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,
2010


OR





[    ]
            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.


(Exact
name of registrant as specified in its charter)
 ___________________________________


Delaware
            13-3612110(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer Identification No.)42
      West 39th
      Street, New York, NY
              (Address of
      principal executive offices)
            10018
              (Zip
      Code)





Registrant’s
telephone number, including area code: (212) 944-8000


Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 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 preceding
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, a non-accelerated filer or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act:








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 4, 2010, there were 24,607,338 shares of Common Stock, $.01 par value,
of the registrant outstanding.









BLUEFLY,
INC.


TABLE
OF CONTENTS


SEPTEMBER
30, 2010








PAGEPART
      I –
              FINANCIAL
      INFORMATIONItem 1.
              Financial
      Statements:Balance
      Sheets as of September 30, 2010 (unaudited)and
      December 31, 2009
              3Statements
      of Operations for the three months endedSeptember
      30, 2010 and 2009 (unaudited)
              4Statements
      of Operations for the nine months endedSeptember
      30, 2010 and 2009 (unaudited)
              5Statements
      of Cash Flows for the nine months endedSeptember
      30, 2010 and 2009 (unaudited)
              6Notes
      to Financial Statements (unaudited)
              7 – 12Item 2.
              Management’s
      Discussion and Analysis of Financial Condition and Results ofOperations
              13 – 19Item 4T.
              Controls
      and Procedures
              19PART
      II –
              OTHER
      INFORMATIONItem 6.
              Exhibits
              21Signatures
              
              22




2




Part
I – FINANCIAL INFORMATION


Item
1. – Financial Statements


BLUEFLY,
INC.


BALANCE
SHEETS




(Unaudited)September 30,
            
            
            December
      31,2010
            
            
            2009AssetsCurrentassets:Cash and cash
      equivalents
            
            $
            6,640,000
            
            
            $
            10,049,000Accounts receivable — net of
      allowance for doubtful accounts
            
            
            3,385,000
            
            
            
            3,319,000Inventories,
      net
            
            
            30,236,000
            
            
            
            17,668,000Prepaid
      inventory
            
            
            1,466,000
            
            
            
            238,000Prepaid
      expenses
            
            
            287,000
            
            
            
            208,000Other current
      assets
            
            
            452,000
            
            
            
            513,000Total current
      assets
            
            
            42,466,000
            
            
            
            31,995,000Property and equipment,
      net
            
            
            3,154,000
            
            
            
            3,506,000Otherassets
            
            
            136,000
            
            
            
            145,000Totalassets
            
            $
            45,756,000
            
            
            $
            35,646,000Liabilities and Stockholders’
      EquityCurrentliabilities:Accounts
      payable
            
            $
            8,520,000
            
            
            $
            4,363,000Allowance for sales
      returns
            
            
            3,633,000
            
            
            
            2,627,000Accrued expensesand other current
      liabilities
            
            
            1,388,000
            
            
            
            2,105,000Deferred
      revenue
            
            
            3,037,000
            
            
            
            3,516,000Total current
      liabilities
            
            
            16,578,000
            
            
            
            12,611,000Total
      liabilities
            
            
            16,578,000
            
            
            
            12,611,000Commitments andcontingencies(Note 4)Stockholders’equity:Common stock–$.01 par
      value;  50,000,000 and 200,000,000 shares authorized as of
      September 30, 2010 and December 31, 2009, respectively; 24,945,736 and
      18,885,239 shares issued as of September 30, 2010 and December 31, 2009,
      respectively, 24,607,338 and 18,552,737 shares outstanding as of September
      30, 2010 and December 31, 2009, respectively
            
            
            246,000
            
            
            
            185,000Treasury
    stock
            
            
            (1,824,000
            )
            
            
            (1,809,000
            )Additional paid-in
      capital
            
            
            182,526,000
            
            
            
            172,127,000Accumulateddeficit
            
            
            (151,770,000
            )
            
            
            (147,468,000
            )Total stockholders’
      equity
            
            
            29,178,000
            
            
            
            23,035,000Totalliabilities andstockholders’equity
            
            $
            45,756,000
            
            
            $
            35,646,000





The
accompanying notes are an integral part of these financial
statements.




3






BLUEFLY,
INC.


STATEMENTS
OF OPERATIONS


(Unaudited)




Three
      Months EndedSeptember
      30,2010
            
            
            2009Net
      sales
            
            $
            19,202,000
            
            
            $
            17,108,000Cost
      of sales
            
            
            12,278,000
            
            
            
            10,269,000Gross profit
            
            
            6,924,000
            
            
            
            6,839,000Selling
      and fulfillment expenses
            
            
            4,115,000
            
            
            
            3,752,000Marketing
      expenses
            
            
            2,944,000
            
            
            
            1,491,000General
      and administrative expenses
            
            
            1,895,000
            
            
            
            2,061,000Total operating
      expenses
            
            
            8,954,000
            
            
            
            7,304,000Operating
      loss
            
            
            (2,030,000
            )
            
            
            (465,000
            )Interest
      expense torelated partystockholders
            
            
            --
            
            
            
            (405,000
            )Other
      interest expense, net
            
            
            (47,000
            )
            
            
            (45,000
            )Net
      loss
            
            $
            (2,077,000
            )
            
            $
            (915,000
            )Basic
      and diluted net loss per common share
            
            $
            (0.08
            )
            
            $
            (0.07
            )Weighted
      average common shares outstanding(basic
      and diluted)
            
            
            24,598,151
            
            
            
            13,844,637




The
accompanying notes are an integral part of these financial
statements.





4





BLUEFLY,
INC.


