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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

[X]   ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE
      ACT OF 1934

      For the fiscal year ended December 31, 2006

[ ]   TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
      ACT OF 1934

      For 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                (I.R.S. Employer
    incorporation or organization)                Identification No.)

     42 West 39th Street, New York, NY                 10018
  (Address of principal executive offices)          (Zip Code)

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

                                   ----------

Securities registered under Section 12(b) of the Exchange Act:

      Title of Each Class            Name of Each Exchange on Which Registered
    -----------------------          -----------------------------------------
    Common Stock, par value                 The Nasdaq Stock Market LLC
        $.01 per share                         Boston Stock Exchange

Securities registered under Section 12(g) of the Exchange   None

Indicate by check mark if the  registrant is a well-known  seasoned  issuer,  as
defined in Rule 405 of the Securities Act.

                                 Yes [ ] No [X]

Indicate  by  check  mark if the  registrant  is not  required  to file  reports
pursuant to Section 13 or Section 15(d) of the Act.

                                 Yes [ ] No [X]

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  disclosure of  delinquent  filers in response to
Item  405 of  Regulation  S-K is not  contained  in this  form,  and will not be
contained,  to the best of the  registrant's  knowledge,  in definitive proxy or
information  statements  incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [X]

Indicate  by check mark  whether  the  registrant  is an  accelerated  filer (as
defined in Rule 12b-2 of the Act).

                                 Yes [ ] No [X]

Indicate by check mark if the  registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).

                                 Yes [ ] No [X]

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer, or a  non-accelerated  filer. See definition of "accelerated
filer and large  accelerated  filer" in Rule 12b-2 of the Exchange  Act.  (Check
one):

Large accelerated filer [ ]  Accelerated filer [ ]  Non-accelerated filer [X]

As of February 23, 2007, there were 130,494,214 shares of Common Stock, $.01 par
value, of the registrant  outstanding.  The aggregate market value of the voting
and non-voting  common equity held by  non-affiliates as of June 30, 2006, based
upon the last sale price of such equity  reported on the Nasdaq Capital  Market,
was approximately $22,064,000.

                       DOCUMENTS INCORPORATED BY REFERENCE

Certain  information  required  by Part  III of Form  10-K  is  incorporated  by
reference to the Registrant's  proxy statement for the 2007 Annual  Stockholders
Meeting, which will be filed with the Securities Exchange Commission.

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                                  BLUEFLY, INC.

                           ANNUAL REPORT ON FORM 10-K

                                      INDEX

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                                                         PART I.

             Special Note Regarding Forward-Looking Statements                                                    3
Item 1       Business                                                                                             3
Item 1A      Risk Factors                                                                                         7
Item 2       Properties                                                                                          13
Item 3       Legal Proceedings                                                                                   13
Item 4       Submission of Matters to a Vote of Security Holders                                                 13

                                                         PART II.

Item 5       Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
               Equity Securities                                                                                 14
Item 6       Selected Financial Data                                                                             15
Item 7       Management's Discussion and Analysis of Financial Condition and Results of Operations               16
Item 7A      Quantitative and Qualitative Disclosures About Market Risk                                          24
Item 8.      Financial Statements and Supplementary Data                                                         25
Item 9.      Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                25
Item 9A.     Controls and Procedures                                                                             25
Item 9B.     Other Information                                                                                   25

                                                         PART III.

Item 10.     Directors and Executive Officers and Corporate Governance                                           25
Item 11.     Executive Compensation                                                                              25
Item 12.     Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      25
Item 13.     Certain Relationships and Related Transactions, and Director Independence                           25
Item 14.     Principal Accounting Fees and Services                                                              26

                                                         PART IV.

Item 15.     Exhibits, Financial Statement Schedules                                                             26

SIGNATURES                                                                                                       29

FINANCIAL STATEMENTS                                                                                             F-1
</TABLE>

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                                     PART I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

This Annual Report contains  "forward-looking  statements" within the meaning of
Section 27A of the  Securities  Act of 1933 and  Section  21E of the  Securities
Exchange Act of 1934.  Forward-looking  statements include,  without limitation,
any statement that may predict,  forecast,  indicate,  or imply future  results,
performance, or achievements, and may contain the words "believe," "anticipate,"
"expect,"  "estimate,"  "project,"  "will be,"  "will  continue,"  "will  likely
result,"  or words or  phrases of similar  meaning.  Forward-looking  statements
involve  risks  and  uncertainties  that may  cause  actual  results  to  differ
materially from the forward-looking  statements ("Cautionary  Statements").  The
risks and uncertainties  include, but are not limited to those matters addressed
herein under "Risk  Factors." All  subsequent  written and oral  forward-looking
statements  attributable  to us or persons  acting on our  behalf are  expressly
qualified in their entirety by the Cautionary Statements.  Readers are cautioned
not to place undue  reliance on these  forward-looking  statements,  which speak
only as of their dates.  We undertake no obligation to publicly update or revise
any forward-looking statements,  whether as a result of new information,  future
events or otherwise.

ITEM 1.  DESCRIPTION OF BUSINESS

GENERAL

Bluefly,  Inc. is a leading online retailer of designer  brands,  fashion trends
and superior  value.  During 2006, we offered over 50,000  different  styles for
sale in categories  such as men's,  women's and accessories as well as house and
home  accessories  from over 350 brands at discounts up to 75% off retail value.
We launched the Bluefly.com  Web site (the "Web site") in September 1998.  Since
its inception,  www.bluefly.com has served over 960,000 customers and shipped to
over 14 countries.

Our common stock is listed on the Nasdaq  Capital Market under the symbol "BFLY"
and on the Boston Stock Exchange under the symbol "BFL" and we are  incorporated
in Delaware. Our executive offices are located at 42 West 39th Street, New York,
New York 10018, and our telephone number is (212) 944-8000. Our Internet address
is www.bluefly.com. We make available, free of charge, through our Web site, our
annual report on Form 10-K,  quarterly reports on Form 10-Q,  current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as  reasonably  practicable  after we
electronically file such material with, or furnish it to, the SEC.

In this  report,  the terms "we," "us,"  "Bluefly"  and the  "Company"  refer to
Bluefly,  Inc.  and  its  predecessors  and  subsidiaries,  unless  the  context
indicates otherwise.

BUSINESS STRATEGY

Our goal is to offer our customers the best designer  brands and latest  fashion
trends at superior  values.  We offer the same types of on-trend  and  in-season
designer  merchandise  as are sold in  luxury  department  stores  at  discounts
normally  found only at outlet stores and off-price  stores.  Similarly,  we are
able to offer an upscale  shopping  experience not available at off-price stores
or outlet malls because of our merchandise  selection and the  presentation  and
product search  capabilities  offered by our Web site. The frequent  addition of
new on-trend products to our site is also key to our marketing  strategy,  as it
gives our shoppers  reason to visit the site and encourages them to be loyal and
active.

Our business is also designed to provide a compelling value  proposition for our
suppliers  and, in  particular,  the more than 350 top  designer  brands that we
offer on our Web site.  Because we work with our suppliers both at the beginning
and  throughout the season,  we are able to help them manage  inventory and cash
flow.  We also create an  environment  that is respectful of the brands we sell.
Our buyers all have backgrounds in a full price branded retail environment.  Our
Web site  creates  a  high-end  retail  environment  that  offers  only the best
designer  brands  and the most  current  trends.  In doing  so, we  support  our
vendors' brands, rather than diluting them as traditional off-price channels do.

We do not believe that we can accomplish  these goals without using the Internet
as a platform.  The direct  marketing of products  that are available in limited
quantities and sizes, and that are not replenishable,  requires a cost-effective
medium that can display a large number of products.  We believe  print  catalogs
are not well  suited  to this  task.  The  paper,  printing,  mailing  and other
production  costs of a print  catalog  can be  significant  and the  lead  times
required to print a catalog make them  significantly  inflexible  in  addressing
inventory  sell  outs,  price  changes  and new  styles.  To work  around  these
limitations, a

                                       3
<PAGE>

traditional  cataloger  typically  requires  products  that  are  replenishable,
available  in a full range of sizes and in  substantial  quantities.  Similarly,
retailing  on  television  is costly  and  requires  substantial  quantities  of
products  that are  available  in all sizes in order for it to be an  economical
medium. In addition,  the number of items that can be displayed on television is
limited,  and  television  does not allow  viewers to search for  products  that
interest them.

The  Internet,  however,  can be a far less  expensive  and far  more  effective
medium. By using the Internet as our platform, the number of items that we offer
is not limited by the high costs of  printing  and  mailing  catalogs.  With the
Internet,  we can automatically update product images as new products arrive and
other items sell out. By using a real-time inventory  database,  we can create a
personalized  shopping  environment  and allow our  customers  to search for the
products  that  specifically  interest  them and are available in their size. In
addition,  we believe  that we are able to more  economically  and  consistently
maintain  an  upscale   environment  through  the  design  of  a  single  online
storefront.

We believe  that we have  created a customer  experience  that is  fundamentally
better than that  offered by  traditional  off-price  retailers.  Similarly,  we
believe  that our  upscale  atmosphere,  professional  photography  and  premium
merchandise  offering create a superior  distribution  channel for designers who
wish to liquidate their  end-of-season and excess merchandise  without suffering
the brand dilution  inherent in  traditional  off-price  channels.  Our customer
research  suggests  that  this  strategy  has  been  successful.   For  example,
respondents to a recent third party study that we  commissioned  rated us at the
level of, or higher than, luxury  department stores for assortment,  quality and
service and rated us much higher for value.

E-COMMERCE AND THE ONLINE APPAREL MARKET

The dramatic  growth of e-commerce  has been widely  reported and is expected to
continue.  According  to the ComScore  Networks,  e-commerce  non travel  retail
spending  (excluding  auctions  and large  corporate  purchases)  eclipsed  $100
billion in 2006 for the first  time,  while  growth  remained  strong 24 percent
increase compared to 2005.  During the holiday shopping season alone,  consumers
spent $24.6 billion, a 26% increase over the $19.6 billion spent in the previous
year, according to ComScore.

According to the Annual E- Commerce Survey  performed by Cowen and Company,  41%
of consumers plan to increase e-commerce spending in 2007,  primarily due to the
convenience of online shopping. The survey also states that underlying trends in
e-commerce  remain strong and Cowen and Company expect that US e-commerce  sales
will grow 20% in 2007.

MARKETING

Our marketing  efforts are focused both on acquiring new customers and retaining
existing  customers.  Active  Bluefly  customers  visit the site  frequently and
purchase from one season to the next at high levels with great predictability. A
significant  portion  of our  sales to  existing  customers  are  driven  by our
customer  emails,  which  highlight new  promotions  and  products,  and provide
special  previews to customers  who have asked to be included in our email list.
In addition,  we believe that our sales to existing  customers are driven by all
aspects of our customer  experience,  including our Web site design,  packaging,
delivery and customer service.

