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OPERATOR: Good afternoon. Ladies and gentlemen, my name is Cara and I will be your host operator on this call. (Operator Instructions). At this time I would like to introduce Eileen Askew, Manager Investor Relations of Blue Nile.
EILEEN ASKEW, MANAGER IR, BLUE NILE, INC.: Good afternoon, and thank you for joining us on our conference call today to review our fourth quarter and full year 2008 financial results. With me today are Mark Vadon, Executive Chairman; Diane Irvine, Chief Executive Officer, and Marc Stolzman, Chief Financial Officer. All will be available for Q&A following today's prepared remarks.
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, sales, margins, expenses, income, operating cash flow, inventory, capital expenditures, international growth, tax rates, stock-based compensation expense, and other financial statements or balance sheet items, as well as statements about the global economic environment, diamond and metal prices, the stock market, the credit market, consumer behavior, currency, competition, the industry, market share, 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 reports on Form 10-Q, our annual reports 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, les 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.
Now I would like to turn the call over to Diane Irvine.
DIANE IRVINE, CEO, BLUE NILE, INC.: Good afternoon everyone. As you know, the 2008 holiday season was the most challenging one for retailers in four decades, and certainly the most difficult since Blue Nile's inception in 1999. Consumers have been faced with significant external pressures from the loss of jobs to significant declines and volatility in the stock market, lower housing prices and frozen credit markets.
These factors have combined to result in historic lows in consumer confidence. The lack of confidence on the part of consumers has had an impact on purchases of high ticket items, including jewelry. MasterCard Spending Pulse reported that luxury items showed the highest year-over-year decline of any retail category during the holiday season, with sales down more than 34%. And jewelry was the poorest performer in the luxury category.
The holiday sales reports from high-end public jewelry retailers reflected US comp store sales declines of 31% or greater year-on-year. Given this environment, we are pleased with our performance for the quarter. Overall for Q4 sales declined 23%, after increasing 23% in the fourth quarter a year ago.
In a difficult environment we achieved a significant level of earnings and $25.1 million of adjusted EBITDA, and most importantly, strong relative performance for the year. We ended the year with no debt, and have maintained strong liquidity.
Our fourth quarter sales results in comparison to other high-end jewelry retailers are evidence that we continued to build market share during this turbulent time. For the year, while our sales of $295 million declined 7.5% from the prior year, comScore estimated that online jewelry sales declined 12% in 2008.
We believe that we're not only gaining share online, but we're certainly also increasing our market share overall compared to off-line and online competitors.
Looking at specific business trends during the quarter, the engagement jewelry category performed relatively better than nonengagement jewelry, and represented a larger portion of our overall sales mix compared to the fourth quarter of 2007. Sales of nonengagement jewelry appeared to have been more impacted from consumers pulling back on discretionary purchases.
High-end jewelry sales at price points above $25,000 were the most affected, and had greater declines as compared to our overall sales on a year-over-year basis.
Turning to our profitability for the quarter, our highly variable cost structure served us well. While it is difficult to immediately adjust the entire cost structure to adapt to a change in sales trends, such as we experienced in Q4, we were able to take action on some of our costs during the quarter. We are actively managing our cost structure and believe that we can show improved margins in 2009 as we adjust to this difficult macroenvironment.
From an inventory standpoint we took steps with our suppliers to reduce our inventory during the quarter and achieved a 10% year-over-year reduction in our inventory balance. We will continue to manage inventory at appropriate levels in line with the cautious outlook for 2009.
One of the great features of our business model is its cash flow generation capabilities. For seven consecutive years from 2001 through 2007 our business generated substantial free cash flow each and every year. In 2008 we experienced a different dynamic as a result of the significant change in our sales trends in Q4, where we saw the benefits of our negative working capital model work against us in a period of sales decline.
Despite that, the cash flow generation dynamics of our business remained strong. Looking ahead, we fully expect to generate positive free cash flow in 2009.
I would like to touch on the diamond pricing environment. On our last call we indicated that diamond prices had risen nearly 20% over year earlier levels in the third quarter. This was the highest year-over-year diamond price increase in the history of our business.
Demand for diamonds globally has fallen as a result of the economic environment, and this is having an impact on diamond prices. We began to see diamond price decreases in the fourth quarter, and we continue to see prices decline in Q1.
We believe that our business will benefit significantly in a declining diamond pricing environment. In such an environment our competitive advantage versus a traditional jeweler who holds inventory will be clear to the consumer as we will pass those savings on to consumers in the form of lower pricing on a real-time basis.
Further, since we generally purchase a diamond after it has been selected by a customer, we have the ability to operate within our traditional margin structure in this environment, and our P&L will not be strained with markdowns like the physical jeweler.
Given all the turmoil within the jewelry industry, I would like to explain why we believe this environment is beneficial for our business over the long term. The number of jewelers operating in the United States continues to shrink. In 2008 there was a 5% reduction in retail jewelry capacity, including the bankruptcies of Whitehall and Friedman's Jewelers. Already this year there had been several additional bankruptcies, including Shane Company, Fortunoff and Christian Bernard Jewelers. And we expect that there will be...
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