STATEMENTS
OF OPERATIONS


(Unaudited)




Nine
      Months EndedSeptember
      30,2010
            
            
            2009Net
      sales
            
            $
            59,987,000
            
            
            $
            56,868,000Cost
      of sales
            
            
            36,748,000
            
            
            
            35,370,000Gross profit
            
            
            23,239,000
            
            
            
            21,498,000Selling
      and fulfillment expenses
            
            
            12,090,000
            
            
            
            12,177,000Marketing
      expenses
            
            
            9,451,000
            
            
            
            6,271,000General
      and administrative expenses
            
            
            5,852,000
            
            
            
            6,160,000Total operating
      expenses
            
            
            27,393,000
            
            
            
            24,608,000Operating
      loss
            
            
            (4,154,000
            )
            
            
            (3,110,000
            )Interest
      expense torelated partystockholders
            
            
            --
            
            
            
            (917,000
            )Other
      interest expense, net
            
            
            (148,000
            )
            
            
            (194,000
            )Net
      loss
            
            $
            (4,302,000
            )
            
            $
            (4,221,000
            )Basic
      and diluted net loss per common share
            
            $
            (0.18
            )
            
            $
            (0.31
            )Weighted
      average common shares outstanding(basic
      and diluted)
            
            
            23,377,501
            
            
            
            13,840,733




The
accompanying notes are an integral part of these financial
statements.




5




BLUEFLY,
INC.


STATEMENTS
OF CASH FLOWS


(Unaudited)




Nine
      Months EndedSeptember
      30,2010
            
            
            2009Cash
      flows from operating activities:Net loss
            
            $
            (4,302,000
            )
            
            $
            (4,221,000
            )Adjustments
      to reconcile net loss to net cash (used in) provided by operating
      activities:Depreciation and
      amortization
            
            
            1,864,000
            
            
            
            2,281,000Stock based
      compensation
            
            
            441,000
            
            
            
            466,000Provisions for
      returns
            
            
            1,006,000
            
            
            
            (650,000
            )Bad debt
    expense
            
            
            222,000
            
            
            
            250,000Reserve for inventory
      obsolescence
            
            
            328,000
            
            
            
            (370,000
            )Amortization of discount on notes payable to
      related partystockholders
            
            
            --
            
            
            
            263,000Change
      in fair value of embedded derivative financial liability torelated
      party stockholders
            
            
            --
            
            
            
            428,000Change in operating assets and
      liabilities:(Increase) decrease
      in:Accounts
      receivable
            
            
            (288,000
            )
            
            
            (704,000
            )Inventories
            
            
            (12,896,000
            )
            
            
            5,620,000Prepaid
    inventory
            
            
            (1,228,000
            )
            
            
            26,000Prepaid
    expenses
            
            
            (79,000
            )
            
            
            265,000Other assets
            
            
            46,000
            
            
            
            (98,000
            )Increase (decrease)
      in:Accounts
    payable
            
            
            4,157,000
            
            
            
            (3,182,000
            )Accrued expenses and other
      current liabilities
            
            
            (702,000
            )
            
            
            (272,000
            )Deferred
    revenue
            
            
            (479,000
            )
            
            
            183,000Interest payable to related
      party stockholders
            
            
            --
            
            
            
            (62,000
            )Net
      cash (used in) provided by operating activities
            
            
            (11,910,000
            )
            
            
            223,000Cash
      flows from investing activities:Purchases of property and
      equipment
            
            
            (1,504,000
            )
            
            
            (161,000
            )Net
      cash used in investing activities
            
            
            (1,504,000
            )
            
            
            (161,000
            )Cash
      flows from financing activities:Net proceeds from common stock
      issuance
            
            
            10,020,000
            
            
            
            --Purchase of treasury
      stock
            
            
            (15,000
            )
            
            
            (5,000
            )Net
      cash provided by (used in) financing activities
            
            
            10,005,000
            
            
            
            (5,000
            )Net
      (decrease) increase in cash and cash equivalents
            
            
            (3,409,000
            )
            
            
            57,000Cash
      and cash equivalents – beginning of period
            
            
            10,049,000
            
            
            
            4,004,000Cash
      and cash equivalents – end of period
            
            $
            6,640,000
            
            
            $
            4,061,000Supplemental
      disclosure of cash flow information:Cash paid for interest
      expense
            
            $
            181,000
            
            
            $
            181,000




The
accompanying notes are an integral part of these financial
statements.






6




BLUEFLY,
INC.
 NOTES
TO FINANCIAL STATEMENTS
 (UNAUDITED)
 SEPTEMBER
30, 2010




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 for the year ended
December 31, 2009.





The Company has sustainedcumulativenet losses and negative cash flows from
operations sinceinception.As of September 30, 2010,
the Company had an accumulated deficit of $151,770,000.  The Company’s
ability to meet its obligations in the ordinary course of business is dependent
on its ability to establish profitable operations, or find sources to fund
operations.  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 through at least the next 12 months.




Reclassifications




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




Concentration




For the three months ended September 30,
2010 and 2009, the Company acquired approximately 38% and 14%, respectively, of
its inventory from one supplier.




For the nine months ended September 30,
2010 and 2009, the Company acquired approximately 42% and 25%, respectively, of
its inventory from one supplier.




NOTE
2 – THE COMPANY





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




NOTE
3 – FAIR VALUE




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.




NOTE
4 – COMMITMENTS AND CONTINGENCIES




Leases




The
Company leases space under operating leases that expire on various dates through
2020. In March 2010, the Company entered into a lease agreement extending the
term of the lease for space it already occupies for an additional ten years
ending on December 31, 2020.  Future remaining minimum lease payments
under these operating leases, excluding utilities, which have initial or
remaining non-cancelable terms in excess of one year, as of September 30, 2010,
are as follows:




2010
              
              $
              63,0002011
              
              
              386,0002012
              
              
              535,0002013
              
              
              554,0002014
              
              
              573,0002015
      & thereafter
              
              
              3,887,000$
              5,998,000




7


BLUEFLY,
INC.
 NOTES
TO FINANCIAL STATEMENTS
 (UNAUDITED)
 SEPTEMBER
30, 2010




Rent
expense (including amounts related to commercial rent tax) aggregated
approximately $146,000 and $158,000 for the three months ended
September 30, 2010 and 2009, respectively, and $467,000 and $530,000 for
the nine months ended September 30, 2010 and 2009, respectively.




NOTE
5 – STOCKHOLDERS’ EQUITY




Authorized
Shares




The
Company is incorporated in the State of Delaware.  In February 2010,
the Company amended its certificate of incorporation to decrease the number of
authorized shares of Common Stock, $.01 par value per share (the “Common
Stock”), from 200,000,000 shares to 50,000,000 shares and to decrease the number
of authorized shares of Preferred Stock, $.01 par value per share (the
“Preferred Stock”), from 25,000,000 shares to 1,000,000 shares.