From 2001 through  2005,  we acquired new  customers  primarily  through  online
advertising,  word-of-mouth,  sweepstakes and our affiliate program. Although we
had not  allocated  significant  resources  to branding  or to more  traditional
advertising channels such as print during this time, our customer file continued
to grow.  In  September  2005,  we began a national  advertising  campaign  that
featured both print and television,  and we have expanded that campaign over the
past 18 months.

MERCHANDISING

We buy  merchandise  directly  from  designers as well as from other third party
indirect resources.  Currently,  we offer products from more than 350 name brand
designers.  We believe that we have been  successful in opening up more than 200
direct  supply  relationships,  in  part  because  we have  devoted  substantial
resources to establishing  Bluefly.com as a high-end retail environment.  We are
committed to displaying all of our merchandise in an attractive manner, offering
superior  customer  service  and gearing  all  aspects of our  business  towards
creating a better channel for top designers.

                                       4
<PAGE>

During 2004, we re-focused  our  merchandising  strategy to offer more in-season
merchandise and to cover the latest trends,  while continuing to offer a premium
selection of brands.  We continue to refine this  strategy.  As a result of this
merchandise  strategy,  we were  able to  increase  our gross  margins  to their
highest levels ever - 40.1% in 2006 from 29.9% in 2003.

WAREHOUSING AND FULFILLMENT

When we receive an order,  the  information  is  transmitted  to our third party
warehouse and fulfillment  center located in Virginia,  where the items included
in the order are  picked,  packed and  shipped  directly  to the  customer.  Our
inventory  database is updated on a real-time  basis,  allowing us to display on
our Web site only those styles, sizes and colors of product available for sale.

We focus on customer satisfaction throughout our organization. In December 2006,
during our peak weeks of the  holiday  season,  the vast  majority of our orders
were shipped within one business day from receipt of the customer's order.

CUSTOMER SERVICE

We believe  that a high level of  customer  service  and  support is critical to
differentiating  ourselves from traditional  off-price  retailers and maximizing
customer  acquisition and retention efforts.  Our customer service effort starts
with  our  Web  site,  which  is  designed  to  provide  an  intuitive  shopping
experience.  An  easy-to-use  help  center is  available  on the Web site and is
designed to answer many of our customers' most frequently asked  questions.  For
customers  who  prefer  e-mail  or  telephone   assistance,   customer   service
representatives  are  available  seven  days a week to  provide  assistance.  We
utilize customer  representatives  from third party call centers that have teams
dedicated to our business.  We also maintain a team of premiere  representatives
in our New York office,  who provide special services and assist in the training
and  management  of the other  representatives.  To ensure  that  customers  are
satisfied with their  shopping  experience,  we generally  allow returns for any
reason within 90 days of the sale for a full refund.

In January  2007,  we were  awarded the  "E-tailing  Excellence  Award" from the
e-tailing group for the second  consecutive year. This Award recognizes  on-line
merchants who excel in customer service.

TECHNOLOGY

We  have  implemented  a  broad  array  of  state-of-the-art  technologies  that
facilitate Web site management, complex database search functionality,  customer
interaction  and  personalization,   transaction  processing,   fulfillment  and
customer  service  functionality.  Such  technologies  include a combination  of
proprietary  technology and  commercially  available,  licensed  technology.  To
address  the  critical  issues of  privacy  and  security  on the  Internet,  we
incorporate,  for  transmission of  confidential  personal  information  between
customers and our Web server,  Secure Socket Layer Technology  ("SSL") such that
all data is  transmitted  via a 128-bit  encrypted  session.  The  computer  and
communications  equipment on which our Web site is hosted are currently  located
at a third party co-location facility in New York.

In September 2006, we entered into agreements  with Art Technology  Group,  Inc.
("ATG"),  pursuant to which we will license  certain  technology  from ATG to be
used as a platform for future versions of our Web site. We are in the process of
developing an improved  version of our Web site based on ATG  software.  The new
version of our Web site is expected  to launch in the third  quarter of 2007 and
will replace the older version.  The launch of the new Web site will involve the
use of significant internal and external resources. Certain costs related to the
development  of the new  Web  site  will be  capitalized  and  amortized  over a
36-month period.

We expect that the more robust  tools  provided  by the  upgraded  Web site will
allow us to better create and manage,  and measure the  performance  of, on-site
marketing promotions. In addition, we believe that the new Web site will provide
a more  efficient  platform  from which to scale our  technology  infrastructure
should any future  growth in our business  dictate such a need.  There can be no
assurance  that the new Web site will have a  positive  effect on our  business.
See, "Risk Factor - The Implementation Of A New Web site May Place A Significant
Strain On Certain Key Personnel."

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COMPETITION

E-commerce generally, and, in particular,  the online retail apparel and fashion
accessories market, is a relatively dynamic, high-growth market. Our competition
for  online  customers  comes  from a variety  of  sources,  including  existing
land-based  retailers  that are using the Internet to expand  their  channels of
distribution,  established Internet companies and less established companies. In
addition, our competition for customers comes from traditional direct marketers,
designer  brands that may attempt to sell their  products  directly to consumers
through the Internet and land-based  off-price  retail stores,  which may or may
not use the Internet in the future to grow their  customer  base.  Many of these
competitors have longer operating  histories,  significantly  greater resources,
greater brand  recognition  and more firmly  established  supply  relationships.
Moreover, we expect additional competitors to emerge in the future.

We believe that the principal  competitive factors in our market include:  brand
recognition,  merchandise selection, price, convenience, customer service, order
delivery  performance  and site  features.  Although we believe  that we compare
favorably with our competitors,  we recognize that this market is relatively new
and is evolving rapidly, and,  accordingly,  there can be no assurance that this
will continue to be the case.

INTELLECTUAL PROPERTY

We rely on various  intellectual  property laws and contractual  restrictions to
protect  our   proprietary   rights  in  services  and   technology,   including
confidentiality,   invention   assignment  and  nondisclosure   agreements  with
employees and contractors.  Despite these precautions,  it may be possible for a
third  party  to copy or  otherwise  obtain  and use our  intellectual  property
without  our  authorization.  In  addition,  we pursue the  registration  of our
trademarks  and  service  marks  in  the  U.S.  and   internationally   and  the
registration  of our domain  name and  variations  thereon.  However,  effective
intellectual  property protection may not be available in every country in which
the services are made available online.

We rely on technologies  that we license from third parties.  These licenses may
not  continue to be  available  to us on  commercially  reasonable  terms in the
future. As a result, we may be required to obtain substitute technology of lower
quality  or at  greater  cost,  which  could  materially  adversely  affect  our
business, financial condition, results of operations and cash flows.

We do not believe that our business, sales policies or technologies infringe the
proprietary rights of third parties. However, third parties have in the past and
may in the future  claim  that our  business,  sales  policies  or  technologies
infringe their rights. We expect that participants in the e-commerce market will
be  increasingly  subject to  infringement  claims as the number of services and
competitors in the industry grows. Any such claim, with or without merit,  could
be time  consuming,  result in costly  litigation  or  require  us to enter into
royalty or licensing agreements.  Such royalty or licensing agreements might not
be available on terms  acceptable to us, or at all. As a result,  any such claim
of  infringement  against  us could  have a  material  adverse  effect  upon our
business, financial condition, results of operations and cash flows.

GOVERNMENTAL APPROVALS AND REGULATIONS

We are not  currently  subject to direct  regulation  by any domestic or foreign
governmental agency, other than regulations  applicable to businesses generally,
and laws or regulations directly applicable to online commerce. We are not aware
of any permits or licenses that are required in order for us, generally, to sell
apparel and fashion accessories on the Internet, although licenses are sometimes
required to sell products made from specific materials. In addition,  permits or
licenses  may  be  required  from   international,   federal,   state  or  local
governmental  authorities  to operate or to sell certain  other  products on the
Internet  in the  future.  No  assurances  can be given  that we will be able to
obtain  such  permits or  licenses.  We may be  required  to comply  with future
national  and/or  international  legislation and statutes  regarding  conducting
commerce on the Internet in all or specific  countries  throughout the world. No
assurance  can be made that we will be able to comply with such  legislation  or
statutes. Our Internet operations are not currently impacted by federal,  state,
local and foreign environmental protection laws and regulations.

EMPLOYEES

As of February 23, 2007, we had 95 full-time employees and 1 part-time employee,
as compared to 84 full-time  and 2 part-time  employees as of February 23, 2006.
None of our  employees  are  represented  by a labor union,  and we consider our
relations with our employees to be good.

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ITEM 1A.  RISK FACTORS

We Have A History Of Losses And Expect That Losses Will  Continue In The Future.
As of December 31,  2006,  we had an  accumulated  deficit of  $115,997,000.  We
incurred net losses of  $12,193,000,  $3,820,000  and  $3,791,000  for the years
ended  December  31,  2006,  2005  and  2004,  respectively.  We  have  incurred
substantial costs to develop our Web site and infrastructure. In order to expand
our  business,  we  intend  to  invest  in  sales,   marketing,   merchandising,
operations,  information  systems,  site development and additional personnel to
support  these  activities.  We  therefore  may  continue  to incur  substantial
operating losses for the next year. Our ability to become profitable  depends on
our  ability to  generate  and  sustain  substantially  higher  net sales  while
maintaining  reasonable  expense levels,  both of which are uncertain.  If we do
achieve profitability,  we cannot be certain that we would be able to sustain or
increase profitability on a quarterly or annual basis in the future.

Soros,  Maverick And Prentice Each Own A Large Amount Of Our Stock And Therefore
Can Exert Significant Influence Over Our Management And Policies. As of February
23, 2007, affiliates of Soros Fund Management LLC ("Soros")  beneficially owned,
in  the  aggregate,  approximately  39%  of  our  Common  Stock.  Private  funds
associated with Maverick Capital, Ltd. ("Maverick"), and investment entities and
accounts  managed and advised by Prentice  Capital  Management,  LP ("Prentice")
each owned  approximately  24% of our  Common  Stock.  We entered  into a voting
agreement with Soros,  Maverick and Prentice (the "Voting Agreement"),  pursuant
to which  Soros  has the  right to  designate  three  designees  to our Board of
Directors,  and  Maverick  and  Prentice  each have the right to  designate  one
designee.  The Voting Agreement also provides that one designee of Soros and the
designee  of each of  Maverick  and  Prentice  have  the  right  to serve on the
Compensation  Committee and the Governance and Nominating Committee of the Board
of Directors.  If we establish an Executive  Committee,  the designees of Soros,
Maverick  and  Prentice  will be  entitled  to serve on such  committee.  Soros,
Maverick  and Prentice  also have a right of first  refusal (the "Right of First
Refusal") to provide the financing in any private  placement of our Common Stock
that we seek to  consummate  within  on or prior to June 15,  2007 on a pro rata
basis.

In view of their large  percentage  of ownership,  Soros,  Maverick and Prentice
each have the ability to exert  significant  influence  over our  management and
policies,  such  as  the  election  of our  directors,  the  appointment  of new
management  and the approval of any other action  requiring  the approval of our
stockholders,  including any amendments to our certificate of  incorporation,  a
sale of all or substantially all of our assets or a merger.

