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Blue Nile's stock falls to $30-and-change in after-hours trading as management forecasts 2006 sales of $220 million to $245 million. Wall Street was expecting $258 for 2006, according to

Since I have written about Blue Nile on this board, I want to share my thoughts. However, I only listened to the first half of the conference call; also, I have not run 2005's numbers through my Earnings Power model. In other words, I have more work to do on this name.

Okay, initial impressions in no particular order:

1. Management should stop the silly practice of making revenue and earnings forecasts. Just let the chips (carats?) fall where they may, I say. On the other hand, I applaud them for including a cash flow statement in the press release, something that a lot of other companies do not do.

2. Stock options will take a large bite out of 2006 (GAAP) earnings. For this year, management looks to make 62 cents to 72 cents a share, including 14 cents to 16 cents a share in option costs. Ugh. Not quite as bad as the job the refs did in Sunday's Super Bowl (if you are a Seahawk's fan), but close.

3. As if we need yet another object lesson to illustrate the importance of buying at a discount to intrinsic value, Blue Nile is down 33% from its Thanksgiving high of $44. I will update my valuation of Blue Nile and post on this board after the 2005 10-K comes out.

4. Inventory turned 15.6x in 2005, vs. more than 16x in 2004.

5. Year-end cash and equivalents is $114 million

6. The board has authorized management to repurchase $100 million of stock over the next few years. I have no problem with this decision so long as the management is buying back undervalued stock; to repurchase over-valued stock is a waste of stockholders' money. Better to sell over-valued stock than to buy it, oui?

7. 82% of customer calls are answered within 10 seconds, management said on today's call. I think this number helps explain why Blue Nile seems to have so many repeat and referral sales (although I do not know the exact numbers).

8. Management also said they have 3% market share of the U.S. engagement ring business. In a previous conference call they said they want 15% market share, which suggests there is room to grow. Other markets include the U.K. and Canada, as well as non-engagement jewelry.

9. The fourth quarter is the make-or-break quarter, as Blue Nile generated 119% of its net cash from operating activities during the October, November, and December months.

10. Management says "non-GAAP free cash flow for 2005 was $30.2 million, compared to $27.9 million in the prior year, and increase of 8.2%." I respectfully disagree. If you calculate FCF (defensive profits) the way I advise in It's Earnings That Count, then Blue Nile's true cash-generation was $20.3 million in 2006, a 5% decline from 2004's results of $21.4 million. If anyone can tell me how to create a table on these discussion boards, I will post my numbers. One reason for the divergence is because I expense taxes, while Blue Nile treats it as a source of cash.

11. Based on an enterprise value of $443 million and free cash flow of $20.3 million, Blue Nile's trailing EV/FCF multiple is 22x. Not a screaming buy, mind you, but not an outrageous price either considering the high level of customer satisfaction and my belief that this company is still in the early years of its life cycle.

12. As alluded to earlier, I am very interested to see what kind of stock option liability we are facing. So when the 10-K is released, I will share my calculations.

As always, divergent opinions are welcome on this board.


long NILE
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