Private
Placement




On December 21, 2009, the Company
entered into a Securities Purchase Agreement with Rho Ventures VI, L.P. (“Rho”)
pursuant to which the Company agreed to issue and sell to Rho up to 8,823,529
newly issued shares (the “Private Placement Shares”) of itsCommonStock for an aggregate purchase price of
$15,000,000, or $1.70 per share, in a private placement transaction (the
“Private Placement”).  The Company issued and sold 2,786,337 of the
Private Placement Shares to Rho at an initial closing (the “Initial Closing”)
held on December 21, 2009 for an aggregate purchase price of approximately
$4,737,000.  The Company received
proceeds from the Initial Closing of approximately $4,468,000, net of $269,000
of issuance costs.




On
February 25, 2010, the Company completed the second closing (the “Second
Closing”) of the Private Placement. At the Second Closing, the Company issued
and sold the remaining 6,037,192 Private Placement Shares to Rho for an
aggregate purchase price of approximately $10,263,000. The Company received
proceeds from the Second Closing of approximately $10,020,000, net of $243,000
of issuance costs.




Registration
Rights and Warrants Issuance




In
connection with the Private Placement, the Company entered into a Registration
Rights Agreement pursuant to which it agreed to file a registration statement
with respect to the Private Placement Shares within 30 days following the date
of the Second Closing (the “Filing Deadline”) and to cause such registration
statement to be declared effective by the Securities and Exchange Commission
within 180 days following the date of the Second Closing (the “Effectiveness
Deadline”). The Registration Rights Agreement provided that the Company would be
obligated to issue warrants to Rho in certain circumstances if the registration
statement was not filed by the Filing Deadline or declared effective by the
Effectiveness Deadline. The Company filed a registration statement with the
Securities and Exchange Commission covering the Private Placement Shares on
March 10, 2010 and the registration statement was declared effective on May 25,
2010.  As the registration statement was filed within the Filing
Deadline and was declared effective within the Effectiveness Deadline, the
Company did not record any amounts in the financial statements with regards to
warrants.




NOTE
6 – SHARE-BASED COMPENSATION




Authoritative guidance relating to
share-based compensation requiresthe Companyto measure compensation cost for
share-based
compensationawards at fair
value and recognize compensation over the service period for awards expected to
vest. Total share-based compensation expense recorded in the Statements of
Operations was $157,000and $137,000for the three months endedSeptember 30, 2010 and 2009, respectively, and $441,000 and $466,000 for the nine
months ended September 30, 2010 and 2009, respectively.




In February 2010, the Company amended
its Amended and Restated 2005 Stock Incentive Plan (the “Plan”) to increase the
aggregate number of shares of Common Stock that may be the subject of
share-based compensation awards granted pursuant to




8




BLUEFLY,
INC.
 NOTES
TO FINANCIAL STATEMENTS
 (UNAUDITED)
 SEPTEMBER
30, 2010




the Plan by 1,500,000 shares and, in
June 2010, the Company again amended the Plan to increase the aggregate number
of shares of Common Stock that may be the subject of share-based compensation
awards granted pursuant to the Plan by an additional 1,586,392
shares.




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 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, 2009
            
            207,760
            
            
            $
            9.09Options
    granted
            
            1,850,000
            
            
            $
            2.40Options
      cancelled
            
            (20,479
            )
            
            $
            3.96Options
      exercised
            
            --
            
            
            $
            --Balance atSeptember 30, 2010
            
            2,037,281
            
            
            $
            3.06Vested atDecember 31,
      2009
            
            180,787
            
            
            $
            9.94Vested at September 30,
      2010
            
            401,325
            
            
            $
            5.63




During thethirdquarter of2010,4,635 options were cancelled through
normal employee attrition, of which 156optionswerevestedand 4,479 options were
non-vested.During the third quarter of 2010, total
number of options that vested was 113,285 options.The total fair value of the options that
vested during thethirdquarterof 2010was approximately $198,000.  There were85,000options grantedduring thethirdquarterof 2010. AtSeptember 30, 2010, the aggregate intrinsic value of the
fully vested options was
$9,000and the weighted average remaining
contractual life of the optionswasapproximatelynineyears. TheCompanydidnot capitalize any compensation cost,
or modifyany of its stock option grants during
thethree and nine months
ended September 30, 2010.
During thethird quarter of
2010, no options were
exercised and no cash was used to settle equity instruments granted under theCompany’s equity incentive
plans.




As of
September 30, 2010, the total compensation cost related to non-vested stock
option awards not yet recognized was $2,018,000. Total compensation cost is
expected to be recognized over three years on a weighted average
basis.




Restricted
Stock Awards and Deferred Stock Unit Awards




The following table is a summary of
activity related torestrictedstockawardsanddeferredstockunitawardsforemployees at September 30,
2010:




Restricted
                
                
                Deferred
      StockStock
      Awards
                
                
                Unit
      AwardsBalance
      at December 31, 2009
                
                
                8,437
                
                
                
                12,314Shares/Units
      granted
                
                
                8,062
                
                
                
                --Shares/Units
      forfeited
                
                
                (750
                )
                
                
                (51
                )Shares/Units
      restriction lapses
                
                
                (6,562
                )
                
                
                (12,263
                )Balance
      at September 30, 2010
                
                
                9,187
                
                
                
                --Weighted
      average grant date fair value per share
                
                $
                2.24
                
                
                $
                --Aggregate
      grant date fair value
                
                $
                21,000
                
                
                $
                --Weighted
      average vesting service period of shares granted
                
                12
      Months
                
                
                12-36
      MonthsNumber
      of shares/units vested at September 30, 2010
                
                
                --
                
                
                
                --Number
      of shares/units non-vested at September 30, 2010
                
                
                9,187
                
                
                
                --




9




BLUEFLY,
INC.
 NOTES
TO FINANCIAL STATEMENTS
 (UNAUDITED)
 SEPTEMBER
30, 2010





As of
September 30, 2010, the total compensation cost related to non-vested restricted
stock not yet recognized was $7,000.  Total compensation cost is
expected to be recognized within a one year period on a weighted average
basis.