Our Lenders Have Liens On Substantially All Of Our Assets And Could Foreclose In
The Event That We Default Under Our Loan  Facility.  Under the terms of our loan
facility,  our  lender has a first  priority  lien on  substantially  all of our
assets,  including our cash balances. If we default under the loan facility, our
lender  would be  entitled,  among other  things,  to foreclose on our assets in
order to satisfy our obligations under the loan facility.

If Our Co-Location Facility, Third Party Distribution Center Or Third Party Call
Centers Fail,  Our Business  Could Be  Interrupted  For A Significant  Period Of
Time.  Our  ability to receive  and  fulfill  orders  successfully  and  provide
high-quality   customer   service,   largely   depends  on  the   efficient  and
uninterrupted  operation of our computer and communications hardware systems and
fulfillment  center.  Substantially  all  of  our  computer  and  communications
hardware is located at a single  co-location  facility owned by a third party in
New York City.  Primarily all of our inventory is held, and our customer  orders
are filled,  at a third party  distribution  center  located in Virginia,  and a
large majority of our customer  service  representatives  are employees of third
party call centers in Ohio and Maine.  These operations are vulnerable to damage
or  interruption  from  fire,  flood,  storms,  power  loss,  telecommunications
failure,  terrorist  attacks,  acts of war,  break-ins,  earthquake  and similar
events.  We do not presently have redundant  systems in multiple  locations or a
formal disaster recovery plan. Accordingly, a failure at one of these facilities
could interrupt our business for a significant  period of time, and our business
interruption  insurance may be insufficient to compensate us for losses that may
occur.  Any such  interruption  would  negatively  impact our sales,  results of
operations and cash flows for the period in which it occurred,  and could have a
long-term adverse effect on our relationships with our customers and suppliers.

Our  Ability  To  Maintain  Our  Minimum  Availability  Requirement  and Pay Our
Indebtedness  Under Our Loan  Facility Is  Dependent  Upon  Meeting Our Business
Plan.  We are  required  to pay  interest  under our loan  facility on a monthly
basis.  Assuming we meet our business  plan, we will be able to pay our interest
as  required.  To a certain  extent,  however,  our ability to meet our business
plan,  is subject  to general  economic,  financial,  competitive,  legislative,
regulatory  and other  factors  that are beyond our  control,  and  therefore we
cannot assure you that based on our business  plan we will  generate  sufficient
cash flow from  operations to enable us to pay our  indebtedness  under the loan
facility and maintain our minimum availability  requirement  throughout the term
of the agreement.  If we fall short of our business plan and are unable to raise
additional capital, we could

                                       7
<PAGE>

default  under  our loan  facility.  In the  event of a  default  under the loan
facility, our lender would be entitled,  among other things, to foreclose on our
assets (whether  inside or outside a bankruptcy  proceeding) in order to satisfy
our  obligations  under the loan facility.  See "Risk Factors - Our Lenders Have
Liens On  Substantially  All Of Our Assets And Could Foreclose In The Event That
We Default Under Our Loan Facility."

If We Are Not Accurate In Forecasting  Our Revenues,  We May Be Unable To Adjust
Our Operating Plans In A Timely Manner. Because our business has not yet reached
a mature stage, it is difficult for us to forecast our revenues  accurately.  We
base our  current  and future  expense  levels and  operating  plans on expected
revenues, but in the short-term a significant portion of our expenses are fixed.
Accordingly,  we may be unable  to adjust  our  spending  in a timely  manner to
compensate for any unexpected revenue shortfall.  This inability could cause our
operating  results in some  future  quarter to fall  below the  expectations  of
securities  analysts  and  investors.  In that event,  the trading  price of our
Common  Stock could  decline  significantly.  In addition,  any such  unexpected
revenue  shortfall could  significantly  affect our short-term cash flow and our
net worth,  which could require us to seek additional  financing  and/or cause a
default under our loan facility.  See "Risk Factors - Our Ability To Comply With
Our  Financial  Covenants  And Pay Our  Indebtedness  Under Our Loan Facility Is
Dependent Upon Meeting Our Business Plan."

Our National  Advertising  Campaign and Other  Marketing  Initiatives May Not Be
Successful.  Our  success  depends  on  our  ability  to  attract  customers  on
cost-effective  terms.  We  have  relationships  with  online  services,  search
engines,  and other Web sites and  e-commerce  businesses to provide other links
that direct customers to our Web site. In addition,  during 2005 we launched our
first national  television and advertising  campaign,  and we have continued and
expanded on that campaign since that time.  Such campaigns are expensive and may
not result in the cost effective acquisition of customers. We are relying on the
campaign as a significant  source of traffic to our Web site and new  customers.
If these campaigns and initiatives are not successful, our results of operations
will be adversely affected.

We Purchase a Substantial  Portion of Our Inventory from One Supplier.  In 2006,
we purchased  approximately  28% of our inventory from one supplier.  Should our
relationship  with this  supplier  deteriorate  or  terminate,  or  should  this
supplier  lose some or all of its access to the products  that we purchase  from
it, our performance could be adversely affected.  Under such  circumstances,  we
would be required to seek alternative sources of supply for these products,  and
there can be no  assurance  that we would be able to obtain such  products  from
alternative  sources on the same  terms,  or at all.  A failure  to obtain  such
products  on as  favorable  terms  could have an adverse  effect on our  revenue
and/or gross margin.

The Implementation Of The New Web Site May Place A Significant Strain On Our Key
Personnel.  During 2006, we entered into a Master  License  Agreement  with ATG,
pursuant to which we will license  certain  technology  from ATG to be used as a
platform  for future  versions  of our Web site,  and ATG will  provide  certain
support and consulting services in connection therewith.  The new version of our
Web site is expected to launch in the third quarter of 2007 and will replace the
older  version.  The  launch  of the  new  Web  site  will  involve  the  use of
significant  internal  and  external  resources.  We will  need to  develop  new
internal  procedures to operate the new Web site and to make the most  effective
use of the  improvements  available  on the  new  Web  site.  As  with  any  new
technology,  we may experience  instability and performance  issues upon launch,
and such  issues  could  have a  material  adverse  effect on our  revenue  and,
therefore,  our results of  operations.  While we believe that this project is a
prudent  investment  for  our  future  growth  prospects,  the  return  on  this
investment is not certain and the time and  attention  required to build out and
learn  how to best  use the  new Web  site  could  result  in our  inability  to
undertake certain initiatives that could have a more immediate,  positive impact
on our business and/or distract us from other areas of our business that require
the time and attention of those involved in the continued development of the new
Web site.

Unexpected  Changes In Fashion  Trends  Could Cause Us To Have Either  Excess or
Insufficient  Inventory.  Fashion trends can change rapidly, and our business is
sensitive to such  changes.  There can be no assurance  that we will  accurately
anticipate  shifts in fashion trends and adjust our merchandise mix to appeal to
changing  consumer tastes in a timely manner.  If we misjudge the market for our
products or are  unsuccessful  in responding to changes in fashion  trends or in
market demand,  we could  experience  insufficient or excess inventory levels or
higher  markdowns,  either of which would have a material  adverse effect on our
business, financial condition and results of operations.

We Will Be Subject To Cyclical Variations In The Apparel And E-Commerce Markets.
The apparel  industry  historically  has been  subject to  substantial  cyclical
variations.  Furthermore, Internet usage slows down in the summer months. We and
other apparel vendors rely on the expenditure of discretionary  income for most,
if not all, sales.  Economic downturns,  whether real or perceived,  in economic
conditions or prospects  could adversely  affect  consumer  spending habits and,
therefore,  have a material adverse effect on our revenue, cash flow and results
of operations.  Alternatively,  any improvement,  whether real or perceived,  in
economic  conditions or prospects could adversely  impact our ability to acquire
merchandise and, therefore, have a

                                       8
<PAGE>

material  adverse  effect on our business,  prospects,  financial  condition and
results  of  operations,  as our  supply  of  merchandise  is  dependent  on the
inability of designers  and  retailers to sell their  merchandise  in full-price
venues. See "Risk Factors - We Do Not Have Long Term Contracts With The Majority
Of Our Vendors And Therefore The Availability of Merchandise Is At Risk."

We Purchase Product From Some Indirect Supply Sources,  Which Increases Our Risk
of Litigation  Involving The Sale Of Non-Authentic Or Damaged Goods. We purchase
merchandise  both directly from brand owners and  indirectly  from retailers and
third party  distributors.  The purchase of merchandise  from parties other than
the brand owners  increases the risk that we will  mistakenly  purchase and sell
non-authentic or damaged goods, which could result in potential  liability under
applicable laws, regulations,  agreements and orders.  Moreover, any claims by a
brand owner,  with or without merit,  could be time consuming,  result in costly
litigation, generate bad publicity for us, and have a material adverse impact on
our business, prospects, financial condition and results of operations.

Security  Breaches To Our Systems And Database Could Cause  Interruptions to Our
Business And Impact Our Reputation With Customers,  And We May Incur Significant
Expenses to Protect Against Such Breaches. A fundamental  requirement for online
commerce  and   communications  is  the  secure   transmission  of  confidential
information  over public  networks.  There can be no assurance  that advances in
computer  capabilities,  new discoveries in the field of cryptography,  or other
events  or  developments  will not  result  in a  compromise  or  breach  of the
algorithms we use to protect customer transaction and personal data contained in
our customer  database.  A party who is able to circumvent our security measures
could  misappropriate  proprietary  information  or cause  interruptions  in our
operations.  If any such compromise of our security were to occur, it could have
a material  adverse effect on our reputation with customers,  thereby  affecting
our  long-term  growth  prospects.  In  addition,  we may be  required to expend
significant  capital  and other  resources  to  protect  against  such  security
breaches or to alleviate problems caused by such breaches.

Brand  Owners  Could  Establish  Procedures  To Limit Our  Ability  To  Purchase
Products Indirectly.  Brand owners have implemented,  and are likely to continue
to implement,  procedures to limit or control  off-price  retailers'  ability to
purchase products indirectly. In addition, several brand owners in the U.S. have
distinctive  legal  rights  rendering  them the  only  legal  importer  of their
respective  brands  into the U.S. If we acquire  such  product  indirectly  from
distributors  and other third parties who may not have complied with  applicable
customs  laws and  regulations,  such goods could be subject to seizure from our
inventory by U.S. Customs Service,  and the importer may have a civil action for
damages  against us. See "Risk Factors - We Do Not Have Long Term Contracts With
The Majority of Our Vendors And Therefore The  Availability Of Merchandise Is At
Risk."

