UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549





FORM
10-Q





[
      X ]
            
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the quarterly period ended September 30, 2009OR[    ]
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the transition period from_________ to
  __________





Commission
File Number 001-14498





BLUEFLY,
INC.


(Name
of registrant as specified in its charter)


Delaware
            
            13-3612110(State
      or other jurisdiction of
              incorporation
      or organization)
            
            (I.R.S.
      Employer Identification Number)42
      West 39th
      Street, New York, NY
              (Address of
      principal executive offices)
            
            10018
              (Zip
      Code)





Registrant’s
telephone number: (212) 944-8000








Indicate
by check mark whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.    Yes
[X]        No
[   ]





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the past 12
months (or for such shorter period that the registrant was required to submit
and post such files).    Yes
[   ]        No
[   ]





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer or a smaller reporting
company.  See the definitions of “larger accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):





Large
accelerated filer
[  ]        Accelerated
filer    [  ]                   Non-accelerated
filer [   ]       Smaller
reporting company  [ X ]


(Do
not check if a smaller reporting company)








Indicate
by check mark if the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).      Yes
[  ]     No [X]








As of
November 6, 2009, there were 13,936,417 shares of Common Stock, $.01 par value,
of the registrant outstanding.





BLUEFLY,
INC.


TABLE
OF CONTENTS


SEPTEMBER
30, 2009




PAGEPART
      I –
                                    
                                    FINANCIAL
      INFORMATION
                                    
                                    
                                    3Item 1.
                                    
                                    Financial
      Statements:
                                    
                                    
                                    3Balance
      Sheets as of September 30, 2009 (unaudited)
                                      and
      December 31, 2008
                                    
                                    
                                    3Statements
      of Operations for the three months ended
                                      September
      30, 2009 and 2008 (unaudited)
                                    
                                    
                                    4Statements
      of Operations for the nine months ended
                                      September
      30, 2009 and 2008 (unaudited)
                                    
                                    
                                    5Statements
      of Cash Flows for the nine months ended
                                      September
      30, 2009 and 2008 (unaudited)
                                    
                                    
                                    6Notes
      to Financial Statements (unaudited)
                                    
                                    
                                    7 – 16Item 2.
                                    
                                    Management’s
      Discussion and Analysis of Financial Condition
                                      and
      Results of Operations
                                    
                                    
                                    17 –24Item 3.
                                    
                                    Quantitative
      and Qualitative Disclosures About Market Risk
                                    
                                    
                                    25Item 4T.
                                    
                                    Controls
      and Procedures
                                    
                                    
                                    25PART
      II –
                                    
                                    OTHER
      INFORMATION
                                    
                                    
                                    26Item 6.
                                    
                                    Exhibits
                                    
                                    
                                    26Signatures
                                    
                                    
                                    27
 2


Part
I – FINANCIAL INFORMATION


Item
1. – Financial Statements


BLUEFLY,
INC.


BALANCE
SHEETS


(Unaudited)September 30,
                                            
                                            
                                            December
      31,2009
                                            
                                            
                                            2008AssetsCurrentassets:Cash and cash
      equivalents
                                            
                                            $
                                            4,061,000
                                            
                                            
                                            $
                                            4,004,000Accounts receivable — net of
      allowance for doubtful accounts
                                            
                                            
                                            3,754,000
                                            
                                            
                                            
                                            3,300,000Inventories,
      net
                                            
                                            
                                            17,907,000
                                            
                                            
                                            
                                            23,157,000Prepaid
      inventory
                                            
                                            
                                            129,000
                                            
                                            
                                            
                                            155,000Prepaid
      expenses
                                            
                                            
                                            205,000
                                            
                                            
                                            
                                            470,000Other current
      assets
                                            
                                            
                                            537,000
                                            
                                            
                                            
                                            422,000Total current
      assets
                                            
                                            
                                            26,593,000
                                            
                                            
                                            
                                            31,508,000Property and equipment,
      net
                                            
                                            
                                            3,952,000
                                            
                                            
                                            
                                            6,058,000Otherassets
                                            
                                            
                                            148,000
                                            
                                            
                                            
                                            184,000Totalassets
                                            
                                            $
                                            30,693,000
                                            
                                            
                                            $
                                            37,750,000Liabilities and Stockholders’
      EquityCurrentliabilities:Accounts
      payable
                                            
                                            $
                                            5,162,000
                                            
                                            
                                            $
                                            8,344,000Allowance for sales
      returns
                                            
                                            
                                            3,057,000
                                            
                                            
                                            
                                            3,707,000Accrued expensesand other current
      liabilities
                                            
                                            
                                            1,046,000
                                            
                                            
                                            
                                            1,323,000Deferred
      revenue
                                            
                                            
                                            2,814,000
                                            
                                            
                                            
                                            2,876,000Total current
      liabilities
                                            
                                            
                                            12,079,000
                                            
                                            
                                            
                                            16,250,000Notes payable to related party
      shareholders, net of discount
                                            
                                            
                                            2,386,000
                                            
                                            
                                            
                                            3,000,000Embedded derivative financial
      liability to related party shareholders
                                            
                                            
                                            526,000
                                            
                                            
                                            
                                            --Interest payable to related party
      shareholders
                                            
                                            
                                            289,000
                                            
                                            
                                            
                                            106,000Total
      liabilities
                                            
                                            
                                            15,280,000
                                            
                                            
                                            
                                            19,356,000Commitments andcontingenciesStockholders’equity:Common stock–$.01 par
      value;  200,000,000 shares authorized as of September 30, 2009
      and December 31, 2008; 14,088,012 and 14,061,237 shares issued as of
      September 30, 2009 and December 31, 2008, respectively, 13,852,422 and
      l3,831,950 shares outstanding as of September 30, 2009 and December 31,
      2008, respectively
                                            
                                            
                                            138,000
                                            
                                            
                                            
                                            138,000Treasury
    stock
                                            
                                            
                                            (1,617,000
                                            )
                                            
                                            
                                            (1,612,000
                                            )Additional paid-in
      capital
                                            
                                            
                                            164,212,000
                                            
                                            
                                            
                                            163,746,000Accumulateddeficit
                                            
                                            
                                            (147,320,000
                                            )
                                            
                                            
                                            (143,878,000
                                            )Total stockholders’
      equity
                                            
                                            
                                            15,413,000
                                            
                                            
                                            
                                            18,394,000Totalliabilities andstockholders’equity
                                            
                                            $
                                            30,693,000
                                            
                                            
                                            $
                                            37,750,000The
      accompanying notes are an integral part of these financial
      statements.




3


BLUEFLY,
INC.


STATEMENTS
OF OPERATIONS


(Unaudited)




Three
      Months EndedSeptember
      30,2009
                                      
                                      
                                      2008Net
      sales
                                      
                                      $
                                      17,108,000
                                      
                                      
                                      $
                                      19,802,000Cost
      of sales
                                      
                                      
                                      10,269,000
                                      
                                      
                                      
                                      12,495,000Gross profit
                                      
                                      
                                      6,839,000
                                      
                                      
                                      
                                      7,307,000Selling
      and fulfillment expenses
                                      
                                      
                                      3,752,000
                                      
                                      
                                      
                                      4,933,000Marketing
      expenses
                                      
                                      
                                      1,457,000
                                      
                                      
                                      
                                      4,172,000General
      and administrative expenses
                                      
                                      
                                      2,095,000
                                      
                                      
                                      
                                      3,021,000Total operating
      expenses
                                      
                                      
                                      7,304,000
                                      
                                      
                                      
                                      12,126,000Operating
      loss
                                      
                                      
                                      (465,000
                                      )
                                      
                                      
                                      (4,819,000
                                      )Interest
      income
                                      
                                      
                                      8,000
                                      
                                      
                                      
                                      8,000Interest
      expense torelated party
      shareholders
                                      
                                      
                                      (405,000
                                      )
                                      
                                      
                                      (88,000
                                      )Interest
      expense
                                      
                                      
                                      (53,000
                                      )
                                      
                                      
                                      (94,000
                                      )Net
      loss
                                      
                                      
                                      (915,000
                                      )
                                      
                                      
                                      (4,993,000
                                      )Preferred
      stock dividends
                                      
                                      
                                      --
                                      
                                      
                                      
                                      (12,000
                                      )Deemed
      dividend related to beneficial conversion feature onSeries
      F Preferred Stock
                                      
                                      
                                      --
                                      
                                      
                                      
                                      (712,000
                                      )Net
      loss available to common shareholders
                                      
                                      $
                                      (915,000
                                      )
                                      
                                      $
                                      (5,717,000
                                      )Basic
      and diluted net loss per common share
                                      
                                      $
                                      (0.07
                                      )
                                      
                                      $
                                      (0.43
                                      )Weighted
      average common shares outstanding(basic
      and diluted)
                                      
                                      
                                      13,844,637
                                      
                                      
                                      
                                      13,309,383The
      accompanying notes are an integral part of these financial
      statements.





4


BLUEFLY,
INC.


