Key questions and answers from the second quarter fiscal 2007 earnings call conducted by Blue Nile Inc. on August 6, 2007.

Jack Murphy (William Blair): On the last conference call you said that traffic versus conversion was about 50-50 in terms of driving the impressive order growth results. Could you make a similar comment on this quarter as to what you think the split might have been in the quarter?

Mark Vadon: Traffic was even stronger this quarter than last, but we're seeing great trends in both traffic and conversion. As the traffic growth keeps climbing, it gets even harder to improve the conversion because each bit of traffic is a little bit less qualified. Overall, the trends in both of them are great.

Jack Murphy: Since you're raising the guidance on the earnings, what are your thoughts about free cash flow on a full year basis?

Diane Irvine: We don't guide to that number but even with the tax change, that we'd be able to be equal to or better than last year's numbers.

Mark Mahaney (Citigroup): You talked about Nile as a luxury brand. Is there any change in your thinking about how many different luxury products or verticals Blue Nile could be appropriate for in the future?

Mark Vadon: Our intent is not to take the brand beyond the jewelry category. We feel the jewelry category is tremendously large; it's a $60 billion domestic market. If we execute well within that market, we'll be able to grow for a very long time.

When we look at the brand, we believe one of the mistakes a lot of retailers make is they expand too far. They expand their product lines too far and it dilutes the brand. We would rather be well known for being the best in the world at what we do, rather than trying to put other luxury categories up there and gain a little more sales in the short-term at the expense of the long-term value of that brand.

Mark Mahaney: Could you give some specific examples of what non-engagement products in the non-engagement ring area are particularly selling well on Nile?

Diane Irvine: All of our product categories did well during the quarter and certainly in the bridal business when you look at engagements and then in the non-engagement category, wedding bands are one of our very top products so that continues to grow very nicely. We'd love for every customer who comes in for their engagement purpose and then come back to us to buy their wedding bands. All forms of diamond jewelry outside of engagement rings if you look at diamond earrings, diamond pendants and necklaces are doing very well. That would include both customized diamond engagement product where a customer is coming to us starting with a loose diamond and then customizing their ultimate product or purchasing diamond earrings or pendants that are already preset, are doing very well. Pearls and gemstone categories in necklaces, bracelets, earrings, are doing phenomenally well for us. Sterling silver as well, which is a lower price point but provides a great opportunity for customers to come back and repeat. Also, it is a great trial purchase for someone coming into Blue Nile where we can acquire new customers.

Douglas Anmuth (Lehman Brothers): What is your guidance for gross margins going forward?

Diane Irvine: In terms of gross margins, what we had generously anticipated is that once we anniversaried that period of price reduction that we'd be equal to or greater than last year's gross margin. Again, one of the things we pointed out was this quarter's gross margin, except without the one-time refund related to shipping charges, would have been 20.4%, an increase of 50 basis points.

When you look at Q3 and you'll see that if you looked at our results last year for Q3, that's the period of the year when the most engagements happen, more of the mix is driven towards engagement because we don't have a holiday season there. You would generally expect those products with higher ticket to have a lower gross margin percentage than in Q2. But as we look out, we have felt that our mix will be adjusting more and more towards non-engagement products which do carry higher gross margins. We'd expect to be able to over time see continued movement up in our gross margins.

Douglas Anmuth: What are your views on share buybacks at these levels?

Diane Irvine: What we'd like for everyone to understand about the share repurchase program is we'll always be very thoughtful in how we execute that program. Certainly looking at our balance sheet opportunities for investment, we need to be very prudent from a capital allocation standpoint and make the right decisions in the buyback program. We want to always do what's right for our shareholders. In the past two-and-a-half years, we have retired 15% of our outstanding shares. Today we have more cash on our balance sheet than we did even after becoming a public company, so over time that will continue to be a very strategic program for us.

Douglas Anmuth: Could you comment on the price points that you're seeing in the UK and Canada relative to the overall business?

Mark Vadon: The mix in those markets is a little different because they're younger brands so they're more focused on the engagement product line. That's also a function of us not having fully built out the product lines there yet and that will change over time. But if you look within individual product lines, both of those markets have slightly lower price points than the US market. That's true across the industry. The average engagement ring that's sold in the UK is going to be slightly smaller than in the US. When you look over all those businesses today are driving a slightly higher ticket because of the mix. But if you adjust for the mix, eventually those will probably be slightly lower price point markets.

Jim Friedland (Cowen & Co): What types of gross margin does the non-engagement business have? Where could gross margins go going forward?

Diane Irvine: In terms of non-engagement, if you look at diamond non-engagement products, things like diamond stud earrings, diamond pendants, any of those diamond priced with a high ticket will carry a lower gross margin because our gross margin percentage is inversely correlated to the price point. We might be in the '20s going up to gross margins in the '60s for a lower price point item on non-diamond products. There's a broad range of gross margins throughout the business but it's certainly safe to say non-engagement carries a higher gross margin.

We don't have a long-term target for gross margin. The way we think about is we want to optimize the gross profit, the dollars per unit and the dollars to the bottom line. We think that's the way we'll always think about pricing and our consumer value proposition. If we see opportunities to either raise or lower prices in certain categories, if we feel like it's the right thing for the bottom line, that's what we'll do. But over the long-term we also want to represent a great value to consumers. As we grow, we'll continue to see more and more opportunities to be able to cede back in the form of lower price to consumers and still have tremendous profitability.