Our Growth May Place A Significant  Strain On Our Management And  Administrative
Resources And Cause  Disruptions In Our Business.  Historically,  our growth has
placed,  and any further  growth is likely to continue to place,  a  significant
strain on our management and administrative resources. To be successful, we must
continue to implement information  management systems and improve our operating,
administrative, financial and accounting systems and controls. We will also need
to train new  employees and maintain  close  coordination  among our  executive,
accounting,  finance,  marketing,   merchandising,   operations  and  technology
functions.  Any failure to implement such systems and training,  and to maintain
such  coordination,  could affect our ability to plan for, and react quickly to,
changes in our business and,  accordingly,  could cause an adverse impact on our
cash flow and results of  operations  in the periods  during  which such changes
occur. In addition, as our workforce grows, our exposure to potential employment
liability  issues  increases,  and we will need to continue to improve our human
resources  functions  in order  to  protect  against  such  increased  exposure.
Moreover,  our business is dependent upon our ability to expand our  third-party
fulfillment operations, customer service operations,  technology infrastructure,
and inventory levels to accommodate increases in demand, particularly during the
peak holiday selling season.  Our planned expansion efforts in these areas could
cause  disruptions  in our  business.  Any  failure  to expand  our  third-party
fulfillment operations,  customer service operations,  technology infrastructure
or inventory  levels at the pace needed to support  customer demand could have a
material  adverse  effect on our cash flow and results of operations  during the
period in which such  failures  occur and could have a  long-term  effect on our
reputation with our customers.

We Are Heavily Dependent On Third-Party  Relationships,  And Failures By A Third
Party Could Cause  Interruptions To Our Business.  We are heavily dependent upon
our relationships  with our fulfillment  operations  provider,  third party call
center and Web hosting provider, delivery companies like UPS, DHL and the United
States Postal Service,  and credit card processing  companies such as Paymentech
and  Cybersource to service our customers'  needs. To the extent that there is a
slowdown in mail service or package  delivery  services,  whether as a result of
labor difficulties, terrorist activity or otherwise,

                                       9
<PAGE>

our cash flow and results of operations would be negatively impacted during such
slowdown,  and the  results of such  slowdown  could have a  long-term  negative
effect on our  reputation  with our  customers.  The failure of our  fulfillment
operations  provider,  third party call center,  credit card  processors  or Web
hosting  provider to properly  perform their services for us could cause similar
effects. Our business is also generally dependent upon our ability to obtain the
services  of other  persons  and  entities  necessary  for the  development  and
maintenance  of our  business.  If we fail to obtain  the  services  of any such
person or entities upon which we are dependent on satisfactory  terms, or we are
unable  to  replace  such  relationship,  we  would  have to  expend  additional
resources to develop such  capabilities  ourselves,  which could have a material
adverse  impact on our  short-term  cash flow and results of operations  and our
long-term prospects.

We Are In  Competition  With Companies  Much Larger Than  Ourselves.  E-commerce
generally and, in particular,  the online retail apparel and fashion accessories
market,  is a new,  dynamic,  high-growth  market  and is rapidly  changing  and
intensely  competitive.  Our  competition  for customers comes from a variety of
sources including:

     o    existing land-based, full price retailers, that are using the Internet
          to expand their channels of distribution;

     o    less established online companies;

     o    internet sites;

     o    traditional direct marketers; and

     o    traditional  off-price  retail  stores,  which  may or may not use the
          Internet to grow their customer base.

Competition  in our  industry  has  intensified,  and we  expect  this  trend to
continue  as the list of our  competitors  grows.  Many of our  competitors  and
potential  competitors have longer operating  histories,  significantly  greater
resources,  greater brand name  recognition and more firmly  established  supply
relationships.  We believe that the principal  competitive factors in our market
include:

     o    brand recognition;

     o    merchandise selection;

     o    price;

     o    convenience;

     o    customer service;

     o    order delivery performance; and

     o    site features.

There can be no assurance that we will be able to compete  successfully  against
competitors and future competitors,  and competitive pressures faced by us could
force us to increase  expenses  and/or  decrease our prices at some point in the
future.

We Do  Not  Have  Long  Term  Contracts  With  Our  Vendors  And  Therefore  The
Availability  Of  Merchandise  Is  At  Risk.  We  do  not  have  any  agreements
controlling  the long-term  availability  of merchandise or the  continuation of
particular  pricing  practices.  Our contracts with  suppliers  typically do not
restrict such suppliers from selling  products to other buyers.  There can be no
assurance  that our current  suppliers  will  continue to sell products to us on
current  terms  or that we will be able to  establish  new or  otherwise  extend
current  supply  relationships  to ensure product  acquisitions  in a timely and
efficient manner and on acceptable  commercial  terms. In addition,  in order to
entice new vendors to open up  relationships  with us, we sometimes are required
to either make  prepayments or agree to shortened  payment terms. Our ability to
develop and maintain  relationships  with  reputable  suppliers  and obtain high
quality  merchandise is critical to our success. If we are unable to develop and
maintain relationships with suppliers that would allow us to obtain a sufficient
amount and variety of quality  merchandise on acceptable  commercial  terms, our
ability to satisfy our  customers'  needs,  and therefore  our long-term  growth
prospects,  would be materially  adversely  affected.  See "Risk Factors - Brand
Owners  Could  Establish  Procedures  to Limit Our Ability to Purchase  Products
Indirectly."

                                       10
<PAGE>

We Need To Further  Establish  Brand Name  Recognition.  We believe that further
establishing,  maintaining  and enhancing our brand is a critical  aspect of our
efforts to attract and expand our online  traffic.  The number of Internet sites
that offer  competing  services,  many of which  already  have well  established
brands in online services or the retail apparel  industry  generally,  increases
the importance of establishing and maintaining brand name recognition. Promotion
of  Bluefly.com  will depend  largely on our success in providing a high quality
online experience supported by a high level of customer service, which cannot be
assured.  In addition,  to attract and retain online  users,  and to promote and
maintain  Bluefly.com  in  response  to  competitive  pressures,  we may find it
necessary to increase substantially our advertising and marketing  expenditures.
If we are unable to provide high quality online services or customer support, or
otherwise  fail to promote and maintain  Bluefly.com,  or if we incur  excessive
expenses in an attempt to promote and maintain Bluefly.com, our long-term growth
prospects would be materially adversely affected.

There Can Be No  Assurance  That Our  Technology  Systems Will Be Able To Handle
Increased  Traffic;  Implementation Of Changes To Web Site. A key element of our
strategy is to  generate a high  volume of traffic on, and use of,  Bluefly.com.
Accordingly,  the  satisfactory  performance,  reliability  and  availability of
Bluefly.com,  transaction  processing  systems  and network  infrastructure  are
critical to our reputation and our ability to attract and retain  customers,  as
well as maintain adequate  customer service levels.  Our revenues will depend on
the number of visitors who shop on  Bluefly.com  and the volume of orders we can
handle.  Unavailability of our Web site or reduced order fulfillment performance
would reduce the volume of goods sold and could also adversely  affect  consumer
perception of our brand name. We may experience  periodic  system  interruptions
from time to time. If there is a  substantial  increase in the volume of traffic
on Bluefly.com or the number of orders placed by customers,  we will be required
to expand and upgrade further our technology, transaction processing systems and
network  infrastructure.  There  can be no  assurance  that  we  will be able to
accurately  project  the rate or  timing  of  increases,  if any,  in the use of
Bluefly.com or expand and upgrade our systems and  infrastructure to accommodate
such  increases  on a timely  basis.  In order to  remain  competitive,  we must
continue to enhance and improve the  responsiveness,  functionality and features
of Bluefly.com,  which is particularly challenging given the rapid rate at which
new technologies,  customer  preferences and expectations and industry standards
and  practices are evolving in the online  commerce  industry.  Accordingly,  we
redesign and enhance various  functions on our Web site on a regular basis,  and
we may  experience  instability  and  performance  issues  as a result  of these
changes.  See "Risk Factors - The Implementation Of The New Web Site May Place A
Significant Strain On Our Key Personnel."

We May Be Subject To Higher Return Rates. We recognize that purchases of apparel
and fashion  accessories over the Internet may be subject to higher return rates
than traditional store bought merchandise.  We have established a liberal return
policy in order to accommodate our customers and overcome any hesitancy they may
have with  shopping via the Internet.  As a result,  our reserve for returns and
credit card chargebacks for fiscal 2006, 2005 and 2004 has been 39.6%, 37.8% and
36.6%,  respectively.  If return rates are higher than  expected,  our business,
prospects,  financial  condition,  cash flows and results of operations could be
materially adversely affected.

Our Success Is Largely  Dependent Upon Our Executive  Personnel.  We believe our
success will depend to a significant  extent on the efforts and abilities of our
executive personnel. In particular, we rely upon their strategic guidance, their
relationships and credibility in the vendor and financial  communities and their
ability to recruit key operating  personnel.  Our current employment  agreements
with our Chief Executive  Officer,  Chief Financial  Officer and Chief Marketing
Officer run  through  July 2009,  July 2009 and  September  2008,  respectively,
however  there can be no  assurance  that any of them will not  terminate  their
employment  earlier.  The loss of the services of any of our executive  officers
could  have  a  material  adverse  effect  on  our  credibility  in  the  vendor
communities and our ability to recruit new key operating personnel.

Our Success Is  Dependent  Upon Our Ability To Attract  New Key  Personnel.  Our
operations  will also depend to a great extent on our ability to attract new key
personnel  with  relevant  experience  and retain  existing key personnel in the
future. The market for qualified personnel is extremely competitive. Our failure
to attract additional  qualified  employees could have a material adverse effect
on our prospects for long-term growth.

There Are Inherent Risks Involved In Expanding Our Operations.  We may choose to
expand  our   operations  by  developing   new  Web  sites,   promoting  new  or
complementary  products  or sales  formats,  expanding  the breadth and depth of
products  and  services   offered,   expanding  our  market   presence   through
relationships  with third  parties,  adopting  non-Internet  based  channels for
distributing  our  products,   or  consummating   acquisitions  or  investments.
Expansion of our operations in this manner would require significant  additional
expenses and  development,  operations and editorial  resources and would strain
our  management,  financial  and  operational  resources.  For example,  we have
historically expended significant internal resources in connection

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<PAGE>

with the redesign of our Web site and the implementation of our online strategic
alliances.  Moreover,  in the event  that we  expand  upon our  efforts  to open
brick-and-mortar  outlet  stores,  we will be  required  to  devote  significant
internal  resources and capital to such efforts.  There can be no assurance that
we would be able to expand our efforts and  operations  in a  cost-effective  or
timely manner or that any such efforts would increase overall market acceptance.
Furthermore,  any new  business  or Web site that is not  favorably  received by
consumer or trade customers could damage our reputation.

We May Be Liable For  Infringing  The  Intellectual  Property  Rights Of Others.
Third parties may assert  infringement  claims  against us. From time to time in
the ordinary  course of business we have been,  and we expect to continue to be,
subject to claims alleging infringement of the trademarks and other intellectual
property rights of third parties. These claims and any resulting litigation,  if
it occurs,  could subject us to significant  liability for damages. In addition,
even if we prevail,  litigation could be time-consuming  and expensive and could
result in the diversion of our time and attention. Any claims from third parties
may also result in limitations on our ability to use the  intellectual  property
subject to these  claims  unless we are able to enter into  agreements  with the
third parties making these claims.

We May Be Liable for Product Liability Claims. We sell products  manufactured by
third parties, some of which may be defective.  If any product that we sell were
to cause  physical  injury or injury to property,  the injured  party or parties
could bring  claims  against us as the retailer of the  product.  Our  insurance
coverage may not be adequate to cover every claim that could be  asserted.  If a
successful claim were brought against us in excess of our insurance coverage, it
could have a material adverse effect on our cash flow and on our reputation with
customers.  Unsuccessful  claims  could result in the  expenditure  of funds and
management time and could have a negative impact on our business.