STATEMENTS
OF OPERATIONS


(Unaudited)




Nine
      Months EndedSeptember
      30,2009
                                    
                                    
                                    2008Net
      sales
                                    
                                    $
                                    56,868,000
                                    
                                    
                                    $
                                    68,381,000Cost
      of sales
                                    
                                    
                                    35,370,000
                                    
                                    
                                    
                                    43,040,000Gross profit
                                    
                                    
                                    21,498,000
                                    
                                    
                                    
                                    25,341,000Selling
      and fulfillment expenses
                                    
                                    
                                    12,177,000
                                    
                                    
                                    
                                    14,525,000Marketing
      expenses
                                    
                                    
                                    6,237,000
                                    
                                    
                                    
                                    10,620,000General
      and administrative expenses
                                    
                                    
                                    6,194,000
                                    
                                    
                                    
                                    9,858,000Total operating
      expenses
                                    
                                    
                                    24,608,000
                                    
                                    
                                    
                                    35,003,000Operating
      loss
                                    
                                    
                                    (3,110,000
                                    )
                                    
                                    
                                    (9,662,000
                                    )Interest
      income
                                    
                                    
                                    18,000
                                    
                                    
                                    
                                    57,000Interest
      expense torelated party
      shareholders
                                    
                                    
                                    (917,000
                                    )
                                    
                                    
                                    (131,000
                                    )Interest
      expense
                                    
                                    
                                    (212,000
                                    )
                                    
                                    
                                    (231,000
                                    )Net
      loss
                                    
                                    
                                    (4,221,000
                                    )
                                    
                                    
                                    (9,967,000
                                    )Preferred
      stock dividends
                                    
                                    
                                    --
                                    
                                    
                                    
                                    (34,000
                                    )Deemed
      dividend related to beneficial conversion feature onSeries
      F Preferred Stock
                                    
                                    
                                    --
                                    
                                    
                                    
                                    (712,000
                                    )Net
      loss available to common shareholders
                                    
                                    $
                                    (4,221,000
                                    )
                                    
                                    $
                                    (10,713,000
                                    )Basic
      and diluted net loss per common share
                                    
                                    $
                                    (0.31
                                    )
                                    
                                    $
                                    (0.81
                                    )Weighted
      average common shares outstanding(basic
      and diluted)
                                    
                                    
                                    13,840,733
                                    
                                    
                                    
                                    13,275,955The
      accompanying notes are an integral part of these financial
      statements.




5


BLUEFLY,
INC.


STATEMENTS
OF CASH FLOWS


(Unaudited)




Nine
      Months EndedSeptember
      30,2009
                          
                          
                          2008Cash
      flows from operating activities:Net loss
                          
                          $
                          (4,221,000
                          )
                          
                          $
                          (9,967,000
                          )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation and
      amortization
                          
                          
                          2,281,000
                          
                          
                          
                          1,622,000Stock based
      compensation
                          
                          
                          466,000
                          
                          
                          
                          2,241,000Provisions for
      returns
                          
                          
                          (650,000
                          )
                          
                          
                          211,000Bad debt
    expense
                          
                          
                          250,000
                          
                          
                          
                          398,000Reserve for inventory
      obsolescence
                          
                          
                          (370,000
                          )
                          
                          
                          300,000Amortization of discount on notes payable to
      related partyshareholders
                          
                          
                          263,000
                          
                          
                          
                          --Change in fair value of
      embedded derivative financial liability to
                            related party
      shareholders
                          
                          
                          428,000
                          
                          
                          
                          --Change in operating assets and
      liabilities:(Increase) decrease
      in:Accounts
      receivable
                          
                          
                          (704,000
                          )
                          
                          
                          (1,453,000
                          )Inventories
                          
                          
                          5,620,000
                          
                          
                          
                          (149,000
                          )Prepaid
    inventory
                          
                          
                          26,000
                          
                          
                          
                          (688,000
                          )Prepaid
    expenses
                          
                          
                          265,000
                          
                          
                          
                          (795,000
                          )Other assets
                          
                          
                          (98,000
                          )
                          
                          
                          (150,000
                          )Increase (decrease)
      in:Accounts
    payable
                          
                          
                          (3,182,000
                          )
                          
                          
                          1,944,000Accrued expenses and other
      current liabilities
                          
                          
                          (272,000
                          )
                          
                          
                          530,000Interest payable to related
      party shareholders
                          
                          
                          183,000
                          
                          
                          
                          45,000Deferred
    revenue
                          
                          
                          (62,000
                          )
                          
                          
                          422,000Net
      cash provided by (used in) operating activities
                          
                          
                          223,000
                          
                          
                          
                          (5,489,000
                          )Cash
      flows from investing activities:Purchases of property and
      equipment
                          
                          
                          (161,000
                          )
                          
                          
                          (2,299,000
                          )Net
      cash used in investing activities
                          
                          
                          (161,000
                          )
                          
                          
                          (2,299,000
                          )Cash
      flows from financing activities:Proceeds from notes issued to
      related party shareholders
                          
                          
                          --
                          
                          
                          
                          3,000,000Purchase of treasury
      stock
                          
                          
                          (5,000
                          )
                          
                          
                          (22,000
                          )Net
      cash (used in) provided by financing activities
                          
                          
                          (5,000
                          )
                          
                          
                          2,978,000Net
      increase (decrease) in cash and cash equivalents
                          
                          
                          57,000
                          
                          
                          
                          (4,810,000
                          )Cash
      and cash equivalents – beginning of period
                          
                          
                          4,004,000
                          
                          
                          
                          6,730,000Cash
      and cash equivalents – end of period
                          
                          $
                          4,061,000
                          
                          
                          $
                          1,920,000Supplemental
      disclosure of cash flow information:Cash paid for
      interest
                          
                          $
                          181,000
                          
                          
                          $
                          193,000Deemed dividend related to
      beneficial conversion feature onSeries F Preferred
      Stock
                          
                          $
                          --
                          
                          
                          $
                          712,000Warrants issued to related
      party shareholders
                          
                          $
                          --
                          
                          
                          $
                          173,000The
      accompanying notes are an integral part of these financial
      statements.




6


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





NOTE
1 – BASIS OF PRESENTATION





The
accompanying financial statements include the accounts of Bluefly, Inc. (the
“Company”). The financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnote disclosures required by accounting principles generally accepted in
the United States of America for complete financial statements. In the opinion
of management, all adjustments (consisting mainly of normal recurring accruals)
considered necessary for a fair presentation have been included. The results of
operations of any interim period are not necessarily indicative of the results
of operations to be expected for the fiscal year due to seasonal and other
factors. For further information, refer to the financial statements and
accompanying footnotes included in the Company's Form 10-K and Form 10-K/A for
the year ended December 31, 2008.





The Company has sustained net losses and
negative cash flows from operations sinceinception.As ofSeptember 30, 2009, the Company had an accumulated deficit
of $147,320,000.  The Company believes that its existing cash balance,
combined with working capital and the funds available from the Company’s
existing credit facility, will be sufficient to enable the Company to meet
planned expenditures under a streamlined business plan through at least the next
12 months.  The streamlined business plan calls for, among other
things, reductions in marketing and capital expenditures, delaying new hires and
making selective inventory purchases.





The Company is currently exploring
sources of additional capital in order to maximize the growth of its business.
However, there can be no assurance that the Company will be able to identify a
source for such financing, or that such financing will be available on terms
acceptable to the Company.  Should the Company experience
unanticipated losses or expenditures that exceed current estimates and be unable
to raise additional capital, management would implement a plan to further reduce
costs. That plan would include a further reduction in work force as well as
further reductions in overhead costs and capital expenditures. If the Company is
unable to maintain adequate liquidity, future operations will need to be scaled
back or discontinued.




Reclassifications




Certain amounts in the financial
statements of the prior periods have been reclassified to conform to the current
period presentation for comparative purposes.




Summary of Significant Accounting
Policies




Derivative financial
instrument




As a result of the recent adoption of
Financial Accounting StandardsBoard(“FASB”) guidance now codified as FASB
Accounting Standards Codification (“ASC”) Topic 815-40,Contracts in
Entity’s Own Equity,
described more fully in Note 5, the Company carries an embedded derivative
financial instrument on its Balance Sheet.  The Company does not use
the embedded derivative financial instrument to manage financial exposure or
enter into hedging activities.




The Company records its embedded
derivative financial instrument on its Balance Sheet at fair
value.  The fair value is based on a valuation model that requires
inputs including contractual terms, market prices, yield curves and measures of
volatility.  The Company’s embedded derivative financial instrument is
classified as a Level II value on its Balance Sheet.  Any changes in
fair value of the embedded derivative financial instrument are recorded in its
Statement of Operations.




Concentration




For the three and nine months endedSeptember 30,
2009, the Company acquired
approximately 14% and 25%, respectively, of its inventory from one supplier. For
the three and nine months endedSeptember 30, 2008, the Company acquired approximately 15%
and 30%, respectively, of its inventory from one supplier.




7


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009




Subsequent events




In preparing these financial statements,
the Company has evaluated subsequent events throughNovember 10,2009, which is the date that the financial
statements were issued.  The Company is not aware of any material
significant events that occurred sinceSeptember 30, 2009that required recognition or disclosure
in these financial statements.




NOTE
2 – THE COMPANY





The
Company is a leading Internet retailer that sells over 350 brands of designer
apparel, accessories and home products at discounts of up to 75% off of retail
value.  The Company’s e-commerce Web site (“Bluefly.com” or “Web
Site”) was launched in September 1998.




NOTE
3 – NET LOSS PER SHARE





The
Company has determined net loss per share in accordance with FASB guidance now
codified as FASB ASC Topic 260, Earnings per Share. Basic net
loss per share excludes dilution and is computed by dividing net loss available
to common shareholders by the weighted average number of common shares
outstanding for the period.