NOTE
7 – SUBORDINATED CONVERTIBLE NOTES




In July 2008, the Company issued
Subordinated Notes in the aggregate principal amount of $3,000,000 that had a
term expiring three years from the date of issuance and bore interest at the
rate of 8% per annum, compounded annually, which was payable in cash upon
maturity or conversion (the “Subordinated Notes”).  In December 2009,
in connection with the Private Placement, all outstanding Subordinated Notes
were converted into shares of Common Stock at a conversion price of $1.70 per
share.




In connection with the adoptionofauthoritative guidance relating to
determining whether an instrument (or embedded feature) is indexed to an
entity’s own stock,on
January 1, 2009, the Company determined that the embedded conversion feature
included in each
ofthe Subordinated Noteswasnot indexed to the Company’s own stock
and, therefore,such
feature qualified asan
embedded derivative financial liability (the “Embedded Derivative”), which
requiredbifurcation andmustbe separately accountedfor as a separate
instrument.




The Company measured the fair value of
the Embedded Derivative using a Black-Scholes valuation model as of January 1,
2009 to determine the cumulative effect of the change in accounting principle to
be recorded.The Company
recordedacumulative effect of the change in
accounting principle of approximately $779,000, which was recognized as a
decrease in accumulated deficit at January 1, 2009.  The amount
recognized in the Company’s Balance Sheet upon the initial adoption ofthe authoritative guidance
described abovewas
determined based on the amounts that would have been recognized ifthe authoritative guidancehad been applied from the issuance date
of the Subordinated Notes and the amount recognized in the Company’s Balance
Sheet upon the initial application ofthe authoritative guidance.  In addition, as a result of
the bifurcation, the Company recognized an Embedded Derivative of approximately
$98,000 and adiscount on
the Subordinated Notes of $877,000, which reduced the carrying value of the
Subordinated Notes at the date of adoption.  This discount
representedadditional non-cash interest expense
thatwas to be amortized over the remaining
life of the Subordinated Notes.




The Company also re-measured the fair
value of the Embedded Derivative at September 30, 2009.  Any change in
fair value was recorded as part of interest expense to related party
stockholders.  The assumptions used at September 30, 2009 were 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 was 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 was based on the interest rate for
U.S. Treasury Notes having a maturity period equal to the then remaining
maturity life of the Subordinated Notes.




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
stockholders in the Statement of Operations, as follows:





10




BLUEFLY,
INC.
 NOTES
TO FINANCIAL STATEMENTS
 (UNAUDITED)
 SEPTEMBER
30, 2010


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





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




NOTE
8 – NET LOSS PER SHARE




Basic net
loss per share excludes dilution and is computed by dividing net loss available
to common stockholders 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
stockholders 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 each of the
following periods presented:


Three
      Months EndedSeptember
      30,2010
            
            2009Net
      loss
            
            $
            (2,077,000
            )
            
            $
            (915,000
            )Weighted
      average common shares outstanding (basic)
            
            
            24,598,151
            
            
            
            13,844,637Options and warrants(1)(2)
            
            
            --
            
            
            
            --Preferred stock and
      subordinated notes(1)
            
            
            --
            
            
            
            --Restricted stock and deferred
      stock awards(1)
            
            
            --
            
            
            
            --Weighted
      average common shares outstanding (diluted)
            
            
            24,598,151
            
            
            
            13,844,637




11


BLUEFLY,
INC.
 NOTES
TO FINANCIAL STATEMENTS
 (UNAUDITED)
 SEPTEMBER
30, 2010




(1)
              For the
      three months ended September 30, 2010 and 2009, the Company had weighted
      average shares of the following potentially dilutive securities that wereexcluded as
      the effects would be
anti-dilutive:


Options and
      warrants
            
            
            2,961
            
            
            
            482Preferred
      stock and subordinated notes
            
            
            --
            
            
            
            821,918Restricted
      stock and deferred stock awards
            
            
            9,187
            
            
            
            265,965


(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
      30,2010
            
            2009Net
      loss
            
            $
            (4,302,000
            )
            
            $
            (4,221,000
            )Weighted
      average common shares outstanding (basic)
            
            
            23,377,501
            
            
            
            13,840,733Options and warrants(1)(2)
            
            
            --
            
            
            
            --Preferred stock and
      subordinated notes(1)
            
            
            --
            
            
            
            --Restricted stock and deferred
      stock awards(1)
            
            
            --
            
            
            
            --Weighted
      average common shares outstanding (diluted)
            
            
            23,377,501
            
            
            
            13,840,733


(1)
              For the
      nine months ended September 30, 2010 and 2009, the Company had weighted
      average shares of the following potentially dilutive securities that wereexcluded as
      the effects would be
anti-dilutive:




Options and
      warrants
            
            
            3,873
            
            
            
            482Preferred
      stock and subordinated notes
            
            
            --
            
            
            
            821,918Restricted
      stock and deferred stock awards
            
            
            12,698
            
            
            
            272,116




(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
9 – RECENT ACCOUNTING PRONOUNCEMENTS




In February 2010, the Financial
Accounting Standards Board (“FASB”) issued an update to authoritative guidance
relating to subsequent events, which was effective upon the issuance of the
update.  The Company adopted this authoritative guidance on February
28, 2010.  The update to the authoritative guidance relating to
subsequent events removes the requirement for Securities and Exchange Commission
filers to disclose the date through which subsequent events have been evaluated
in both issued and revised financial statements.  The adoption of this
update to the authoritative guidance relating to subsequent events did not
impact the Company’s financial position or operating results other than removing
the disclosure.





12





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 and accessories at discounts of up to 75% off of retail
value.  We launched our Web Site in September 1998.





Our net
sales increased by approximately 12% to $19,202,000 for the three months ended
September 30, 2010 from $17,108,000 for the three months ended September 30,
2009.  Our gross margin percentage decreased to 36.1% for the three
months ended September 30, 2010 from 40.0% for the three months ended September
30, 2009. Our gross profit increased slightly to $6,924,000 for the three months
ended September 30, 2010 compared to $6,839,000 for the three months ended
September 30, 2009. The decrease in our gross margin percentage was primarily
attributable to a decrease in our product margins relating to the continued
growth of our luxury designer merchandise, which historically has lower margins
compared to our contemporary merchandise but also leads to a higher average
order size.  Gross margin percentage also decreased as a result of an
increase in inventory reserves in connection with an increase in inventory
balances to support the fourth quarter. We incurred an operating loss of
$2,030,000 for the three months ended September 30, 2010 as compared to an
operating loss of $465,000 for the three months ended September 30,
2009.  The increase in operating loss was primarily the result of a
planned increase in marketing expenses in online and offline marketing
programs.