We  Cannot   Guarantee  The  Protection  Of  Our  Intellectual   Property.   Our
intellectual  property  is critical to our  success,  and we rely on  trademark,
copyright,  domain names and trade secret  protection to protect our proprietary
rights.  Third parties may infringe or  misappropriate  our  trademarks or other
proprietary rights,  which could have a material adverse effect on our business,
prospects,  results of  operations or financial  condition.  While we enter into
confidentiality  agreements  with  our  employees,   consultants  and  strategic
partners and generally  control access to and  distribution  of our  proprietary
information,  the steps we have taken to protect our proprietary  rights may not
prevent  misappropriation.  We are pursuing  registration of various trademarks,
service  marks and domain  names in the  United  States  and  abroad.  Effective
trademark,  copyright and trade secret  protection may not be available in every
country,  and there  can be no  assurance  that the  United  States  or  foreign
jurisdictions will afford us any protection for our intellectual property. There
also can be no assurance that any of our  intellectual  property rights will not
be challenged,  invalidated or circumvented. In addition, we do not know whether
we  will  be  able  to  defend  our  proprietary   rights  since  the  validity,
enforceability and scope of protection of proprietary rights in Internet-related
industries is uncertain and still evolving. Moreover, even to the extent that we
are  successful in defending  our rights,  we could incur  substantial  costs in
doing so.

Our  Business  Could Be Harmed By  Consumers'  Concerns  About The  Security  Of
Transactions  Over The  Internet.  Concerns  over the  security of  transactions
conducted  on the  Internet  and  commercial  online  services,  the increase in
identity  theft and the  privacy  of users may also  inhibit  the  growth of the
Internet and  commercial  online  services,  especially as a means of conducting
commercial  transactions.  Moreover,  although  we have  developed  systems  and
processes  that  are  designed  to  protect  consumer  information  and  prevent
fraudulent  credit card  transactions  and other security  breaches,  failure to
mitigate  such fraud or  breaches  could have a material  adverse  effect on our
business, prospects, financial condition and results of operations.

We Face Legal  Uncertainties  Relating  To The  Internet  In General  And To Our
Industry In Particular And May Become Subject To Costly  Government  Regulation.
We are not  currently  subject to direct  regulation  by any domestic or foreign
governmental agency, other than regulations  applicable to businesses generally,
and laws or regulations  directly applicable to online commerce.  However, it is
possible  that laws and  regulations  may be  adopted  that  would  apply to the
Internet and other online services.  Furthermore,  the growth and development of
the market for online  commerce  may prompt  calls for more  stringent  consumer
protection laws that may impose additional burdens on those companies conducting
business online. The adoption of any additional laws or regulations may increase
our cost of doing  business  and/or  decrease  the demand for our  products  and
services and increase our cost of doing business.

The  applicability  to the  Internet of existing  laws in various  jurisdictions
governing issues such as property  ownership,  sales and other taxes,  libel and
personal  privacy  is  uncertain  and may take  years to  resolve.  Any such new
legislation  or  regulation,  the  application  of  laws  and  regulations  from
jurisdictions  whose  laws  do  not  currently  apply  to our  business,  or the
application of

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<PAGE>

existing laws and  regulations  to the Internet and online  commerce  could also
increase our cost of doing  business.  In  addition,  if we were alleged to have
violated  federal,  state or  foreign,  civil or  criminal  law,  we could  face
material  liability and damage to our  reputation  and, even if we  successfully
defend any such claim, we would incur  significant costs in connection with such
defense.

We Face  Uncertainties  Relating To Sales And Other Taxes.  We are not currently
required to pay sales or other  similar  taxes in respect of  shipments of goods
into states other than Virginia,  Ohio, New Jersey, Maine and New York. However,
state taxation laws and  regulations  may change in the future,  and one or more
states  may seek to impose  sales tax  collection  obligations  on  out-of-state
companies, such as our company, that engage in online commerce. In addition, any
new operation in states outside Virginia,  Ohio, New Jersey,  Maine and New York
could subject  shipments  into such states to state sales taxes under current or
future laws. A successful assertion by one or more states or any foreign country
that the sale of  merchandise  by us is subject to sales or other  taxes,  could
subject us to material liabilities and, to the extent that we pass such costs on
to our customers, could decrease our sales.

The  Holders  Of Our Common  Stock May Be  Adversely  Affected  By The Rights Of
Holders Of Preferred Stock That May Be Issued In The Future.  Our certificate of
incorporation  and by-laws,  as amended,  contain  certain  provisions  that may
delay, defer or prevent a takeover.  Our Board of Directors has the authority to
issue up to 15,479,250  additional  shares of preferred  stock, and to determine
the price,  rights,  preferences and  restrictions,  including voting rights, of
those  shares,   without  any  further  vote  or  action  by  the  stockholders.
Accordingly,  our Board of  Directors  is  empowered,  without  approval  of the
holders of Common Stock,  to issue  preferred  stock,  for any reason and at any
time,  with  such  rates  of  dividends,   redemption  provisions,   liquidation
preferences,  voting rights,  conversion privileges and other characteristics as
it may deem necessary or appropriate. The rights of holders of Common Stock will
be subject to, and may be  adversely  affected  by, the rights of holders of any
preferred stock that may be issued in the future.

We  Rely On The  Effectiveness  Of Our  Internal  Controls.  Section  404 of the
Sarbanes-Oxley  Act of 2002  requires that we establish and maintain an adequate
internal control structure and procedures for financial  reporting and assess on
an on-going basis the design and operating effectiveness of our internal control
structure and procedures for financial reporting. Management will be responsible
for assessing the design and the  effectiveness of our internal controls for the
year ending December 31, 2007. Our independent  registered  accounting firm will
be  required to audit the design and  operating  effectiveness  of our  internal
controls  and  attest  to   management's   assessment  of  the  design  and  the
effectiveness  of our internal  controls.  The first such audit will be required
for our fiscal year ending December 31, 2008. It is possible that, as we prepare
for this audit,  we could  discover  certain  deficiencies  in the design and/or
operation of our internal  controls that could  adversely  affect our ability to
record, process,  summarize and report financial data. We have invested and will
continue to invest significant  resources in this process.  Because management's
assessment  of  internal  controls  has not been  required to be reported in the
past, we are uncertain as to what impact a conclusion that deficiencies exist in
our internal  controls over financial  reporting would have on the trading price
of our Common Stock.

ITEM 2.  PROPERTIES

We lease approximately  26,000 square feet of office space in New York City. The
property is in good operating condition. The leases expire in 2008 through 2010.
Our  total  lease  expense  for  the  current   office  space  during  2006  was
approximately $457,000.

ITEM 3.  LEGAL PROCEEDINGS

We currently,  and from time to time,  are involved in litigation  incidental to
the  conduct  of our  business.  However,  we are not  party to any  lawsuit  or
proceeding  which in the  opinion  of  management  is likely to have a  material
adverse effect on us.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was  submitted  to a vote of  stockholders  of the Company  during the
fourth quarter of 2006.

                                       13
<PAGE>

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S  COMMON EQUITY,  RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

MARKET INFORMATION

The Company's common stock, par value $.01 per share ("Common Stock"), is quoted
on The Nasdaq Capital Market and the Boston Stock Exchange.  The following table
sets  forth the high and low bid prices  for the  Common  Stock for the  periods
indicated, as reported by the Nasdaq Capital Market:

         FISCAL 2006                               HIGH            LOW
         --------------------------------------   -------        -------
         First Quarter                            $  1.49        $  0.96
         Second Quarter                           $  1.23        $  0.68
         Third Quarter                            $  1.20        $  0.93
         Fourth Quarter                           $  1.59        $  0.79

         FISCAL 2005                               HIGH            LOW
         --------------------------------------   -------        -------
         First Quarter                            $  2.34        $  1.22
         Second Quarter                           $  2.24        $  1.20
         Third Quarter                            $  1.88        $  1.40
         Fourth Quarter                           $  1.87        $  0.97

HOLDERS

As of February 23, 2007, there were  approximately  115 holders of record of the
Common Stock. We believe that there were more than 5,000  beneficial  holders of
the Common Stock as of such date.

DIVIDENDS

We have never declared or paid cash dividends on our Common Stock.  In addition,
the terms of our credit facility contain  restrictions on our ability to declare
or pay dividends.  We currently  intend to retain any future earnings to finance
future growth and, therefore, do not anticipate paying any cash dividends in the
foreseeable future.

PERFORMANCE GRAPH

                Comparison of Five-Year Cumulative Total Returns
                             Performance Report for
                                   BLUEFLY INC

Produced on 02/20/2007 including data to 12/29/2006

                        [Performance Graph Appears Here]

Company Index: BLUEFLY INC

Market Index:  Nasdaq Stock Market (US Companies)

Peer Index:    Nasdaq Retail Trade Stocks

               SIC 5200-5599, 5700-5799, 5900-5999 US & Foreign

           Date                  Company Index    Market Index      Peer Index
----------------------------    --------------   --------------   --------------
12/31/2001                             100.000          100.000          100.000
01/31/2002                              95.789           99.239          101.593
02/28/2002                              78.684           88.920           98.443
03/28/2002                              94.737           94.751          100.313
04/30/2002                              76.316           86.879          105.119
05/31/2002                              91.579           83.047          104.808
06/28/2002                              68.421           75.525          102.677
07/31/2002                              47.895           68.628           88.398
08/30/2002                              52.632           67.899           85.127
09/30/2002                              44.737           60.597           82.364
10/31/2002                              36.842           68.875           89.156
11/29/2002                              62.105           76.553           92.289
12/31/2002                              86.316           69.131           84.968
01/31/2003                              51.053           68.383           81.658
02/28/2003                              41.579           69.344           81.585
03/31/2003                              43.158           69.544           82.668
04/30/2003                              43.158           75.865           91.890
05/30/2003                              71.053           82.526           96.778
06/30/2003                              58.947           83.850           97.721
07/31/2003                              56.316           89.627          103.696
08/29/2003                              52.632           93.536          110.968
09/30/2003                              77.895           92.320          105.508
10/31/2003                             136.842           99.753          118.094
11/28/2003                             251.579          101.232          119.593
12/31/2003                             213.158          103.365          118.315
01/30/2004                             215.263          106.429          119.724
02/27/2004                             195.789          104.426          123.573
03/31/2004                             168.421          102.648          124.074
04/30/2004                             142.105           99.246          122.562
05/28/2004                             142.158          102.543          126.344
06/30/2004                             113.158          105.693          133.772
07/30/2004                              95.263           97.626          128.665
08/31/2004                             109.474           95.235          126.442
09/30/2004                              90.526           98.077          131.420
10/29/2004                             150.474          102.053          139.122
11/30/2004                             131.579          108.341          146.381
12/31/2004                             122.105          112.489          150.068
01/31/2005                              86.842          106.636          144.848
02/28/2005                              68.421          106.030          145.142
03/31/2005                              75.789          103.334          147.157
04/29/2005                              67.895           99.574          140.770
05/31/2005                              86.316          107.273          153.690
06/30/2005                              94.737          106.838          154.571
07/29/2005                              84.737          113.656          163.304
08/31/2005                              82.632          111.853          150.690
09/30/2005                              80.526          111.942          146.235
10/31/2005                              85.789          110.504          150.102
11/30/2005                              76.316          116.531          153.877
12/30/2005                              58.947          114.881          151.492
01/31/2006                              57.368          119.953          154.954
02/28/2006                              56.842          118.760          156.671
03/31/2006                              58.421          121.855          165.355
04/28/2006                              58.947          120.896          166.116
05/31/2006                              36.853          113.603          160.218
06/30/2006                              63.684          113.602          161.553
07/31/2006                              54.737          109.270          149.288
08/31/2006                              55.263          114.122          148.436
09/29/2006                              52.105          118.051          160.496
10/31/2006                              47.368          123.832          170.228
11/30/2006                              46.316          127.068          165.849
12/29/2006                              67.368          126.212          165.445

This performance graph shall not be deemed "filed" for purposes of Section 18 of
the  Securities  Exchange  Act of  1934,  as  amended  (the  "Exchange  Act") or
otherwise  subject to the liabilities under that Section and shall not be deemed
to be  incorporated by reference into any filing of Bluefly under the Securities
Act of 1933, as amended or the Exchange Act.