Diluted
net loss per share is computed by dividing net loss available to common
shareholders by the weighted average number of common shares outstanding for the
period, adjusted to reflect potentially dilutive securities using the treasury
stock method for options, warrants, restricted stock awards and deferred stock
unit awards, and the if-converted method for preferred stock and the
Subordinated Notes. Due to the Company’s net loss, (i) options and warrants to
purchase shares of Common Stock, (ii) preferred stock and Subordinated Notes
convertible into shares of Common Stock, (iii) restricted stock awards that have
not yet vested and (iv) deferred stock unit awards for shares that have not yet
been delivered were not included in the computation of diluted loss per share,
as the effects would be anti-dilutive. Accordingly, basic and diluted weighted
average shares outstanding are equal for the following periods
presented:





Three
      Months EndedSeptember
      30,2009
                  
                  2008Net
      loss
                  
                  $
                  (915,000
                  )
                  
                  $
                  (4,993,000
                  )Preferred
      stock dividends
                  
                  
                  --
                  
                  
                  
                  (12,000
                  )Deemed
      dividend related to beneficial conversion feature onSeries
      F Preferred Stock
                  
                  
                  --
                  
                  
                  
                  (712,000
                  )Net
      loss available to common shareholders
                  
                  $
                  (915,000
                  )
                  
                  $
                  (5,717,000
                  )Weighted
      average common shares outstanding (basic)
                  
                  
                  13,844,637
                  
                  
                  
                  13,309,383Options and warrants(1)(2)
                  
                  
                  --
                  
                  
                  
                  --Preferred stock and
      subordinated notes(1)
                  
                  
                  --
                  
                  
                  
                  --Restricted stock and deferred
      stock awards(1)
                  
                  
                  --
                  
                  
                  
                  --Weighted
      average common shares outstanding (diluted)
                  
                  
                  13,844,637
                  
                  
                  
                  13,309,383(1)For the
      three months ended September 30, 2009 and 2008, the Company had weighted
      average shares of the following potentially dilutive securities that
      were
                    excluded:Options and
      warrants
                  
                  
                  482
                  
                  
                  
                  13





8


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





Preferred
      stock and subordinated notes
                
                
                821,918
                
                
                
                822,301Restricted
      stock and deferred stock awards
                
                
                265,965
                
                
                
                1,037,633(2)Under the
      treasury-stock method, the Company excluded all options and warrants from
      the computation of weighted average shares outstanding as a result of the
      exercise price of the options and warrants being greater than the average
      market price of the Company’s Common
  Stock.





Nine
      Months EndedSeptember
      30,2009
                
                2008Net
      loss
                
                $
                (4,221,000
                )
                
                $
                (9,967,000
                )Preferred
      stock dividends
                
                
                --
                
                
                
                (34,000
                )Deemed
      dividend related to beneficial conversion feature onSeries
      F Preferred Stock
                
                
                --
                
                
                
                (712,000
                )Net
      loss available to common shareholders
                
                $
                (4,221,000
                )
                
                $
                (10,713,000
                )Weighted
      average common shares outstanding (basic)
                
                
                13,840,733
                
                
                
                13,275,955Options and warrants(1)(2)
                
                
                --
                
                
                
                --Preferred stock and
      subordinated notes(1)
                
                
                --
                
                
                
                --Restricted stock and deferred
      stock awards(1)
                
                
                --
                
                
                
                --Weighted
      average common shares outstanding (diluted)
                
                
                13,840,733
                
                
                
                13,275,955(1)For the
      nine months ended September 30, 2009 and 2008, respectively, the Company
      had weighted average shares of the following potentially dilutive
      securities that were
                  excluded:Options and
      warrants
                
                
                482
                
                
                
                13Preferred
      stock and subordinated notes
                
                
                821,918
                
                
                
                364,324Restricted
      stock and deferred stock awards
                
                
                272,116
                
                
                
                1,056,244(2)Under the
      treasury-stock method, the Company excluded all options and warrants from
      the computation of weighted average shares outstanding as a result of the
      exercise price of the options and warrants being greater than the average
      market price of the Company’s Common
  Stock.





NOTE
4 – SHARE-BASED COMPENSATION





The
Company accounts for stock-based compensation in accordance with the provisions
of FASB guidance now codified as FASB ASC Topic 718, Compensation – Stock
Compensation (“Topic 718”), which requires that the costs resulting from
all share-based payment transactions be recognized in the financial statements
at their fair values. The Company adopted Topic 718 using the modified
prospective application method under which the provisions of Topic 718 apply to
new awards and to awards modified, repurchased, or cancelled after the adoption
date. Additionally, compensation cost for the portion of the awards for which
the requisite service has not been rendered that are outstanding as of the
adoption date is recognized in the Statements of Operations over the remaining
service period after the adoption date based on the award’s original estimate of
fair value. Total share-based compensation expense recorded in the Statements of
Operations was $137,000 and $466,000 for the three and nine months ended
September 30, 2009, respectively, and $594,000 and $2,241,000 for the three and
nine months ended September 30, 2008, respectively.





Stock
Options


The fair value of options granted is
estimated on the date of grant using a Black-Scholes option pricing model.
Expected volatilities are calculated based on the historical volatility ofthe price ofthe Company'sCommon Stock. Management
monitors


9


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





share option exercise and employee
termination patterns to estimate forfeiture rates within the valuation model.
The expected holding period of options represents the period of time that
options granted are expected to be outstanding. The risk-free interest rate for
periods within the expected life of the option is based on the interest rate of
U.S. Treasury notesin effect on the date of the
grant.





The following table summarizes the
Company’s stock option activity:





Number of
                
                
                WeightedAverageShares
                
                
                ExercisePriceBalance atDecember 31, 2008
                
                
                354,856
                
                
                $
                9.83Options
    granted
                
                
                11,000
                
                
                $
                1.49Options
      cancelled
                
                
                (157,096
                )
                
                $
                10.13Options
      exercised
                
                
                --
                
                
                $
                --Balance atSeptember 30, 2009
                
                
                208,760
                
                
                $
                9.13Vested atDecember 31,
      2008
                
                
                317,064
                
                
                $
                10.32Vested atSeptember 30,
      2009
                
                
                176,803
                
                
                $
                10.10


During thethirdquarter of2009,7,500 options were cancelled through
normal employee attrition, of which 6,000optionswerevestedand 1,500 options were
non-vested.During the third quarter of 2009, 28,043
options vested.The total fair value of the options that
vested during thethirdquarterof 2009was approximately $283,000.  There were11,000options grantedduring thethirdquarterof 2009. AtSeptember 30, 2009, the aggregate intrinsic value of the
fully vested options was
$0and the weighted average
remaining contractual life of the optionswas approximately5years. TheCompanydidnot capitalize any compensation cost,
or modifyany of its stock option grants during
thenine months endedSeptember 30,
2009. During thethird quarter of
2009, no options were
exercised and no cash was used to settle equity instruments granted under theCompany’s equity incentive
plans.




As of
September 30, 2009, the total compensation cost related to non-vested stock
option awards not yet recognized was $69,000. Total compensation cost is
expected to be recognized over two years on a weighted average
basis.





Restricted StockAwardsand Deferred Stock Unit
Awards


The following table is a summary of
activity related torestrictedstockawardsanddeferredstockunitawardsforemployees atSeptember 30, 2009:<
/fo nt>


Restricted
                
                
                Deferred
      StockStock
      Awards
                
                
                Unit
      AwardsBalance atDecember 31,
      2008
                
                
                6,750
                
                
                
                286,175Shares/Unitsgranted
                
                
                9,187
                
                
                
                --Shares/Units forfeited
                
                
                (750
                )
                
                
                (12,529
                )Shares/Units restriction
      lapses
                
                
                (6,750
                )
                
                
                (18,338
                )Balance atSeptember 30,
      2009
                
                
                8,437
                
                
                
                255,308Weighted average grant date fair
      value per share
                
                $
                0.92
                
                
                $
                7.17Aggregate grant date fair value
                
                $
                8,000
                
                
                $
                1,831,000Weighted average vesting service
      period of shares granted
                
                12 Months
                
                
                12-36
MonthsNumber of shares/units vested atSeptember 30,
      2009
                
                
                --
                
                
                
                240,358Number of shares/units unvested atSeptember 30,
      2009
                
                
                8,437
                
                
                
                14,950





10


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





As of
September 30, 2009, the total compensation cost related to non-vested restricted
stock and deferred stock units not yet recognized was $41,000.  Total
compensation cost is expected to be recognized within a one year period on a
weighted average basis.




11


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





NOTE
5 – SUBORDINATED CONVERTIBLE NOTES





In July 2008, the Company issued
subordinated convertible notes (the “Subordinated Notes”) in the aggregate
principal amount of $3,000,000 that have a term expiring three years from the
date of issuance and bear interest at the rate of 8% per annum, compounded
annually.  Interest is payable in cash upon maturity or
conversion.




The Subordinated Notes are convertible,
at the holder’s option into (a) equity securities that the Company might issue
in any subsequent round of financing at a price equal to the lowest price per
share paid by any investor in such subsequent round of financingin addition to(b) Common Stock at a price per share
equal to $3.65, which represented the 20-day trailing average stock price on the
date of issuance of the Subordinated Notes(collectively, the “embedded conversion
feature”).




In connection with the adoptionofFASB guidance now codified as FASB ASC
Topic 815-40,Contracts in
Entity’s Own Equity,
(“Topic 815-40”) on January 1, 2009, the Company
determined that the embedded conversion feature in the Subordinated Notes is not
indexed to the Company’s own stock and, therefore, is an embedded derivative
financial liability (the “Embedded Derivative”), which requires bifurcation andmustbe separately accounted for pursuant toFASB guidance now codified
as FASB ASC Topic 815-15,Derivativesand
Hedging
– Embedded Derivatives.