Marketing
expenses (excluding staff related costs) increased to $2,641,000 for the three
months ended September 30, 2010 from $1,319,000 for the three months ended
September 30, 2009.  Marketing expenses (excluding staff related
costs) increased primarily as a result of an increase in both online and offline
marketing programs of $443,000 and $706,000, respectively, and an increase in
our integrated social media marketing programs of $172,000. This increase is
directly attributable to an increase in traffic driving marketing activities,
specifically a new promotion entitled Closet Confessions, which has aired on
Bravo.  This unique and highly recognized program has been successful
in bringing new visitors to our Web Site since it launched in early September
2010.  We believe that this program will favorably impact our sales
during the holiday season.  Marketing expenses (including staff
related costs) as a percentage of net sales increased to 15.3% for the three
months ended September 30, 2010 compared to 8.7% for the three months ended
September 30, 2009. General and administrative expenses decreased to $1,895,000
from $2,061,000 for the three months ended September 30, 2009.  This
decrease is attributable to a decrease in salary and salary related expenses of
$146,000 and amortization expenses related to leasehold improvements and
internally-developed software related to financial application systems recorded
in 2009 of $105,000, which were partially offset by increases in professional
fees of $96,000.





Our
reserve for returns and credit card chargeback’s increased to 39.2% of gross
sales for the third quarter of 2010 compared to 37.9% for the third quarter of
2009.  The increase was primarily caused by a continued shift in our
merchandise mix towards luxury designer merchandise, which traditionally have a
higher average order size but also slightly higher return rates.  We
believe that this increase in return rates has been more than offset by higher
average order sizes that have been generated by this shift in merchandise
mix.





At
September 30, 2010, we had an accumulated deficit of $151,770,000. The
cumulative net losses and accumulated deficit resulted primarily 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 then outstanding preferred stock and
the payment of dividends to holders of our preferred stock.




Results
Of Operations




For The Three Months EndedSeptember 30, 2010Compared To The Three Months EndedSeptember 30,
2009.




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:




2010
              
              
              2009As
      a % of
                Net
      Sales
              
              
              
              
              
              As
      a % of
                Net
      SalesNet
      sales
              
              $
              19,202
              
              100.0
              %
              
              $
              17,108
              
              100.0
              %Cost
      of sales
              
              
              12,278
              
              63.9
              
              
              
              10,269
              
              60.0Gross
      profit
              
              
              6,924
              
              36.1
              
              
              
              6,839
              
              40.0Selling
      and fulfillment expenses
              
              
              4,115
              
              21.4
              
              
              
              3,752
              
              21.9Marketing
      expenses
              
              
              2,944
              
              15.3
              
              
              
              1,491
              
              8.7General
      and administrative expenses
              
              
              1,895
              
              9.9
              
              
              
              2,061
              
              12.1Total
      operating expenses
              
              
              8,954
              
              46.6
              
              
              
              7,304
              
              42.7Operating
      (loss) income
              
              
              (2,030
              )
              (10.5
              )
              
              
              (465
              )
              (2.7
              )Interest
      expense, net
              
              
              (47
              )
              (0.3
              )
              
              
              (450
              )
              (2.6
              )Net
      loss
              
              $
              (2,077
              )
              (10.8
              )%
              
              $
              (915
              )
              (5.3
              )%




13


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:




2010
            
            
            2009Averageordersize (including shipping &
      handling)
            
            $
            321.33
            
            
            $
            274.58Newcustomersadded during theperiod*
            
            
            34,601
            
            
            
            34,753*Based
      on unique email addresses


In
addition to the financial statement items and metrics listed above, which are
non-GAAP financial measurements, we also report gross sales, another 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, 2010 increased by approximately 15% to
$31,563,000 from $27,555,000 for the three months ended September 30, 2009. For
the three months ended September 30, 2010, we recorded a provision for returns
and credit card chargeback’s and other discounts of $12,361,000, or
approximately 39.2% of gross sales. For the three months ended September 30,
2009, the provision for returns and credit card chargeback’s and other discounts
was $10,447,000, or approximately 37.9% of gross sales. The increase in this
provision as a percentage of gross sales resulted from a continued shift in our
merchandise mix towards luxury designer merchandise, which traditionally have a
higher average order size but also slightly higher return rates. We believe that
this increase in return rates has been more than offset by higher average order
sizes that have been generated by this shift in merchandise mix.





After the
necessary provisions for returns and credit card chargeback’s, our net sales for
the three months ended September 30, 2010 was $19,202,000. This represents an
increase of approximately 12% compared to the three months ended September 30,
2009, in which net sales totaled $17,108,000. The increase in net sales resulted
primarily from a 17% increase in average order size and traffic driving
marketing activities, including Closet Confessions aired on Bravo, which was
partially offset by a decrease in the number of customer orders. For the three
months ended September 30, 2010, revenue from shipping and handling (which is
included in net sales) decreased approximately 6% to $900,000 from $961,000 for
the three months ended September 30, 2009.Shipping and handling
revenue decreased primarily as a result of a decrease in the number of customer
orders, which was offset by higher average order sizes.





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, 2010 was $12,278,000
resulting in a gross margin percentage of approximately 36.1%. Cost of sales for
the three months ended September 30, 2009 was $10,269,000, resulting in a gross
margin percentage of 40.0%. Gross profit increased slightly to $6,924,000 for
the three months ended September 30, 2010 compared to $6,839,000 for the three
months ended September 30, 2009. The decrease in gross margin percentage is
attributable to a decrease in product margins relating to the continued growth
of our luxury designer merchandise, which historically has lower margins
compared to our contemporary merchandise but creates a higher average order
size.  Gross margin percentage also decreased as a result of an
increase in inventory reserves in connection with an increase in inventory
balances to support the fourth quarter.





