size of our traffic relative to the size of the panels being used to estimate this stuff. If it’s hard to estimate our traffic in the US, trying to estimate our traffic off of panel data internationally, the margin of errors got to be just massive there. So I would just again caution people to be relatively careful using that traffic data that’s being released out there.

Jim Friedland – Cowen & Co.

Okay. And on international, if you look at the revenue mix you’re seeing there, is it the same kind of split that you are seeing in the US where it’s 70% engagement roughly, 20% non-engagement diamond, and 10% other? And then second part of international is, looking to Q3 as international gets a little bit bigger, is there any sort of seasonality where Q3 is little bit weaker, just again given seasonality, or is it just too early to see that?

Diane Irvine

Jim, in terms of the revenue mix, we don’t have product offering in those markets. So, those international markets tend to be much more diamond driven, whether that’s engagement ring or other forms of diamond jewelry. So they are very much about diamonds at this point. We have in Canada and the UK more of a broadened offering, but it still is not the same as what’s on the US website today. In terms of seasonality, the one thing I’d mention which we’ve talked about many times, but as you know, last May of ’07, we launched the websites in local currency in Canada and the UK. So we’ve had the anniversary of that re-launch of those websites. And I suppose post the anniversary one could say, well, maybe the growth rates would come off somewhat, but I’d say as you look at the second half, international will be exception growth for us with all of those markets. So we’re very excited about the markets and what we are seeing there in terms of the demand.

Jim Friedland – Cowen & Co.

Okay, great. Thanks a lot.

Operator

We have no further questions at this time.

Diane Irvine

Okay. Thanks everyone for joining us today and we will look forward to talking with you following our third quarter release.

Operator

This concludes your Blue Nile conference call for today. You may now disconnect your line.

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Source: Blue Nile, Inc. Q2 2008 Earnings Call Transcript
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