The Company measured the fair value of
the Embedded Derivative using a Black-Scholes valuation model as ofJanuary 1, 2009to determine the cumulative effect of
the change in accounting principle to be recorded.  The Company also
re-measured the fair value of the Embedded Derivative atSeptember 30, 2009.  Any change in fair value is
recorded as part of interest expense to related party
shareholders.  The assumptions used atSeptember 30, 2009are as follows:




(Unaudited)September
      30, 2009Risk-free
      interest rate
                
                
                0.95
                
                %Expected
      life (in years)
                
                
                1.81Dividend
      yield
                
                
                0.00
                
                %Expected
      volatility
                
                
                110.94
                
                %


Expected volatility is based on the
historical volatility of the price of the Company’s Common Stock, measured over
the same period of time as the remaining maturity life of the Subordinated
Notes.  The risk free interest rate is based on the interest rate for
U.S. Treasury Notes having a maturity period equal to the remaining maturity
life of the Subordinated Notes.




The Company recorded cumulative effect
of the change in accounting principle of approximately $779,000, which was
recognized as a decrease in accumulated deficit atJanuary 1, 2009.  The amount recognized in
the Company’s Balance Sheet upon the initial adoption of Topic 815-40 was
determined based on the amounts that would have been recognized if Topic 815-40
had been applied from the issuance date of the Subordinated Notes and the amount
recognized in the Company’s Balance Sheet upon the initial application of Topic
815-40.  In addition, as a result of the bifurcation, the Company
recognized a discount on the Subordinated Notes of $877,000, which reduced the
carrying value of the Subordinated Notes at the date of
adoption.  This discount represents additional non-cash interest
expense that is to be amortized over the remaining life of the Subordinated
Notes and as a result, the Company incurred an incremental non-cash interest
expense of approximately $136,000 for the three months endedMarch 31, 2009.  The following table details
the application of Topic 815-40 on previously reported
results:




As
      reported
                    
                    
                    
                    As
      AdjustedMarch
      31,
                    
                    Adjustments
                    
                    March
      31,BALANCE
      SHEET (Unaudited)
                    
                    2009
                    
                    (1)
                    
                    
                    2009AssetsCurrent assets:Cash and cash
      equivalents
                    
                    $
                    2,003,000
                    
                    
                    $
                    
                    $
                    2,003,000Accounts receivable — net of
      allowance for doubtful accounts
                    
                    
                    3,402,000
                    
                    
                    
                    
                    
                    3,402,000





12


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





Inventories,
      net
                
                
                20,835,000
                
                
                
                
                
                
                
                20,835,000Prepaid
      inventory
                
                
                83,000
                
                
                
                
                
                
                
                83,000Prepaid
      expenses
                
                
                345,000
                
                
                
                
                
                
                
                345,000Other current
      assets
                
                
                376,000
                
                
                
                
                
                
                
                376,000Total
      current assets
                
                
                27,044,000
                
                
                
                
                
                
                
                27,044,000Property and equipment,
      net
                
                
                5,342,000
                
                
                
                
                
                
                
                5,342,000Other
assets
                
                
                181,000
                
                
                
                
                
                
                
                181,000Total
assets
                
                $
                32,567,000
                
                
                $
                
                
                
                $
                32,567,000Liabilities and stockholders
      equityCurrentliabilities:Accountspayable
                
                $
                6,303,000
                
                
                $
                
                
                
                $
                6,303,000Allowance for sales
      returns
                
                
                3,073,000
                
                
                
                
                
                
                
                3,073,000Accrued expenses and other current
      liabilities
                
                
                982,000
                
                
                
                
                
                
                
                982,000Deferred
      revenue
                
                
                3,461,000
                
                
                
                
                
                
                
                3,461,000Total current
      liabilities
                
                
                13,819,000
                
                
                
                
                
                
                
                13,819,000Notes payable to related party
      shareholders
                
                
                3,000,000
                
                
                
                (789,000
                )
                
                
                2,211,000Embedded derivative financial
      liability to related partyshareholders
                
                
                --
                
                
                
                146,000
                
                
                
                146,000Interest payable to related party
      shareholders
                
                
                165,000
                
                
                
                
                
                
                
                165,000Total
      liabilities
                
                
                16,984,000
                
                
                
                (643,000
                )
                
                
                16,341,000Stockholders’equity:Common
stock
                
                
                138,000
                
                
                
                
                
                
                
                138,000Treasury
    stock
                
                
                (1,617,000
                )
                
                
                
                
                
                
                (1,617,000
                )Additional paid-in
      capital
                
                
                163,924,000
                
                
                
                
                
                
                
                163,924,000Accumulateddeficit
                
                
                (146,862,000
                )
                
                
                643,000
                
                
                
                (146,219,000
                )Total
      stockholders’ equity
                
                
                15,583,000
                
                
                
                643,000
                
                
                
                16,226,000Total
      liabilities and stockholders’ equity
                
                $
                32,567,000
                
                
                $
                --
                
                
                $
                32,567,000




(1)
            These
      adjustments include (i) a reduction in the carrying value of the notes
      payable to related party shareholders of $877,000 in the form of a
      discount, which represents additional non-cash interest expense to be
      amortized over the remaining maturity life, (ii) the recognition of an
      embedded derivative financial liability to related party shareholders of
      $98,000 and (iii) the cumulative effect of a change in accounting
      principle as a result of the adoption of Topic 815-40 on January 1, 2009
      of $779,000 as a reduction in accumulated deficit.  These
      adjustments were offset by (iv) the amortization of the discount on notes
      payable to related party shareholders of $88,000 and (v) an increase in
      the fair value of the embedded derivative financial liability of $48,000,
      which both represent an incremental interest expense to related party
      shareholders of $136,000 for the three months ended March 31,
      2009.




As
      reported
                
                
                
                As
      AdjustedThree
      months
                
                
                
                Three
      monthsEnded
                
                
                
                EndedSTATEMENT
      OF OPERATIONS
                
                March
      31,
                
                Adjustments
                
                March
      31,(Unaudited)
                
                2009
                
                (2)
                
                
                2009Operating
    loss
                
                $
                (2,806,000
                )
                
                $
                
                
                
                $
                (2,806,000
                )Interest
    income
                
                
                5,000
                
                
                
                
                
                
                
                5,000Interest expense to related party
      shareholders
                
                
                --
                
                
                
                (238,000
                )
                
                
                (238,000
                )





13


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





Interest
      expense
                  
                  
                  (183,000
                  )
                  
                  
                  102,000
                  
                  
                  
                  (81,000
                  )Net
      loss
                  
                  $
                  (2,984,000
                  )
                  
                  $
                  (136,000
                  )
                  
                  $
                  (3,120,000
                  )Basic
      and diluted net loss per common share
                  
                  $
                  (0.22
                  )
                  
                  
                  
                  
                  
                  $
                  (0.23
                  )Weighted
      average common shares outstanding(basic
      and diluted)
                  
                  
                  13,832,679
                  
                  
                  
                  
                  
                  
                  
                  13,832,679




(2)
            These
      adjustments include (i) the amortization of the discount on notes payable
      to related party shareholders of $88,000 and (ii) an increase in the fair
      value of the embedded derivative financial liability of $48,000, which
      both represent an incremental interest expense to related party
      shareholders of $136,000 for the three months ended March 31,
      2009.  Furthermore, the Company reclassified (iii) $59,000
      relating to accrued and unpaid interest expense to related party
      shareholders and (iv) $43,000 relating to amortization expense in
      connection with warrants issued to certain related
  parties.




As ofSeptember 30, 2009, the Company’s Subordinated Notes
consisted of the following:




(Unaudited)September 30,
                
                
                December
      31,2009
                
                
                2008Notes payable to related party
      shareholders
                
                $
                3,000,000
                
                
                $
                3,000,000Unamortized discount on notes
      payable to related party shareholders
                
                
                (614,000
                )
                
                
                --Totalnotes payable to related party
      shareholders, net
                
                $
                2,386,000
                
                
                $
                3,000,000


For the three and nine months ended
September 30, 2009, the Company recognized interest expense in connection with
its Subordinated Notes, including changes in fair value of the Embedded
Derivative, which were included in total interest expense to related party
shareholders in the Statement of Operations, as follows:




(Unaudited)Three
      Months EndedSeptember
      30, 2009Interest
      expense to related party shareholders
                
                $
                64,000Amortization
      of discount on notes payable to related party shareholders
                
                
                88,000Appreciation
      in fair value of embedded derivative financial liability to related
      party
                  Shareholders
                
                
                253,000Total
      interest expense to related party shareholders
                
                $
                405,000







(Unaudited)Nine
      Months EndedSeptember
      30, 2009Interest
      expense to related party shareholders
                
                $
                183,000Amortization
      of discount on notes payable to related party shareholders
                
                
                306,000Appreciation
      in fair value of embedded derivative financial liability to related
      party
                  Shareholders
                
                
                428,000Total
      interest expense to related party shareholders
                
                $
                917,000




14


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009





NOTE
6 - FAIR VALUE





Effective  January
1,
2008,  the  Company  implemented  FASB
guidance now codified as FASB ASC Topic 820,  Fair Value  Measurements
and Disclosures,  ("Topic 820"),  which defines fair
value, establishes a framework for measuring fair value and expands
disclosure  about  fair  value  measurements
except as it applied to the non-financial assets and non-financial liabilities
subject toTopic 820-10, which the Company adopted
on January 1, 2009.   The Company’s financial instruments
consist of cash and cash equivalents, other assets, accounts payable and accrued
expenses.  The carrying amounts of these financial instruments
approximate fair value due to their short maturities. The fair value hierarchy
for disclosure of fair value measurements under Topic 820 is as
follows:





Level 1 - Quoted prices in active
markets for identical assets or liabilities





Level 2 - Quoted prices for similar
assets and liabilities in active markets orinputs that are
observable





Level 3 - Inputs that are unobservable
(for example cash flow modeling inputsbased on
assumptions)





In
connection with the determination of the Embedded Derivative in the Subordinated
Notes discussed in Note 5, the Company evaluates the fair value measurement of
the Embedded Derivative on a recurring basis to determine the appropriate level
to classify them for each reporting period. This determination requires
significant judgments to be made by the Company. The following table sets forth
the Company’s liabilities that were measured at fair value as of September 30,
2009, by level within the fair value hierarchy:





September 30,
      2009
                            
                            
                            Quoted Prices
      inActive
      Marketsfor
      IdenticalAssets(Level
      1)
                            
                            
                            Significant
      OtherObservableInputs(Level
      2)
                            
                            
                            SignificantUnobservableInputs(Level
      3)Liabilities:Embedded conversion
      feature
                            
                            $
                            526,000
                            
                            
                            $
                            --
                            
                            
                            $
                            526,000
                            
                            
                            $
                            --Total embedded derivative
      financial liability
                            
                            $
                            526,000
                            
                            
                            $
                            --
                            
                            
                            $
                            526,000
                            
                            
                            $
                            --





NOTE
7 – RECENT ACCOUNTING PRONOUNCEMENTS





In May 2008, the FASB issuedFASB guidance now codified
as FASB ASC Topic 470-20,Debt with Conversion
and Other Options("Topic 470-20"),whichrequires the liability and equity
components of convertible debt instruments that may be settled in cash upon
conversion (including partial cash settlement) to be separately accounted for in
a manner that reflects the issuer's nonconvertible debt borrowing rate. The
resulting debt discountisamortized over the period during which
the debt is expected to be outstanding (i.e., through the first optional
redemption date) as additional non-cash interest expense.The equity component is
determined by deducting the fair value of the liability component.Topic 470-20iseffective beginning inthe Company’sfirst quarter of 2009 and is required
to be applied retrospectively to all presented periods, as
applicable.As
the Company’s Subordinated Notes may not be settled in cash upon conversion, the
adoption of this standard onJanuary 1, 2009does not impactthe Company’s financial positionoroperating results relating to its
convertible debt.





In September 2008, the FASB issued FASB
guidance now codified as FASB ASC Topic 260,Earnings per
Share(“Topic 260”), which
address whether financial instruments granted in share-based payment
transactions are participating securities prior to vesting and, therefore, need
to be included in the computation of earnings per share under the two-class
method described in Topic 260.  As the Company’s financial instruments
granted in share-based payment transactions are not participating securities
prior to vesting, in accordance with Topic 260, the adoption of this standard on
January 1, 2009 does not impact the Company’s financial position or operating
results relating to the financial instruments granted pursuant to its
share-based payment programs.




15


BLUEFLY,
INC.


NOTES
TO FINANCIAL STATEMENTS (unaudited)


SEPTEMBER
30, 2009







In April 2009, the FASB issued FASB
guidance now codified as FASB ASC Topic 825,Financial
Instruments(“Topic 825”),
which is effective June 15, 2009.  Topic 825 requires the Company to
disclose the fair values of certain instruments in interim financial
statements.  The Company adopted the provisions of Topic 825 onJune 30, 2009.  The adoption of Topic 825
did not impact the Company’s financial position or operating results relating to
the Company’s financial instruments.




In May 2009, the FASB issued FASB
guidance now codified as FASB ASC Topic 855,Subsequent
Events(“Topic 855”), which
is effective June 15, 2009.  Topic 855 provides guidance for
disclosing events that occur after the balance sheet date, but prior to the
issuance of the financial statements. The Company adopted the provisions of
Topic 855 onJune 30,
2009.  The
adoption of Topic 855 did not have any impact to the Company’s financial
position or operating results.




In June 2009, the FASB issued FASB
guidance now codified as FASB ASC Topic 105,Generally Accepted
Accounting Principles(“Topic 105”), which is effectiveSeptember 15, 2009.  Topic 105 does not alter
currentU.S.generally accepted accounting
principles, but rather integrates existing accounting standards with other
authoritative guidance.  As a result of the integration, Topic 105
will be a single source of authoritative guidance for non-governmental entities
and will also supersede all other previously issued non-SECaccounting and reporting
guidance.  The Company adopted the provisions of Topic 105 onSeptember 30,
2009.  The
adoption of Topic 105 did not have any impact to the Company’s financial
position or operating results other than to change the references in the
financial statement footnotes to the ASC topics.




16


Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





Overview





Bluefly,
Inc. is a leading Internet retailer that sells over 350 brands of designer
apparel, accessories and home furnishingsat discounts of up to 75%
off of retail value.  We launched our Web site in September
1998.





Our net
sales decreased by approximately 14% to $17,108,000 for the three months ended
September 30, 2009 from $19,802,000 for the three months ended September 30,
2008.  Our gross margin percentage increased to 40.0% for the three
months ended September 30, 2009 from 36.9% for the three months ended September
30, 2008. Our gross profit dollars decreased by 6% to $6,839,000 for the three
months ended September 30, 2009 from $7,307,000 for the three months ended
September 30, 2008. We incurred an operating loss of $465,000 for the three
months ended September 30, 2009 as compared to an operating loss of $4,819,000
for the three months ended September 30, 2008.  The improvement in
operating loss was primarily a result of a reduction in our marketing expenses
and general and administrative expenses and a decrease in variable operating
fulfillment expenses. We believe that the decrease in net sales was primarily
attributable to our planned decrease in inventory purchases in response to the
overall decline in consumer spending.  We anticipate that this planned
decrease in inventory purchases will continue to adversely impact revenues for
future quarters unless we are successful in our efforts to raise additional
capital for the business.





Marketing
expenses (excluding staff related costs) decreased to $1,319,000 for the third
quarter of 2009 from $3,949,000 for the third quarter of 2008, primarily as a
result of a reduction in our national print and advertising campaign expenses of
approximately $1,922,000 and a reduction in online marketing program expenses of
approximately $607,000. Marketing expenses (including staff related costs) as a
percentage of net sales decreased to 8.5% for the three months ended September
30, 2009 compared to 21.1% for the three months ended September 30, 2008. As
offline advertising expenses decrease, the mix of marketing expenditures will
continue to shift toward online media as we believe that online marketing
programs are more efficient because they are more easily measurable and can be
optimized to achieve certain sales goals. General and administrative expenses
decreased to $2,095,000 from $3,021,000 for the third quarter of 2008, primarily
as a result of a reduction in salary and salary related expenses as well as a
decrease in overall professional and consulting fees.





Our
reserve for returns and credit card chargebacks decreased to 37.9% of gross
sales for the third quarter of 2009 compared to 39.4% for the third quarter of
2008.  The decrease was primarily caused by a reduction in our return
rate which was, in turn, caused, in part, by a shift in our merchandise mix.
Historically, our merchandise mix had been shifting towards higher end products,
which tend to drive return rates higher. As part of our streamlined business
plan, we refined our merchandising mix to shift toward more contemporary
merchandise and we believe this resulted in a decrease in the return rate.
Additionally, we believe that the reduction in return rate was partially caused
by customers making fewer impulse purchases, which are generally more likely to
be returned.





At
September 30, 2009, we had an accumulated deficit of $147,320,000. The net
losses and accumulated deficit resulted from the costs associated with
developing and marketing our Web site and building our infrastructure, as well
as non-cash beneficial conversion charges resulting from decreases in the
conversion price of our preferred stock and the payment of dividends to holders
of our preferred stock. Prior to the beginning of the current economic downturn
in the second half of 2008, we had experienced consistent revenue growth. This
growth should not be considered indicative of future performance, particularly
given the challenging economic environment that we now face.




Results
Of Operations




For The Three Months EndedSeptember30, 2009Compared To The Three Months EndedSeptember30, 2008.