                                       14
<PAGE>

ITEM 6.   SELECTED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction
with  the  consolidated  financial  statements  and the  notes  thereto  and the
information  contained  in Item 7,  "Management's  Discussion  and  Analysis  of
Financial  Condition  and  Results of  Operations."  Historical  results are not
necessarily  indicative of future results.  The selected  financial data for the
years ended  December 31, 2003 and 2002 and at December 31, 2004,  2003 and 2002
are derived from our audited  financial  statements not included in this report.
In January  2006,  the start of the first  quarter of fiscal  2006,  the Company
adopted the  provisions of Statement of Financial  Accounting  Standards No. 123
(revised 2004),  "Share-Based Payment" ("SFAS No. 123(R)"),  which requires that
the costs resulting from all stock-based  payment  transactions be recognized in
the financial  statements  at their fair values.  Results for prior periods have
not been restated. All data is in thousands, except share data:

<TABLE>
<CAPTION>
                                                                                Year Ended December 31,
                                                   ------------------------------------------------------------------------------
                                                       2006              2005           2004              2003           2002
                                                   ------------      ------------   ------------      ------------   ------------
<S>                                                <C>               <C>            <C>               <C>            <C>
Statement of Operations Data:

Net sales                                          $     77,062      $     58,811   $     43,799      $     37,928   $     30,606
Cost of sales                                            46,153            35,816         27,393            26,603         20,571
                                                   ------------      ------------   ------------      ------------   ------------
   Gross profit                                          30,909            22,995         16,406            11,325         10,035

Selling and fulfillment expenses                         15,808            12,880         11,783            10,163          9,272
Marketing expenses                                       14,196             6,961          2,120             1,898          2,275
General and administrative expenses                      13,001             6,299          6,408             5,207          4,686
                                                   ------------      ------------   ------------      ------------   ------------
   Total operating expenses                              43,005            26,140         20,311            17,268         16,233

Operating loss                                          (12,096)(3)        (3,145)        (3,905)           (5,943)        (6,198)

Interest expense                                           (599)             (856)          (733)             (464)          (349)
Interest/other income                                       502               181            847                38             68
                                                   ------------      ------------   ------------      ------------   ------------

   Net loss                                             (12,193)           (3,820)        (3,791)           (6,369)        (6,479)
Basic and diluted loss per share:                  $      (0.23)     $      (0.54)  $      (0.55)     $      (0.88)  $      (2.44)
Basic and diluted weighted average number of
common shares outstanding available to common
stockholders(2)                                      80,170,532        16,153,020     14,586,752        11,171,018      9,927,027

                                                                                    As of December 31,
                                                   ------------------------------------------------------------------------------
                                                       2006              2005           2004              2003           2002
                                                   ------------      ------------   ------------      ------------   ------------
Balance Sheet Data:

Cash and cash equivalents                          $     20,188      $      9,408   $      7,938(1)   $      7,721   $      1,749
Inventories, net                                         24,189            16,893         12,958            11,340         10,868
Other current assets                                      4,229             3,536          2,559             1,863          1,159
Total assets                                             52,430            33,045         25,541            22,998         16,595
Current liabilities                                      14,603            11,936          9,413             8,459          7,072
Long term liabilities                                      --               5,244          4,739             4,260          2,439
Shareholders' equity                                     37,827            15,865         11,389            10,279          7,084
</TABLE>

(1)  Includes restricted cash of $1,253
(2)  Weighted  average  shares  increased to 80.2 million in 2006 as a result of
     the June 2006 financing and the conversion of the Company's preferred stock
     into common stock in connection with the financing.
(3)  This amount includes non-cash expense of approximately $4.5 million related
     to stock-based compensation, recorded in accordance with SFAS 123R.

                                       15
<PAGE>

ITEM 7. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

This  discussion  and  analysis  of  our  financial  condition  and  results  of
operations   contains   forward-looking   statements   that  involve  risks  and
uncertainties.  We have based these  forward-looking  statements  on our current
expectations and projections of future events. However, our actual results could
differ  materially from those discussed  herein as a result of the risks that we
face,  including  but not limited to those risks  stated in "Risk  Factors,"  or
faulty assumptions on our part. In addition,  the following discussion should be
read in conjunction with the audited  consolidated  financial statements and the
related notes thereto included elsewhere in this report.

OVERVIEW

Bluefly,  Inc.  is a leading  Internet  retailer  that  sells over 350 brands of
designer apparel, accessories and home furnishings at discounts of up to 75% off
of retail value.  We launched our Web site in September 1998. Over the past five
years our sales have grown at a compounded  annual growth rate of more than 28%,
while our gross margin  percentage  has increased from 30.5% in 2001 to 40.1% in
2006.

The  recent  increase  in our  margin  and sales is the  direct  result of a new
merchandise  strategy that we began to implement in spring 2004. As part of that
strategy we are  bringing  current  season  merchandise  and the latest  fashion
trends to our customer for great value.  While there will be some fluctuation in
our gross margin  percentage  from quarter to quarter as we further  develop our
merchandising  and  marketing  strategy,  we  believe  that  we  will be able to
maintain margins at the current levels.

We believe that there is an opportunity to accelerate the growth of our business
while  continuing to provide our customers  with the great values that they have
become  accustomed  to. In an effort to take advantage of this  opportunity,  we
launched  a  national  advertising  campaign  in 2005,  and have  continued  and
expanded upon it in the last eighteen months.  We intend to continuously  review
the results of the campaign and use the learnings to refine and improve upon our
marketing strategy.

Our net sales  increased over 31% to $77,062,000 for the year ended December 31,
2006 from  $58,811,000  for the year ended  December 31, 2005.  Our gross margin
increased to 40.1% in 2006 from 39.1% in 2005,  37.5% in 2004, 29.9% in 2003 and
32.8% in 2002. Our gross profit  increased by more than 34% to  $30,909,000  for
the year ended  December 31, 2006 from  $22,995,000  for the year ended December
31,  2005.  This growth in gross profit was driven by the increase in net sales,
and by the increase in gross margins. Our operating loss increased by over 284%,
to $12,096,000 in 2006, from $3,145,000 in 2005.

Total  marketing  expenses  increased by 104% to  $14,196,000  for the full year
2006,  from  $6,961,000  for the full year 2005.  We  increased  our spending in
marketing  (excluding  staff related costs) by 102% to $12,602,000  for the full
year 2006,  from  $6,250,000  for the full year 2005.  The  primary  goal of our
marketing  campaign is to build upon the awareness created by the initial launch
of the  campaign  in fall  2005,  both  with new  customers  as well as with our
existing  customers.  A large portion of the increased  marketing  expense was a
result of the costs associated with our national advertising  campaign.  For the
first three quarters of 2006, our net sales increased by approximately  25%, 40%
and 36%,  respectively,  as compared to the same periods in 2005. In general, we
intend to market our business more  aggressively than we have in previous years.
This more  aggressive  growth  strategy  will cause our  marketing  expense as a
percentage of revenue to increase in the short-term; however, we believe that it
is a prudent  investment  in our business  given that our margin  structure  and
average  order size have  historically  resulted in a relatively  high  positive
contribution to overhead and marketing on a customer's first order.

Our reserve for returns and credit card chargebacks  increased to 39.6% of gross
sales for the year  ended  December  31,  2006  compared  to 37.8% in 2005.  The
increase was primarily  caused by a shift in our merchandise mix towards certain
product  categories  that  historically  have  generated  higher  return  rates.
However, we believe that this increase in return rates has been more than offset
by the higher gross margins and average order sizes that have been  generated by
this shift in merchandise mix.

A portion of our inventory  includes  merchandise  that we either purchased with
the intention of holding for the appropriate  season or were unable to sell in a
prior season and have  determined to hold for the next selling  season,  subject
(in some cases) to appropriate mark-downs. In recent years we have increased the
amount  of  inventory  purchased  on a pack  and  hold  basis  in  order to take
advantage of opportunities in the market.

                                       16
<PAGE>

On January 1, 2006,  we adopted SFAS No.  123(R),  which  requires  expensing of
stock options. As a result, we recorded total share-based  compensation expenses
of $4,454,000  for the year ended  December 31, 2006.  Results for prior periods
have not been  restated  due to the adoption  based on the modified  prospective
approach.

At December 31, 2006, we had an  accumulated  deficit of  $115,997,000.  The 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 Preferred  Stock of  approximately  $33.0 million,  and
non-cash charges of  approximately  $4.5 million in connection with the adoption
of SFAS 123(R).  In order to expand our business,  we intend to invest in sales,
marketing, merchandising,  operations, information systems, site development and
additional personnel to support these activities.  Therefore, we may continue to
incur substantial operating losses.  Although we have experienced revenue growth
in recent years,  this growth may not be sustainable and therefore should not be
considered indicative of future performance.

CRITICAL ACCOUNTING POLICIES

Management Estimates

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect the reported  amounts of assets and  liabilities  and the  disclosure  of
contingent  assets and liabilities at the dates of the financial  statements and
the reported amounts of revenues and expenses during the reporting periods.  The
most  significant  estimates  and  assumptions  relate  to the  adequacy  of the
allowances for sales returns,  recoverability  of  inventories,  useful lives of
property  and  equipment,  the  realization  of  deferred  tax  assets,  and the
calculations  related to stock-based  compensation.  Actual amounts could differ
significantly from these estimates.