14




Selling and fulfillment
expenses:  Selling and fulfillment expenses increased by
approximately 10% for the three months ended September 30, 2010 compared to the
three months ended September 30, 2009. Selling and fulfillment expenses were
comprised of the following:




Three
      Months Ended September 30,
            
            Percentage(All data
      in thousands)
            
            2010
            
            2009
            
            DifferenceAs
      a % of
            
            
            
            
            
            As
      a % of
            
            IncreaseNet
      Sales
            
            
            
            
            
            Net
      Sales
            
            (Decrease)Operating
            
            $
            1,747
            
            
            9.1
            %
            
            $
            1,662
            
            
            9.7
            %
            
            5.1
            %Technology
            
            
            1,387
            
            
            7.2
            
            
            
            1,265
            
            
            7.4
            
            
            9.6E-Commerce
            
            
            981
            
            
            5.1
            
            
            
            825
            
            
            4.8
            
            
            18.9Total selling and fulfillment
      expenses
            
            $
            4,115
            
            
            21.4
            %
            
            $
            3,752
            
            
            21.9
            %
            
            10.0
            %




As a
percentage of net sales, our selling and fulfillment expenses remained
relatively unchanged at approximately 21% for the three months ended September
30, 2010 compared to the three months ended September 30, 2009.





Operating
expenses include all costs related to inventory management, fulfillment,
customer service, and credit card processing. Operating expenses increased by
5.1% for the three months ended September 30, 2010 compared to the three months
ended September 30, 2009 primarily as a result of an increase in credit card
fees.





Technology
expenses consist primarily of staff related costs, amortization of capitalized
costs and Web Site hosting. For the three months ended September 30, 2010,
technology expenses increased by 9.6% compared to the three months ended
September 30, 2009. This increase was primarily attributable to an increase in
expenses related to software support expenses of $103,000 and technology
consulting expenses of $46,000.  These expenses were partially offset
by a decrease in salary and salary related expenses of $44,000, of which
$38,000, related to the development of mobile platform applications such as our
iPhone app and on-going Web Site enhancements, was capitalized.





E-Commerceexpenses include expenses
related to our photo design studio, image processing, and Web Site design. For
the three months ended September 30, 2010, e-commerce expenses increased by
approximately 18.9% as compared to the three months ended September 30, 2010
primarily as a result of increases in consulting fees relating to the
development of new Web Site features, functionalities and enhanced Web Site
experience of $63,000, short-term staffing expenses of $47,000, salary and
salary related expenses of $24,000 and expenses associated with our photo shoots
of approximately $11,000.





Marketing
expenses:Marketing expenses (including staff related costs)
increased to $2,944,000 for the three months ended September 30, 2010 from
$1,491,000 for the three months ended September 30, 2009.





Marketing
expenses include expenses related to our offline advertising; online programs
such as paid search, fees to affiliates, comparison engines and email campaigns;
integrated social media marketing programs and direct mail campaigns; as well as
staff related costs. As a percentage of net sales, our marketing expenses
(including staff related costs) increased to 15.3% for the three months ended
September 30, 2010 from 8.7% for the three months ended September 30,
2009.





The
increase in total marketing expenses (excluding staff related costs) was
primarily a result of traffic building marketing programs of $443,000 related to
our online marketing programs, $706,000 related to our offline advertising and
$172,000 related to our integrated social media marketing programs. The Closet
Confessions program aired on Bravo program was the single biggest driver of the
increase in marketing expenses. This unique and highly recognized program has
been successful in bringing new visitors to our Web Site since it launched in
early September 2010.  We expect the impact of this investment to
continue providing dividends during the holiday season.





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, 2010
decreased by approximately 8% to $1,895,000 as compared to $2,061,000 for the
three months ended September 30, 2009.  The decrease in general and
administrative expenses was primarily the result of decreases in salary and
salary related expenses of $146,000 and amortization expenses related to
leasehold improvements and internally-developed software related to product
application systems recorded in 2009 of $105,000, which were partially offset by
increases in professional fees of $96,000.




15




As a
percentage of net sales, general and administrative expenses for the three
months ended September 30, 2010 decreased to 9.9% from 12.1% for the three
months ended September 30, 2009.





Loss from
operations:  In the three months ended September 30, 2010,
operating loss increased to $2,030,000 from $465,000 in the three months ended
September 30, 2009.





Interest expense to related party
stockholders:Interest
expense to related party stockholders for the three months ended September 30,
2010 decreased to $0 as compared to $405,000 for the three months ended
September 30, 2009. Interest expense to related party stockholders consisted of
stated interest expense, 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.  There was no interest expense to related party stockholders
for the three months ended September 30, 2010 as the subordinated convertible
notes were converted to common stock in connection with the Private Placement
transaction in December 2009.




Other interest expense,
net:Interest
income for the three months ended September 30, 2010 decreased slightly to
$7,000 from $8,000 for the three months ended September 30, 2009. These amounts
related primarily to interest income earned on our cash balances.




Interest
expense for the three months ended September 30, 2010 increased slightly to
$54,000 compared to $53,000 for the three months ended September 30, 2009.
Interest expense consists primarily of fees paid in connection with our credit
facility.




For TheNineMonths EndedSeptember30, 2010Compared To TheNineMonths EndedSeptember30, 2009.