The
following table sets forth our Statements of Operations data for the three
months ended September 30th. All
data is in thousands except as indicated below:




2009
                    
                    2008As
      a % of
                    
                    
                    
                    
                    As
      a % ofNet
      Sales
                    
                    
                    
                    
                    Net
      SalesNet
      sales
                    
                    $
                    17,108
                    
                    100.0
                    %
                    
                    $
                    19,802
                    
                    100.0
                    %





17





Cost
      of sales
                                
                                
                                10,269
                                
                                60.0
                                
                                
                                
                                12,495
                                
                                63.1Gross profit
                                
                                
                                6,839
                                
                                40.0
                                
                                
                                
                                7,307
                                
                                36.9Selling
      and fulfillment expenses
                                
                                
                                3,752
                                
                                21.9
                                
                                
                                
                                4,933
                                
                                24.9Marketing
      expenses
                                
                                
                                1,457
                                
                                8.5
                                
                                
                                
                                4,172
                                
                                21.1General
      and administrative expenses
                                
                                
                                2,095
                                
                                12.3
                                
                                
                                
                                3,021
                                
                                15.2Total operating
      expenses
                                
                                
                                7,304
                                
                                42.7
                                
                                
                                
                                12,126
                                
                                61.2Operating loss
                                
                                
                                (465
                                )
                                (2.7
                                )
                                
                                
                                (4,819
                                )
                                (24.3
                                )Interest
      expense, net
                                
                                
                                (450
                                )
                                (2.6
                                )
                                
                                
                                (174
                                )
                                (0.9
                                )Net loss
                                
                                $
                                (915
                                )
                                (5.3
                                )%
                                
                                $
                                (4,993
                                )
                                (25.2
                                )%





We also
measure and evaluate ourselves against certain other key operational metrics.
The following table sets forth our actual results based on these other metrics
for the three months ended September 30th, as
indicated below:




2009
                  
                  
                  2008Averageordersize (including shipping &
      handling)
                  
                  $
                  274.58
                  
                  
                  $
                  292.03Newcustomersadded during theperiod*
                  
                  
                  34,753
                  
                  
                  
                  39,055*Based
      on unique email addresses


In
addition to the financial statement items and metrics listed above, we also
report gross sales, which is a non-GAAP financial measure.  We define
gross sales as the total dollar amount of orders received by customers
(including shipping and handling) net of customer credits, but before any
reserves are taken for returns or bad debt.  We believe that the
presentation of gross sales is useful to investors because (a) it provides an
alternative measure of the total demand for the products sold by us and (b) it
provides a basis upon which to measure the percentage of total demand that is
reserved for both returns and bad debt.  Management uses the gross
sales measure for these same reasons.





Net sales:Gross sales for the
three months ended September 30, 2009 decreased by approximately 16% to
$27,555,000 from $32,649,000 for the three months ended September 30, 2008. For
the three months ended September 30, 2009, we recorded a provision for returns
and credit card chargebacks and other discounts of $10,447,000 or approximately
37.9% of gross sales. For the three months ended September 30, 2008, the
provision for returns and credit card chargebacks and other discounts was
$12,847,000, or approximately 39.4% of gross sales. The decrease in this
provision as a percentage of gross sales resulted from a reduction in the return
rate, which was, in part, caused by a shift in our merchandise mix.
Historically, our merchandise mix had been shifting towards higher end products
which tend to have higher return rates. As part of our streamlined business
plan, we refined our merchandising mix to shift to more contemporary
merchandise. Accordingly, we believe we experienced a corresponding decrease in
the return rate.  In addition, we believe that the reduction in return
rate was partially caused by customers making fewer impulse purchases, which are
generally more likely to be returned.





After the
necessary provisions for returns, credit card chargebacks and adjustments for
sales taxes, our net sales for the three months ended September 30, 2009 was
$17,108,000. This represents a decrease of approximately 14% compared to the
three months ended September 30, 2008, in which net sales totaled $19,802,000.
The decrease in net sales resulted primarily from an 11% decrease in the number
of new customers acquired as well as a 6.0% decrease in average order size. We
believe that the decrease in both of these measures was primarily attributable
to our planned decrease in inventory purchases in response to the overall
decline in consumer spending. For the three months ended September 30, 2009,
revenue from shipping and handling (which is included in net sales) decreased
approximately 13% to $961,000 from $1,104,000 for the three months ended
September 30, 2008.Shipping and handling
revenue decreased at a smaller percentage than revenue as a whole as a result of
a decrease in the average order size, which is based on orders placed by the
customer, as compared to the decrease in overall product sales, which is based
on quantity of merchandise purchased by the customer.





Cost of sales:  Cost
of sales consists of the cost of product sold to customers, in-bound and
out-bound shipping costs, inventory reserves, commissions and packing materials.
Cost of sales for the three months ended September 30, 2009 totaled $10,269,000
resulting in a gross margin percentage of approximately 40.0%. Cost of sales for
the three months ended September 30, 2008 totaled $12,495,000, resulting in a
gross margin percentage of 36.9%. Gross profit dollars decreased by
approximately 6%, to


18


$6,839,000
for the three months ended September 30, 2009 compared to $7,307,000 for the
three months ended September 30, 2008. The decrease in gross profit dollars
resulted from the related decrease in sales.  The increase in gross
margin percentage was attributable to improved product margins resulting from a
shift to contemporary merchandise and decreases in our inventory reserves, which
were offset slightly by higher freight costs.





Selling and fulfillment
expenses:  Selling and fulfillment expenses decreased by 24%
for the three months ended September 30, 2009 compared to the three months ended
September 30, 2008. Selling and fulfillment expenses were comprised of the
following:





Three
      Months Ended September 30,
                            
                            Percentage(All data
      in thousands)
                            
                            2009
                            
                            2008
                            
                            DifferenceAs
      a % of
                            
                            
                            
                            
                            As
      a % of
                            
                            IncreaseNet
      Sales
                            
                            
                            
                            
                            Net
      Sales
                            
                            (Decrease)Operating
                            
                            $
                            1,662
                            
                            9.7
                            %
                            
                            $
                            2,105
                            
                            10.6
                            %
                            
                            (21.0
                            )
                            %Technology
                            
                            
                            1,265
                            
                            7.4
                            
                            
                            
                            1,768
                            
                            8.9
                            
                            
                            (28.5
                            )E-Commerce
                            
                            
                            825
                            
                            4.8
                            
                            
                            
                            1,060
                            
                            5.4
                            
                            
                            (22.2
                            )Total selling and fulfillment
      expenses
                            
                            $
                            3,752
                            
                            21.9
                            %
                            
                            $
                            4,933
                            
                            24.9
                            %
                            
                            (23.9
                            )
                            %


As a
percentage of net sales, our selling and fulfillment expenses decreased to 21.9%
for the three months ended September 30, 2009 from 24.9% for the three months
ended September 30, 2008.





Operating
expenses include all costs related to inventory management, fulfillment,
customer service, and credit card processing. Operating expenses decreased for
the three months ended September 30, 2009 by approximately 21.0% compared to the
three months ended September 30, 2008 primarily as a result of decreased
variable costs associated with fulfillment costs (e.g., picking and packing
orders and processing returns) and a decrease in fees associated with our
customer service call center.





Technology
expenses consist primarily of staff related costs, amortization of capitalized
costs and Web site hosting. For the three months ended September 30, 2009,
technology expenses decreased by approximately 28.5% compared to the three
months ended September 30, 2008. This decrease was attributable to a decrease in
salary and salary related expenses of approximately $255,000, a decrease in
consulting fees of approximately $124,000 and decrease in web hosting and
software support expenses of approximately $116,000, which were partially offset
by an increase in depreciation expenses, included in technology expenses, of
approximately $25,000 as compared to the three months ended September 30, 2008
related to the development of our new Website, which was placed into service in
August 2008.





E-Commerceexpenses include expenses
related to our photo design studio, image processing, and Web site design. For
the three months ended September 30, 2009, e-commerce expenses decreased by
approximately 22.2% as compared to the three months ended September 30, 2008,
primarily as a result of decreases in salary and salary related expenses of
approximately $115,000 and a decrease in expenses associated with photo shoots
of approximately $63,000.





Marketing
expenses:Marketing expenses decreased by 65% to $1,457,000
for the three months ended September 30, 2009 from $4,172,000 for the three
months ended September 30, 2008.





Marketing
expenses include expenses related to online and print advertising, paid search,
email campaigns, comparison engines, fees to affiliates, and direct mail
campaigns as well as staff related costs. As a percentage of net sales, our
marketing expenses decreased to 8.5% for the three months ended September 30,
2009 from 21.1% for the three months ended September 30, 2008.





The
decrease in total marketing expenses was attributable to a reduction in national
print and television advertising campaign expenses of approximately $1,922,000
and a reduction in online marketing program expenses of approximately
$607,000.  In addition, as a response to our planned decrease in
inventory purchases we reduced our marketing expenses.





General and administrative
expenses:
General and administrative expenses include merchandising, finance and
administrative salaries and related expenses, insurance costs, accounting and
legal fees, depreciation and other office related expenses.  General
and administrative expenses for the three months ended September 30, 2009
decreased by approximately 31% to $2,095,000 as compared to $3,021,000 for the
three months ended September 30, 2008.  The decrease in general and
administrative expenses was


19


primarily
the result of a decrease in equity based compensation of approximately $387,000,
a decrease in salary and salary related expenses of approximately $304,000 and a
decrease in overall professional fees of approximately $105,000.





As a
percentage of net sales, general and administrative expenses for the three
months ended September 30, 2009 decreased to approximately 12.3% from 15.2% for
the three months ended September 30, 2008.





Loss from
operations:  For the three months ended September 30, 2009, we
incurred an operating loss of $465,000 compared to an operating loss of
$4,819,000 for the three months ended September 30, 2008.





Interest income:Interest
income for the three months ended September 30, 2009 remained unchanged at
$8,000. These amounts related primarily to interest income earned on our cash
balances.





Interest expense to related party
shareholders:Interest
expense to related party shareholders for the three months ended September 30,
2009 increased to $405,000 from $88,000 for the three months ended September 30,
2008. Interest expense to related party shareholders consists of amortization
expense from warrants issued to certain related parties, accrued interest
expense due upon maturity, non-cash changes in fair value of the embedded
derivative and non-cash amortization of the discount relating to our outstanding
subordinated convertible notes issued to certain related parties as a result of
the application of a newly adopted accounting pronouncement.  The
increase in interest expense to related party shareholders was primarily the
result of the recognition of the embedded derivative financial liability
relating to the embedded conversion feature within the subordinated convertible
notes and the amortization of the debt discount.




Interest expense:Interest
expense for the three months ended September 30, 2009 totaled $53,000, compared
to $94,000 for the three months ended September 30, 2008. Interest expense
consists primarily of fees paid in connection with our credit
facility.