Revenue Recognition

We recognize  revenue in accordance with Staff  Accounting  Bulletin ("SAB") No.
104  "Revenue  Recognition".  Gross sales  consists  primarily  of revenue  from
product  sales and  shipping  and  handling  charges  and is net of  promotional
discounts.  Net sales represent gross sales, less provisions for returns, credit
card  chargebacks,  and  adjustments  for  uncollected  sales taxes.  Revenue is
recognized when all the following criteria are met:

     o    A customer executes an order.

     o    The  product  price  and the  shipping  and  handling  fee  have  been
          determined.

     o    Credit card  authorization  has occurred and  collection is reasonably
          assured.

     o    The product has been shipped and received by the customer.

Shipping  and  handling  billed  to  customers  are  classified  as  revenue  in
accordance  with  Financial  Accounting  Standards  Board  ("FASB") Task Force's
Emerging  Issues Task Force  ("EITF") No.  00-10,  "Accounting  for Shipping and
Handling Fees and Costs" ("EITF No. 00-10").

Provision for Returns and Doubtful Accounts

We  generally  permit  returns  for any  reason  within  90  days  of the  sale.
Accordingly, we establish a reserve for estimated future returns and bad debt at
the time of shipment based primarily on historical  data. We perform credit card
authorizations  and check the verification of our customers prior to shipment of
merchandise.  However,  our future  return and bad debt rates could  differ from
historical patterns, and, to the extent that these rates increase significantly,
it could have a material adverse effect on our business,  prospects, cash flows,
financial condition and results of operations.

Inventory Valuation

Inventories, which consist of finished goods, are stated at the lower of cost or
market value.  Cost is determined by the first-in,  first-out  ("FIFO")  method.
This  valuation  requires us to make  judgements  based on  currently  available
information, about the

                                       17
<PAGE>

saleability  of such  merchandise,  the  selling  price,  etc.  Based  upon this
evaluation,  we review our  inventory  levels in order to  identify  slow-moving
merchandise and establish a reserve for such merchandise.

Deferred Tax Valuation Allowance

We  recognize  deferred  income tax assets and  liabilities  on the  differences
between the financial  statement and tax bases of assets and  liabilities  using
enacted  statutory  rates in effect for the years in which the  differences  are
expected  to reverse.  The effect on deferred  taxes of a change in tax rates is
realized in income or loss in the period that  included the  enactment  date. We
have assessed the future taxable income and determined  that a 100% deferred tax
valuation allowance is deemed necessary.  In the event that we were to determine
that we would be able to realize our deferred tax assets,  an  adjustment to the
deferred  tax  valuation  allowance  would  increase  income in the period  such
determination is made.

Stock-Based Compensation

As of January 1, 2006,  we adopted  SFAS  123(R)  which  requires  us to measure
compensation cost for stock awards at fair value and recognize compensation over
the service period for awards  expected to vest.  Determining  the fair value of
stock-based awards at the grant date requires considerable  judgment,  including
estimating  expected  volatility,  expected  term,  risk-free  interest rate and
expected  forfeitures.  If factors change and we employ  different  assumptions,
stock-based  compensation  expense  may differ  significantly  from what we have
recorded in the past.

RESULTS OF OPERATIONS

The following  table sets forth our  statement of operations  data for the years
ended December 31st. All data is in thousands except as indicated below:

<TABLE>
<CAPTION>
                                               2006                      2005                  2004
                                        --------------------    --------------------    --------------------
                                                   As a % of               As a % of               As a % of
                                                   Net Sales               Net Sales               Net Sales
                                                   ---------               ---------               ---------
<S>                                     <C>             <C>      <C>            <C>     <C>           <C>
 Net sales                              $ 77,062       100.0%   $ 58,811       100.0%   $ 43,799       100.0%
 Cost of sales                            46,153        59.9%     35,816        60.9%     27,393        62.5%
                                        --------                --------                --------
   Gross profit                           30,909        40.1%     22,995        39.1%     16,406        37.5%

 Marketing expenses                       14,196        18.4%      6,961        11.8%      2,120         4.9%
 Selling and fulfillment expenses         15,808        20.5%     12,880        21.9%     11,783        26.9%
 General and administrative expenses      13,001        16.9%      6,299        10.7%      6,408        14.6%
                                        --------                --------                --------
   Total operating expenses               43,005        55.8%     26,140        44.4%     20,311        46.4%

 Operating loss                          (12,096)      (15.7)%    (3,145)       (5.3)%    (3,905)       (8.9)%
 Interest (expense) other income             (97)       (0.1)%      (675)       (1.2)%       114         0.3%
                                        --------                --------                --------
   Net loss                             $(12,193)      (15.8)%  $ (3,820)       (6.5)%  $ (3,791)       (8.6)%
</TABLE>

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 years ended December 31st, as indicated below:

<TABLE>
<CAPTION>
                                                         2006           2005           2004
                                                     ------------   ------------   ------------
<S>                                                  <C>            <C>            <C>
Average Order Size (including shipping & handling)   $     257.64   $     220.17   $     188.51
New Customers Added during the Year*                      177,213        148,975        127,177
</TABLE>

*    Based on unique email addresses

                                       18
<PAGE>

FOR THE YEAR ENDED  DECEMBER  31, 2006  COMPARED TO THE YEAR ENDED  DECEMBER 31,
2005

Net sales:  Gross  sales for the year  ended  December  31,  2006  increased  by
approximately  35% to $127,556,000  from $94,586,000 for the year ended December
31,  2005.  The  provision  for returns and credit  card  chargebacks  and other
credits  was  approximately  40%  for  2006  and 38% for  2005,  resulting  in a
provision of $50,494,000  for the year ended  December 31, 2006 and  $35,775,000
for the year ended December 31, 2005.

After  the  necessary  provisions  for  returns,  credit  card  chargebacks  and
adjustments  for  uncollected  sales  taxes,  our net sales  for the year  ended
December  31, 2006 were  $77,062,000.  This  represents  an increase of over 31%
compared  to the year  ended  December  31,  2005,  in which net  sales  totaled
$58,811,000. The growth in net sales was largely driven by the increase in gross
average  order size  (approximately  17% higher  than the full year 2005) and an
increase in the number of new customers acquired  (approximately 19% higher than
the full year 2005).  Shipping  and handling  revenue  (which is included in net
sales) increased by 14% to $4,403,000 for the year ended December 31, 2006, from
$3,874,000  for the year ended  December  31, 2005.  Revenue  from  shipping and
handling increased at a lower rate than overall revenue,  due to the increase in
our average order size.

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 year ended  December 31, 2006 totaled
$46,153,000,  resulting in a gross margin of approximately  40.1%. Cost of sales
for the year ended December 31, 2005 totaled  $35,816,000,  resulting in a gross
margin  of  39.1%.  The  increase  in gross  margin  was  driven by our focus on
negotiating  better  prices with vendors as well as our strategy of selling more
in-season  product,  which has more value to our customer and therefore  demands
higher margins,  and the timing of our promotions.  While we believe that we can
continue  to generate  gross  margin at or near these  levels in the future,  we
believe that it may be difficult for us to continue to increase the gross margin
level at the rate that we have over the past few years.

Gross Profit: As a result of the increases in net sales and gross margin,  gross
profit  increased by over 34%, to  $30,909,000  for the year ended  December 31,
2006, from $22,995,000 for the year ended December 31, 2005.

Marketing expenses:  Marketing expenses increased by 104% to $14,196,000 for the
year ended  December 31, 2006 from  $6,961,000  for the year ended  December 31,
2005.

As a percentage of net sales, our marketing  expenses increased to 18.4% for the
year ended  December  31, 2006 from 11.8% for the year ended  December 31, 2005.
The  increase  in  marketing  expenses  as a  percentage  of net sales  resulted
primarily from costs  associated with our national  advertising  campaign (which
was  launched in  September  2005).  We  significantly  increased  our  national
advertising  campaign  during 2006, and we plan to continue to grow our national
advertising  campaign during the next  12-months.  We spent  approximately  $7.1
million and $3.2 million on our national  advertising campaign in 2006 and 2005,
respectively, and we expect to spend approximately $7.2 million in 2007.

Marketing expenses include expenses related to our national ad campaign,  online
and print advertising,  "sweepstakes" promotions as well as staff related costs.
Marketing  expenses increased by a higher percentage than revenue as a result of
the costs associated with our national marketing  campaign.  Costs in connection
with this campaign are being recorded as the magazines and commercials are being
released. As a result, we expect marketing expense as a percentage of revenue to
increase in the short-term.  We believe that this is a prudent investment in our
business   given  that  our  margin   structure  and  average  order  size  have
historically  resulted in a relatively high positive contribution to overhead on
a customer's first order.

Selling and fulfillment expenses:  Selling and fulfillment expenses increased by
approximately 23% for the year 2006 compared to the year ended 2005. The selling
and fulfillment expenses were comprised of the following:

<TABLE>
<CAPTION>
                                       Year Ended             Year Ended           Percentage Difference
                                    December 31, 2006       December 31, 2005       increase (decrease)
                                  ---------------------   ---------------------    ---------------------
<S>                               <C>                     <C>                                         <C>
Operating                                     8,353,000               6,925,000                       21%
Technology                                    4,203,000               3,567,000                       18%
E-Commerce                                    3,252,000               2,388,000                       36%
                                  ---------------------   ---------------------
                                  $          15,808,000   $          12,880,000                       23%
</TABLE>

                                       19
<PAGE>

Operating   expenses   include  all  costs  related  to  inventory   management,
fulfillment,  customer service,  and credit card processing.  Operating expenses
increased  in  2006  by 21%  compared  to 2005 as a  result  of  variable  costs
associated  with the increased  sales volume (e.g.,  picking and packing orders,
processing  returns and credit card fees),  and an increase in customer  service
and salary related expenses.  Operating costs as a percentage of sales decreased
as a result of  economies  of scale.  Variable  expenses  related to picking and
packing orders  increased by 24% to $2.1 million from $1.7 million.  Credit card
fees remained  relatively  unchanged at $1.8  million,  as the current year fees
were  partially  offset by a refund of  approximately  $274,000  from one of our
credit  card  processors.  Both  expenses  remained  relatively  constant  as  a
percentage of gross sales at 2% for 2006 and 2005.

Technology  expenses consist  primarily of staff related costs,  amortization of
capitalized  costs and Web site hosting.  For the year ended  December 31, 2006,
technology  expenses  increased by approximately  18% compared to the year ended
December 31, 2005.  This  increase  resulted  from an increase in headcount  and
salary related expenses,  consulting expenses and costs associated with software
support and was  partially  offset by a decrease in  depreciation  expense and a
decrease in web hosting expense.

E-Commerce  expenses  include  expenses  related  to  our  photo  studio,  image
processing,  third  party  software  and Web site  design.  For the  year  ended
December 31, 2006, this amount increased by approximately 36% as compared to the
year ended  December 31, 2005,  primarily  due to an increase in salary  related
expenses as well as increased  expenses  related to photo shoots.  These amounts
were partially offset by a decrease in expenses associated with analytic tools.

The increase was offset  partially from economies of scale in our operations and
technology expenses,  as some of the fixed costs involved in maintaining our Web
site and processing orders were allocated over a larger number of orders. One of
our  goals is to  achieve  greater  economies  of scale as our  business  grows,
although  there can be no assurance  that we will be  successful in doing so. We
plan to  continue  to invest in all of these  areas in the near term in order to
grow our business.