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:




2010
              
              
              2009As
      a % of
              
              
              
              
              
              As
      a % ofNet
      Sales
              
              
              
              
              
              Net
      SalesNet
      sales
              
              $
              59,987
              
              
              
              100.0
              %
              
              $
              56,868
              
              
              
              100.0
              %Cost
      of sales
              
              
              36,748
              
              
              
              61.3
              
              
              
              35,370
              
              
              
              62.2Gross profit
              
              
              23,239
              
              
              
              38.7
              
              
              
              21,498
              
              
              
              37.8Selling
      and fulfillment expenses
              
              
              12,090
              
              
              
              20.2
              
              
              
              12,177
              
              
              
              21.4Marketing
      expenses
              
              
              9,451
              
              
              
              15.8
              
              
              
              6,271
              
              
              
              11.0General
      and administrative expenses
              
              
              5,852
              
              
              
              9.7
              
              
              
              6,160
              
              
              
              10.9Total operating expenses
              
              
              27,393
              
              
              
              45.7
              
              
              
              24,608
              
              
              
              43.3Operating loss
              
              
              (4,154
              )
              
              
              (7.0
              )
              
              
              (3,110
              )
              
              
              (5.5
              )Interest
      expense, net
              
              
              (148
              )
              
              
              (0.2
              )
              
              
              (1,111
              )
              
              
              (1.9
              )Net loss
              
              $
              (4,302
              )
              
              
              (7.2
              )%
              
              $
              (4,221
              )
              
              
              (7.4
              )%




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:




2010
            
            
            2009Averageordersize (including shipping &
      handling)
            
            $
            303.19
            
            
            $
            263.38Newcustomersadded during theperiod*
            
            
            113,927
            
            
            
            120,076*Based
      on unique email addresses




16




Net sales:Gross sales for the
nine months ended September 30, 2010 increased by approximately 7% to
$99,092,000 from $92,511,000 for the nine months ended September 30, 2009. For
the nine months ended September 30, 2010, we recorded a provision for returns
and credit card chargeback’s and other discounts of $39,105,000 or approximately
39.5% of gross sales. For the nine months ended September 30, 2009, the
provision for returns and credit card chargeback’s and other discounts was
$35,643,000, or approximately 38.5% of gross sales. The increase in this
provision as a percentage of gross sales resulted from a continued shift in our
merchandise mix towards luxury designer merchandise, which traditionally have a
higher average order size but also slightly higher return rates. We believe that
this increase in return rates has been more than offset by higher average order
sizes that have been generated by this shift in merchandise mix.





After the
necessary provisions for returns and credit card chargeback’s, our net sales for
the nine months ended September 30, 2010 was $59,987,000. This represents an
increase of approximately 5% compared to the nine months ended September 30,
2009, in which net sales totaled $56,868,000. The increase in net sales resulted
primarily from a 15% increase in average order size and traffic driving
marketing activities, including Closet Confessions aired on Bravo, which was
partially offset by a decrease in the number of customer orders. For the nine
months ended September 30, 2010, revenue from shipping and handling (which is
included in net sales) decreased approximately 9% to $3,038,000 from $3,341,000
for the nine months ended September 30, 2009.Shipping and handling
revenue decreased primarily as a result of a decrease in the number of customer
orders, which was offset by higher average order sizes.





Cost of sales: Cost of sales
for the nine months ended September 30, 2010 totaled $36,748,000 resulting in a
gross margin percentage of approximately 38.7%. Cost of sales for the nine
months ended September 30, 2009 totaled $35,370,000, resulting in a gross margin
percentage of 37.8%. Gross profit increased by approximately 8% to $23,239,000
for the nine months ended September 30, 2010 compared to $21,498,000 for the
nine months ended September 30, 2009. The increase in both gross margin
percentage and gross profit was attributable to an increase in overall product
margins due to a reduction in promotional incentives relative to 2009, which was
partially offset by an increase in inventory reserves in connection with an
increase in inventory balances to support the fourth quarter.





Selling and fulfillment
expenses:  Selling and fulfillment expenses decreased slightly
to $12,090,000 for the nine months ended September 30, 2010 compared to
$12,177,000 for the nine months ended September 30, 2009. Selling and
fulfillment expenses were comprised of the following:




Nine
      Months Ended September 30,
            
            Percentage(All data
      in thousands)
            
            2010
            
            2009
            
            DifferenceAs
      a % of
            
            
            
            
            
            As
      a % of
            
            IncreaseNet
      Sales
            
            
            
            
            
            Net
      Sales
            
            (Decrease)Operating
            
            $
            5,459
            
            
            9.1
            %
            
            $
            5,586
            
            
            9.8
            %
            
            (2.3
            )
            %Technology
            
            
            4,029
            
            
            6.7
            
            
            
            4,233
            
            
            7.4
            
            
            (4.8
            )E-Commerce
            
            
            2,602
            
            
            4.4
            
            
            
            2,358
            
            
            4.2
            
            
            10.3Total selling and fulfillment
      expenses
            
            $
            12,090
            
            
            20.2
            %
            
            $
            12,177
            
            
            21.4
            %
            
            (0.7
            )
            %




As a
percentage of net sales, our selling and fulfillment expenses decreased slightly
to 20.2% for the nine months ended September 30, 2010 from 21.4% for the nine
months ended September 30, 2009.





Operating
expenses decreased for the nine months ended September 30, 2010 by approximately
2.3% compared to the nine months ended September 30, 2009 as a result of
decrease in variable costs associated with fulfillment expenses (e.g., picking
and packing orders and processing returns) of $354,000, which was partially
offset by increases in credit card fees of $189,000.





For the
nine months ended September 30, 2010, technology expenses decreased by
approximately 4.8% compared to the nine months ended September 30, 2009. This
decrease was attributable to decreased depreciation expenses, included in
technology expenses, of approximately $205,000 and salary and salary related
expenses of $172,000, of which $87,000, related to the development of mobile
platform applications such as our iPhone app and on-going Web Site enhancements,
was capitalized.  These expenses were partially offset by an increase
in software support expenses of approximately $167,000.





For the
nine months ended September 30, 2010, e-commerce expenses increased by
approximately 10.3% as compared to the nine months ended September 30, 2009
primarily as a result of increases in consulting fees relating to the
development of new Web Site features and functionalities of $139,000, short-term
staffing expenses of $91,000 and shipping expenses of $39,000, which were
partially offset by a decrease in salary and salary related expenses of
$20,000.




17




Marketing
expenses:Marketing expenses (including staff related costs)
increased to $9,451,000 for the nine months ended September 30, 2010 from
$6,271,000 for the nine months ended September 30, 2009.





As a
percentage of net sales, our marketing expenses (including staff related costs)
increased to 15.8% for the nine months ended September 30, 2010 from 11.0% for
the nine months ended September 30, 2009.





The
increase in total marketing expenses (excluding staff related costs) was
primarily a result of increases in traffic building marketing programs of
$898,000 related to our online marketing programs, $1,352,000 related to our
offline advertising and $552,000 related to our integrated social media
marketing programs. The Closet Confessions program aired on Bravo was the single
biggest driver of the increase in marketing expenses.  This unique and
highly recognized program has been successful in bringing new visitors to our
Web Site since it launched in early September 2010.  We expect the
impact of this investment to continue providing dividends during the holiday
season.