For TheNineMonths EndedSeptember30, 2009Compared To TheNineMonths EndedSeptember30,
 2008.





The
following table sets forth our Statements of Operations data for the nine months
ended September 30th. All
data is in thousands except as indicated below:


2009
                              
                              2008As
      a % of
                              
                              
                              
                              
                              As
      a % ofNet
      Sales
                              
                              
                              
                              
                              Net
      SalesNet
      sales
                              
                              $
                              56,868
                              
                              100.0
                              %
                              
                              $
                              68,381
                              
                              100.0
                              %Cost
      of sales
                              
                              
                              35,370
                              
                              62.2
                              
                              
                              
                              43,040
                              
                              62.9Gross profit
                              
                              
                              21,498
                              
                              37.8
                              
                              
                              
                              25,341
                              
                              37.1Selling
      and fulfillment expenses
                              
                              
                              12,177
                              
                              21.4
                              
                              
                              
                              14,525
                              
                              21.2Marketing
      expenses
                              
                              
                              6,237
                              
                              11.0
                              
                              
                              
                              10,620
                              
                              15.5General
      and administrative expenses
                              
                              
                              6,194
                              
                              10.9
                              
                              
                              
                              9,858
                              
                              14.4Total operating
      expenses
                              
                              
                              24,608
                              
                              43.3
                              
                              
                              
                              35,003
                              
                              51.2Operating loss
                              
                              
                              (3,110
                              )
                              (5.5
                              )
                              
                              
                              (9,662
                              )
                              (14.1
                              )Interest
      expense, net
                              
                              
                              (1,111
                              )
                              (1.9
                              )
                              
                              
                              (305
                              )
                              (0.5
                              )Net loss
                              
                              $
                              (4,221
                              )
                              (7.4
                              )%
                              
                              $
                              (9,967
                              )
                              (14.6
                              )%





We also
measure and evaluate ourselves against certain other key operational metrics.
The following table sets forth our actual results based on these other metrics
for the nine months ended September 30th, as
indicated below:




20




2009
                  
                  
                  2008Averageordersize (including shipping &
      handling)
                  
                  $
                  263.38
                  
                  
                  $
                  282.73Newcustomersadded during theperiod*
                  
                  
                  120,076
                  
                  
                  
                  141,584*Based
      on unique email addresses





Net sales:Gross sales for the
nine months ended September 30, 2009 decreased by approximately 19% to
$92,511,000 from $113,728,000 for the nine months ended September 30, 2008. For
the nine months ended September 30, 2009, we recorded a provision for returns
and credit card chargebacks and other discounts of $35,643,000 or approximately
38.5% of gross sales. For the nine months ended September 30, 2008, the
provision for returns and credit card chargebacks and other discounts was
$45,347,000, or approximately 39.9% of gross sales. The decrease in this
provision as a percentage of gross sales resulted from a reduction in the return
rate, which was, in part, caused by a shift in our merchandise mix.
Historically, our merchandise mix had been shifting towards higher end products
which tend to have higher rates. As part of our streamlined business plan, we
refined our merchandising mix to shift to more contemporary merchandise.
Accordingly, we believe we experienced a corresponding decrease in the return
rate.  In addition, we believe that the reduction in return rate was
partially caused by customers making fewer impulse purchases, which are
generally more likely to be returned.





After the
necessary provisions for returns, credit card chargebacks and adjustments for
sales taxes, our net sales for the nine months ended September 30, 2009 was
$56,868,000. This represents a decrease of approximately 17% compared to the
nine months ended September 30, 2008, in which net sales totaled $68,381,000.
The decrease in net sales resulted primarily from a 15% decrease in the number
of new customers acquired as well as a 7% decrease in average order size. We
believe that the decrease in both of these measures was primarily attributable
to our planned decrease in inventory purchases in response to the decline in
consumer spending. For the nine months ended September 30, 2009, revenue from
shipping and handling (which is included in net sales) decreased approximately
14% to $3,341,000 from $3,898,000 for the nine months ended September 30,
2008.Shipping and
handling revenue decreased at a smaller percentage than revenue as a whole as a
result of a decrease in the average order size, which is based on orders placed
by the customer, as compared to the decrease in overall product sales, which is
based on quantity of merchandise purchased by the customer.





Cost of sales: Cost of sales
for the nine months ended September 30, 2009 totaled $35,370,000 resulting in a
gross margin percentage of approximately 37.8%. Cost of sales for the nine
months ended September 30, 2008 totaled $43,040,000, resulting in a gross margin
percentage of 37.1%. Gross profit dollars decreased by approximately 15%, to
$21,498,000 for the nine months ended September 30, 2009 compared to $25,341,000
for the nine months ended September 30, 2008. The slight increase in gross
margin percentage is a result of improved product margins and a decrease in
inventory reserves.  The decrease in gross profit dollars was
primarily driven by the decrease in sales and increased freight costs in
connection with customer shipments, which was partially offset by the increase
in the product margin percentage.





Selling and fulfillment
expenses:  Selling and fulfillment expenses decreased by 16%
for the nine months ended September 30, 2009 compared to the nine months ended
September 30, 2008. Selling and fulfillment expenses were comprised of the
following:




Nine
      Months Ended September 30,
                      Percentage(All data
      in thousands)
                      
                      2009
                      
                      2008
                      DifferenceAs
      a % of
                      
                      
                      
                      
                      As
      a % of
                      IncreaseNet
      Sales
                      
                      
                      
                      
                      Net
      Sales
                      (Decrease)Operating
                      
                      $
                      5,586
                      
                      9.8
                      %
                      
                      $
                      7,506
                      
                      11.0
                      %
                      (25.6
                      )
                      %Technology
                      
                      
                      4,233
                      
                      7.4
                      
                      
                      
                      4,263
                      
                      6.2
                      
                      (0.7
                      )E-Commerce
                      
                      
                      2,358
                      
                      4.2
                      
                      
                      
                      2,756
                      
                      4.0
                      
                      (14.4
                      )Total selling and fulfillment
      expenses
                      
                      $
                      12,177
                      
                      21.4
                      %
                      
                      $
                      14,525
                      
                      21.2
                      %
                      (16.2
                      )
                      %


As a
percentage of net sales, our selling and fulfillment expenses remained
relatively unchanged at 21% for the nine months ended September 30, 2009
compared to the nine months ended September 30, 2008.


21


Operating
expenses decreased for the nine months ended September 30, 2009 by approximately
25.6% compared to the nine months ended September 30, 2008 as a result of
decreased variable costs associated with fulfillment costs (e.g., picking and
packing orders and processing returns), decreased credit card fees, a decrease
in salary expenses and fees associated with our customer service call
center.





For the
nine months ended September 30, 2009, technology expenses remained relatively
unchanged compared to the nine months ended September 30, 2008. Excluding
depreciation expenses relating to our new Web site of $1,325,000 and $293,000
for the nine months ended September 30, 2009 and 2008, respectively, which is
included in technology expenses, technology expenses decreased by approximately
$1.1 million or 26.7% compared to the nine months ended September 30,
2008.





For the
nine months ended September 30, 2009, e-commerce expenses decreased by
approximately 14.4% as compared to the nine months ended September 30, 2008,
attributable to decreases in salary and salary related expenses of approximately
$233,000 and expenses associated with consulting fees and photo shoots of
approximately $34,000.





Marketing
expenses:Marketing expenses (including staff related costs)
decreased by 41% to $6,237,000 for the nine months ended September 30, 2009 from
$10,620,000 for the nine months ended September 30, 2008.





As a
percentage of net sales, our marketing expenses decreased to 11.0% for the nine
months ended September 30, 2009 from 15.5% for the nine months ended September
30, 2008.





The
decrease in total marketing expenses was mainly attributable to a reduction in
online marketing programs expenses of approximately $1,382,000 and a reduction
in national print and television advertising campaign expenses of approximately
$2,603,000. In addition, as a response to our planned decrease in inventory
purchases we reduced our marketing expenses.





General and administrative
expenses:
General and administrative expenses for the nine months ended September 30, 2009
decreased by approximately 37% to $6,194,000 as compared to $9,858,000 for the
nine months ended September 30, 2008.  The decrease in general and
administrative expenses was primarily the result of a decrease in equity based
compensation of approximately $1,604,000, a decrease in salary and salary
related expenses of approximately $1,202,000 and a decrease in overall
professional fees of approximately $419,000.





As a
percentage of net sales, general and administrative expenses for the nine months
ended September 30, 2009 decreased to approximately 10.9% from 14.4% for the
nine months ended September 30, 2008.





Loss from
operations:  Operating loss decreased in the nine months ended
September 30, 2009 to $3,110,000 from $9,662,000 in the nine months ended
September 30, 2008.





Interest income:Interest
income for the nine months ended September 30, 2009 decreased to $18,000 from
$57,000 for the nine months ended September 30, 2008.





Interest expense to related party
shareholders:Interest
expense to related party shareholders for the nine months ended September 30,
2009 totaled $917,000 compared to $131,000 for the nine months ended September
30, 2008. The increase in interest expense to related party shareholders was
primarily the result of the recognition of the embedded derivative financial
liability relating to the embedded conversion feature within the subordinated
convertible notes and the amortization of the debt discount.





Interest expense:Interest
expense for the nine months ended September 30, 2009 totaled $212,000, compared
to $231,000 for the nine months ended September 30, 2008.