General and administrative
expenses:
General and administrative expenses for the nine months ended September 30, 2010
decreased by approximately 5% to $5,852,000 as compared to $6,160,000 for the
nine months ended September 30, 2009.  The decrease in general and
administrative expenses was primarily the result of a decrease in amortization
expenses related to leasehold improvements and internally-developed software
related to product application systems recorded in 2009 of $195,000, salary
and salary related expenses of $108,000 and rent expense of
$63,000.  These decreases in general and administrative expenses were
partially offset by an increase in franchise taxes of $94,000.





As a
percentage of net sales, general and administrative expenses for the nine months
ended September 30, 2010 decreased to approximately 9.7% from 10.9% for the nine
months ended September 30, 2009.





Loss from
operations:  For the nine months ended September 30, 2010,
operating loss increased to $4,154,000 from $3,110,000 for the nine months ended
September 30, 2009.





Interest expense to related party
stockholders:Interest
expense to related party stockholders for the nine months ended September 30,
2010 decreased to $0 as compared to $917,000 for the nine months ended September
30, 2009. Interest expense to related party stockholders consisted primarily of
stated interest expense, 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. There was no
interest expense to related party stockholders for the nine months ended
September 30, 2010 as the subordinated convertible notes were converted to
common stock in connection with the Private Placement transaction in December
2009.





Other interest expense,
net:Interest
income for the nine months ended September 30, 2010 increased to $31,000 from
$18,000 for the nine months ended September 30, 2009.





Interest
expense for the nine months ended September 30, 2010 decreased to $179,000
compared to $212,000 for the nine months ended September 30, 2009.





Liquidity
And Capital Resources




General




At
September 30, 2010, we had approximately $6.6 million in cash and cash
equivalents compared to $10.0 million and $4.1 million at December 31, 2009 and
September 30, 2009, respectively. Working capital, which is computed as total
current assets less total current liabilities and represents a measure of
operating liquidity, at September 30, 2010 and 2009 was $25.9 million and $14.5
million, respectively.  Working capital at December 31, 2009 was $19.4
million.  As of September 30, 2010, we had an accumulated deficit of
approximately $151.8 million.  We have incurred negative cash flows
and cumulative net losses since inception.





Changes
in cash and cash equivalents at September 30, 2010 compared to December 31, 2009
are primarily attributable to normal increases in working capital requirements
relating to changes in operating assets and liabilities, which includes an
increase in inventory purchases of approximately $12.9 million, in advance of
and, to support the fourth quarter.  This increase in inventory
purchases was partially offset by an increase in accounts payable of
approximately $4.2 million relating to the timing of invoices and
payments.





18




In
February 2010, we completed the Second Closing of the Private Placement
financing with Rho in which we received approximately $10,020,000, net of
$243,000 of issuance costs.





We
believe that our existing cash balance, combined with working capital and the
funds available from our credit facility will be sufficient to enable us to meet
planned expenditures through at least the next 12 months.  There can
be no assurance that we will achieve or sustain positive cash flows from
operations or profitability.





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, 2010,
total availability under the credit facility was approximately $7.5 million, of
which $3.5 million was committed for letters of credit in favor of suppliers,
leaving approximately $4.0 million available for further borrowings. The terms
of the credit facility contain a material adverse condition
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 immediately 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 0.75% 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 such letter of credit,
or a portion thereof, remains open.




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 media placements. As of September 30, 2010, we had
approximately $1,466,000 of prepaid inventory and approximately $87,000 of
prepaid marketing expenses on our Balance Sheet compared to $238,000 and
$12,000, respectively, as of December 31, 2009 and $128,000 and $34,000,
respectively, as of September 30, 2009.




Commitments
and Long-Term Obligations




As of
September 30, 2010, we had the following commitments and long-term
obligations:




LessThan
            
            
            
            
            
            
            
            
            
            
            
            More
ThanTotal
            
            
            
            1 Year
            
            
            
            1-3 Years
            
            
            
            3-5 Years
            
            
            
            5 YearsMarketing andadvertising
            $
            3,136,000
            
            
            $
            3,136,000
            
            
            $
            --
            
            
            $
            --
            
            
            $
            --Operatingleases
            
            5,998,000
            
            
            
            383,000
            
            
            
            1,014,000
            
            
            
            1,157,000
            
            
            
            3,444,000Employmentcontracts
            
            4,670,000
            
            
            
            2,101,000
            
            
            
            2,569,000
            
            
            
            --
            
            
            
            --Total commitments and long-term
      obligations
            $
            13,804,000
            
            
            $
            5,620,000
            
            
            $
            3,583,000
            
            
            $
            1,157,000
            
            
            $
            3,444,000




We
believe that in order to grow the business, we will need to make additional
marketing and advertising commitments in the future.  However, our
marketing budget is subject to a number of factors, including our results of
operations.




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 OfficerandChief 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 OfficerandChief Financial Officer concluded
that, as of the Evaluation
Date,our disclosure
controls and procedureswere effectiveinensuringthat information required to be
disclosedby usin the reports that we file
or submit under the Exchange Actwere recorded, processed, summarized and
reported,within the time periods specified in
the SEC’s rules and forms, andwere effective to ensure that
information required to be




19




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-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 realize
benefits from our increased marketing expenses;risks associated with the economic
downturn; risks associated withaffiliates of Rho Ventures, LP,
affiliates 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;risks associated with our dependence on
one supplier for a material portion of our inventory;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;our potential exposure to product
liability claims in the event that products sold by us are defective;the dependence on third
parties and certain relationships for certain services, including our dependence
on UPSand 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; our ability to raise additional capital, if needed,to support the growth of our business;
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 WebSite; 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; uncertainties relating to the imposition of sales tax on Internet
sales; our ability to
utilize our net operating losses; and the effectiveness of our internal
controls.




20




Part
II  - OTHER INFORMATION




Item
6.   Exhibits





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








Exhibit Number
            Description31.1
            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.




21




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
8, 2010




22