Liquidity
And Capital Resources




General




At
September 30, 2009, we had approximately $4.1 million in cash and cash
equivalents compared to $4.0 million and $1.9 million at December 31, 2008 and
September 30, 2008, respectively. Working capital at September 30, 2009 and 2008
was $14.5 million and $15.5 million, respectively.  Working capital at
December 31, 2008 was $15.3 million.  As of September 30, 2009, we had
an accumulated deficit of approximately $147.3 million.  We have
incurred negative cash flows and net losses since inception.


22


The
global economic downturn has negatively impacted, and may in the future
negatively impact, our liquidity.  Prior to the beginning of the
economic downturn in the second half of 2008, we had experienced consistent
revenue growth. This growth should not be considered indicative of our future
performance, particularly given the challenging economic environment that we now
face.





We
believe that our existing cash balance, combined with working capital, will be
sufficient to enable us to meet planned expenditures under a streamlined
business plan through at least the next 12 months.  The streamlined
business plan calls for, among other things, reductions in marketing and capital
expenditures, delaying new hires and making selective inventory
purchases.





We are
currently exploring sources of additional capital in order to maximize the
growth of our business. However, there can be no assurance that we will be able
to identify a source for such financing, or that such financing will be
available on terms acceptable to us.  Should we experience
unanticipated losses or expenditures that exceed current estimates and be unable
to raise additional capital, management would implement a plan to further reduce
costs. That plan would include a further reduction in work force as well as
further reductions in overhead costs and capital expenditures.





There can
be no assurance that we will achieve or sustain positive cash flows from
operations or profitability. If we are unable to maintain adequate liquidity,
future operations will need to be scaled back or discontinued.





Credit
Facility




We have a
credit facility with Wells Fargo Retail Finance LLC (“Wells
Fargo”).  Pursuant to the terms of the credit facility, Wells Fargo
provides us with a revolving loan and issues letters of credit in favor of
suppliers or factors.  The credit facility is secured by a lien on
substantially all of our assets. Availability under the credit facility is
determined by a formula that takes into account a certain percentage of our
inventory and a certain percentage of our accounts receivable. The maximum
availability is currently $7,500,000, but can be increased to $12,500,000 at our
request, subject to certain conditions.  As of September 30, 2009,
total availability under the credit facility was approximately $4.3 million of
which $2.9 million was committed for letters of credit in favor of suppliers,
leaving approximately $1.4 million available for further
borrowings.  The credit facility contains a material adverse change
clause.  In the event of a material adverse change in our financial
condition, we would not be able to obtain additional borrowings under the credit
facility and existing borrowings would become due and payable.




Interest
accrues monthly on the average daily amount outstanding under the credit
facility during the preceding month at a per annum rate equal to the prime rate
plus 0.75% or LIBOR plus 3.25%. We also pay a monthly commitment fee on the
unused portion of the credit facility (i.e., $7,500,000 less the amount of loans
outstanding) equal to 0.50% and a servicing fee of $3,333 per
month.  We also pay Wells Fargo certain fees to open letters of credit
and guarantees in an amount equal to a certain specified percentage of the face
amount of the letter of credit for each thirty (30) days of such letter of
credit, or a portion thereof, remains open.




Total
availability under our credit facility is based primarily upon our inventory
levels. In addition, both availability under our credit facility and our
operating cash flows are affected by the payment terms that we receive from
suppliers and service providers, and the extent to which suppliers require us to
provide credit support under our credit facility.  In some instances,
new vendors may require prepayments. We may make prepayments in order to open up
these new relationships, or to gain access to inventory that would not otherwise
be available to us. In addition, from time to time we make prepayments in
connection with our advertising campaign, as in some circumstances we need to
pay in advance of production. As of September 30, 2009, we had approximately
$128,000 of prepaid inventory and approximately $34,000 of prepaid
marketing on our Balance Sheet compared to $155,000 and $174,000, respectively,
as of December 31, 2008 and $982,000 and $1,152,000, respectively, as of
September 30, 2008.




Commitments
and Long Term Obligations




As of
September 30, 2009, we had the following commitments and long term
obligations:




LessThan
                
                
                
                
                
                
                
                
                More ThanTotal
                
                
                1 Year
                
                
                1-3 Years
                
                
                3-5 Years
                
                
                5 YearsMarketing andadvertising
                
                $
                642,000
                
                
                $
                642,000
                
                
                $
                --
                
                
                $
                --
                
                
                $
                --Operatingleases
                
                
                1,098,000
                
                
                
                357,000
                
                
                
                741,000
                
                
                
                --
                
                
                
                --





23





Long-termobligations
                        
                        3,289,000
                        
                        
                        --
                        
                        
                        
                        3,289,000
                        
                        
                        
                        --
                        
                        
                        --Employmentcontracts(1)
                        
                        2,710,000
                        
                        
                        543,000
                        
                        
                        
                        2,167,000
                        
                        
                        
                        --
                        
                        
                        --Total commitments and long-term
      obligations
                        $
                        7,739,000
                        
                        $
                        1,542,000
                        
                        
                        $
                        6,197,000
                        
                        
                        $
                        --
                        
                        $
                        --


______________


(1)
            Includes
      approximately $233,000 in executive bonuses payable in less than one
      year.





While we
believe that in order to grow the business, we will need to make additional
marketing and advertising commitments in the future, we are currently operating
under a streamlined business plan.  The streamlined business plan
calls for, among other things, reductions in marketing and capital expenditures,
delaying new hires and making selective inventory purchases.





However,
in order to optimize the growth of our business, we are currently exploring
sources of additional capital. There can be no assurance that we will be able to
identify a source for such capital, or that it will be available on terms
acceptable to us.


24




Item
3. Quantitative and Qualitative Disclosures About Market Risk




We have
assessed our vulnerability to certain market risks, including interest rate risk
associated with financial instruments included in cash and cash equivalents. Due
to the short-term nature of these instruments, we have determined that the risks
associated with interest rate fluctuations related to these financial
instruments do not pose a material risk to us.




Item
4T.  Controls and Procedures.




As of the end of the period covered by
this Form 10-Q (the “Evaluation Date”), we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive Officerandour Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based
upon that evaluation, our Chief Executive Officer andChief Financial Officer concluded that,
as of the Evaluation Date, our disclosure controls and procedureswere
effective in ensuring that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act were recorded, processed,
summarized and reported, within the time periods specified in the Securities and
Exchange Commission’s rules and forms and were effective to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act was accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosure. There have been no changes in
our internal control over financial reporting that occurred during the Company's
most recent fiscal quarter that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.





Special Note Regarding Forward Looking
Statements





This
report may include statements that constitute "forward-looking" statements,
usually containing the words "believe", "project", "expect", or similar
expressions. These statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Forward-looking statements
inherently involve risks and uncertainties that could cause actual results to
differ materially from the forward-looking statements. The risks and
uncertainties are detailed from time to time in reports filed by us with the
Securities and Exchange Commission, including Forms 8-A, 8-K, 10-Q, and 10-K.
These risks and uncertainties
include, but are not limited to, the following:  our history of losses
and anticipatedfuture
losses; our ability to raise additional capital to support the growth of our
business; risks associated with the economic downturn; risks associated withaffiliates ofSorosFund Management,private funds associated withMaverickCapital Ltd.andaffiliates ofPrentice Capital Management, LP each
owning a significant portion of our stock; the potential failure to forecast
revenues and/or to make adjustments to our operating plans necessary as a result
of any failure to forecast accurately; unexpected changes in fashion trends;
cyclical variations in the apparel and e-commerce markets; the risk of default
by us underourcreditfacility and the consequences that might
arise from us having granted a lien on substantially all of our assets under
that agreement; risks of litigationrelated to thesale of unauthentic or damaged goods
and litigation risks related to sales in foreign countries; the dependence on
third parties and certain relationships for certain services, including our
dependence onUPSand USPS (and the risks of a mail
slowdown due to terrorist activity) and our dependence on our third-party web
hosting, fulfillment and customer service centers; online commerce security
risks;the success of our
advertising campaign and risk associated with continuing to operate under a
streamlined business plan;risks related to brand owners’ efforts
to limit our ability topurchase products indirectly;management of potential growth; the
competitive nature of our business and the potential for competitors with
greater resources to enter the business; the availability of merchandise; the
need to further establish brand name recognition; risks associated with our
ability to handle increased traffic and/or continued improvements to our Web
site; rising return rates; dependence upon executive personnelwho do not have long term employment
agreements; the successful
hiring and retaining of new personnel; risks associated with expanding our
operations; risks associated with potential infringement of other’s intellectual
property; the potential inability to protect our intellectual property;
government regulation and legal uncertainties; and uncertainties relating to the
imposition of sales tax on Internet sales.


25


Part
II  - OTHER INFORMATION





Item
6.   Exhibits





The
following is a list of exhibits filed as part of this Report:





Exhibit
Number                                                                      Description


10.1
              Employment
      Agreement, dated as of August 31, 2009, by and between the Company and
      Bradford Matson (incorporated by reference to the Current Report on Form
      8-K filed by the Company with the Commission on September 22,
      2009).31.1
              Certification
      Pursuant to Rule 13a-14(a)/15d-14(a).31.2
              Certification
      Pursuant to Rule 13a-14(a)/15d-14(a).32.1
              Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.32.2
              Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.





26


SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.








BLUEFLY,
INC.





By: /s/ Melissa
Payner-Gregor


Melissa
Payner-Gregor


Chief
Executive Officer








By: /s/ Kara B.
Jenny


Kara B.
Jenny


Chief
Financial Officer








November
10, 2009


27