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  year  ended
December 31, 2006  increased to  $13,001,000  as compared to $6,299,000  for the
year ended  December  31,  2005.  The  increase  in general  and  administrative
expenses was  primarily  the result of the  recording of  $3,895,000  of expense
related to restricted stock,  restricted stock units and employee stock options,
an increase of $379,000 in bad debt expense  related to a receivable  due from a
third party service provider that purchased  inventory from us to be distributed
internationally,   increased  consulting  and  professional  fees  of  $392,000,
increased public company expenses of $301,000 and increased depreciation expense
of $278,000.  In June 2006, we paid approximately  $650,000 of executive bonuses
in  connection  with the financing  that closed during the second  quarter 2006.
Most of these bonuses are included in general and  administrative  expenses.  In
addition, in November 2006, in connection with their new employment  agreements,
the company paid bonuses in the aggregate  amount of $517,890 to the CEO and CFO
intended to compensate  them for the income taxes  payable on  restricted  stock
awards,  received in exchange for their  forfeiting their right to certain fully
vested and out-of-the-money stock options that would have been exercisable.

In January 2007, we commenced an exchange  offer pursuant to which we offered to
exchange certain  outstanding stock options issued to employees and non-employee
directors for restricted  stock awards and/or  deferred  stock unit awards.  See
Footnote 15  "Subsequent  Events" to our  financial  statements  for  additional
information regarding the exchange offer.

As a percentage of net sales,  general and administrative  expenses increased to
16.9% in 2006 from 10.7% in 2005.

Loss  from  operations:  Operating  loss  increased  by over  284% in  2006,  to
$12,096,000 from $3,145,000 in 2005.

Interest expense and interest and other income,  net:  Interest and other income
for the year ended December 31, 2006 increased to $502,000 from $181,000 for the
year ended  December  31,  2005.  Interest  and other income was higher in 2006,
compared to 2005  primarily due to an increase in interest  income earned on our
cash balances.

                                       20
<PAGE>

Interest  expense,  which is comprised  primarily  of interest  paid on our loan
facility and convertible  notes held by Soros.  For the year ended 2006 interest
expense  decreased to $599,000 compared to $856,000 for the year ended 2005. The
convertible  notes were repaid in June 2006,  which  resulted in the decrease in
interest expense for 2006 compared to 2005.

Net loss per share:  Net loss per share  decreased to $0.23 per share from $0.54
per share,  as the number of weighted  average shares  outstanding  increased to
80.2 million in 2006 as a result of the June 2006  financing and the  conversion
of the  Company's  preferred  stock into  common  stock in  connection  with the
financing.

FOR THE YEAR ENDED  DECEMBER  31, 2005  COMPARED TO THE YEAR ENDED  DECEMBER 31,
2004

Net sales:  Gross  sales for the year  ended  December  31,  2005  increased  by
approximately  37% to $94,586,000  from  $69,032,000 for the year ended December
31,  2004.  The  provision  for returns and credit  card  chargebacks  and other
credits  was  approximately  38%  for  2005  and 37% for  2004,  resulting  in a
provision of $35,775,000  for the year ended  December 31, 2005 and  $25,233,000
for the year ended December 31, 2004.

After  the  necessary  provisions  for  returns,  credit  card  chargebacks  and
adjustments  for  uncollected  sales  taxes,  our net sales  for the year  ended
December  31, 2005 were  $58,811,000.  This  represents  an increase of over 34%
compared  to the year  ended  December  31,  2004,  in which net  sales  totaled
$43,799,000. The growth in net sales was largely driven by the increase in gross
average  order size  (approximately  17% higher  than the full year 2004) and an
increase in the number of new customers acquired  (approximately 17% higher than
the full year 2004).  Shipping  and handling  revenue  (which is included in net
sales) increased by 16% to $3,874,000 for the year ended December 31, 2005, from
$3,353,000  for the year ended  December  31, 2004.  Revenue  from  shipping and
handling increased at a lower rate than overall revenue,  due to the increase in
our average order size.

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 year ended  December 31, 2005 totaled
$35,816,000, resulting in gross margin of approximately 39.1%. Cost of sales for
the year ended December 31, 2004 totaled $27,393,000,  resulting in gross margin
of 37.5%.  The increase in gross  margin was driven by our focus on  negotiating
better  prices with vendors as well as our  strategy of selling  more  in-season
product,  which has more value to our  customer  and  therefore  demands  higher
margins,  and the timing of our  promotions.  As our inventory  composition  was
heavily  weighted with newer higher  margin  product there was less lower margin
inventory to negatively affect the margins than there was in 2004.

Gross Profit: As a result of the increases in net sales and gross margin,  gross
profit  increased by over 40%, to  $22,995,000  for the year ended  December 31,
2005, from $16,406,000 for the year ended December 31, 2004.

Selling, marketing and fulfillment expenses:  Selling, marketing and fulfillment
expenses  increased by approximately  42% for the year 2005 compared to the year
ended 2004. The selling,  marketing and  fulfillment  expenses were comprised of
the following:

<TABLE>
<CAPTION>
                                       Year Ended              Year Ended          Percentage Difference
                                    December 31, 2005       December 31, 2004       increase (decrease)
                                  ---------------------   ---------------------    ---------------------
<S>                               <C>                     <C>                                      <C>
Marketing                         $           6,961,000   $           2,120,000                    228.3%
Operating                                     6,925,000               5,848,000                     18.4%
Technology                                    3,567,000               4,086,000                    (12.7)%
E-Commerce                                    2,388,000               1,849,000                     29.1%
                                  ---------------------   ---------------------
                                  $          19,841,000   $          13,903,000                     42.7%
</TABLE>

As a percentage of net sales,  our selling,  marketing and fulfillment  expenses
increased to 33.7% for the year ended  December 31, 2005 from 31.7% for the year
ended  December 31, 2004.  The increase in selling,  marketing  and  fulfillment
expenses as a percentage of net sales resulted  primarily from costs  associated
with our national  advertising  campaign (which was launched in September 2005).
The increase was offset  partially from economies of scale in our operations and
technology expenses,  as some of the fixed costs involved in maintaining our Web
site and processing orders were allocated over a larger number of orders

Marketing expenses include expenses related to our national ad campaign,  online
and print advertising,  "sweepstakes" promotions as well as staff related costs.
Marketing  expenses increased by a higher percentage than revenue as a result of
the

                                       21
<PAGE>

costs associated with our national marketing campaign.  Costs in connection with
this  campaign are being  recorded as the magazines  and  commercials  are being
released.  For the year ended December 31, 2005,  approximately $3.2 million was
expensed in connection with this campaign.

Operating   expenses   include  all  costs  related  to  inventory   management,
fulfillment,  customer service,  and credit card processing.  Operating expenses
increased  in 2005 by over 18%  compared to 2004 as a result of  variable  costs
associated  with the increased  sales volume (e.g.,  picking and packing orders,
processing  returns and credit card  fees),  and was offset by costs  associated
with our 2004 temporary  clearance store, which closed in April 2005.  Operating
costs as a  percentage  of sales  decreased  as a result of  economies of scale.
Variable expenses related to picking and packing orders increased by 30% to $1.7
million  from $1.3  million and credit card fees  increased  by over 29% to $1.8
million from $1.4  million.  Both  expenses  remained  relatively  constant as a
percentage of gross sales at 2% for 2005 and 2004.

Technology  expenses consist  primarily of staff related costs,  amortization of
capitalized  costs and Web site hosting.  For the year ended  December 31, 2005,
technology  expenses  decreased by approximately  13% compared to the year ended
December 31,  2004.  This  decrease  resulted  from a decrease in headcount  and
salary related expenses,  a decrease in depreciation  expense, and a decrease in
web hosting  expense.  These factors were partially offset by an increase in the
costs associated with software support.  Depreciation expense for the year ended
December 31, 2005 was lower than  depreciation  for the year ended  December 31,
2004 due to the fact that costs  associated with our current platform as well as
certain computer equipment was fully depreciated during 2004.

E-Commerce  expenses  include  expenses  related  to  our  photo  studio,  image
processing,  third  party  software  and Web site  design.  For the  year  ended
December 31, 2005, this amount increased by approximately 29% as compared to the
year ended  December 31, 2004,  primarily  due to an increase in salary  related
expenses  as well  as an  increase  in  expenses  associated  with  third  party
software, third party analytics services and our increased use of outside models
for photo shoots.

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  year  ended
December 31, 2005  decreased  slightly to $6,299,000 for the year ended December
2005 as compared to $6,408,000  for the year ended December 31, 2004. The slight
decrease  in general and  administrative  expenses  was the result of  decreased
salary and benefit  expenses,  offset by an increase in public company expenses,
and increases in consulting and accounting fees.

As a percentage of net sales,  general and administrative  expenses decreased to
10.7% in 2005 from 14.6% in 2004.

Loss  from  operations:  Operating  loss  decreased  by  over  19% in  2005,  to
$3,145,000 from $3,905,000 in 2004 as a result of the increase in gross profit.

Interest expense and interest and other income,  net:  Interest and other income
for year ended  December 31, 2005  decreased to $181,000  from  $847,000 for the
year ended  December  31,  2004.  Interest  and other  income was higher in 2004
primarily  because of $564,000 in non-cash income recognized in 2004 to adjust a
liability  associated  with warrants issued by us to their fair value as of June
17, 2004 (at which time the warrants were  re-classified  as equity as described
in Note 6 to our financial statements),  as well as $169,000 realized in 2004 in
connection with the judgment we received in the Breider Moore litigation.

Interest expense for the year ended 2005 totaled  $856,000  compared to $733,000
for the year ended 2004, and related  primarily to fees paid in connection  with
the Loan Facility and interest expense on Convertible Notes held by Soros.

LIQUIDITY AND CAPITAL RESOURCES

General

At December 31, 2006, we had approximately $20.2 million in the form of cash and
cash  equivalents.  Working  capital  at  December  31,  2006 and 2005 was $34.0
million and $17.9 million,  respectively.  In addition, as of December 31, 2006,
we had approximately  $3.2 million committed under the Credit Facility,  leaving
approximately  $4.3 million of  availability,  compared to availability of $3.75
million at December 31, 2005.

                                       22
<PAGE>

We fund our operations through cash on hand, operating cash flow, as well as the
proceeds  of any equity or debt  financing.  Operating  cash flow is affected by
revenue and gross margin levels,  as well as return rates. Any  deterioration in
any of these  financial  measures would have a negative impact on our liquidity.
Total  availability  under  the  Credit  Facility  is based  primarily  upon our
inventory levels. In addition,  both availability  under the 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
request Wells Fargo to provide credit support under the Credit Facility. In some
instances, new vendors may require prepayments.  We may also 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,  we  sometimes  make
prepayments  in  connection   with  our   advertising   campaign,   as  in  some
circumstances we need to pay in advance of production.  As of December 31, 2006,
we had  approximately  $616,000  of prepaid  inventory  and  $102,000 of prepaid
marketing expense on our balance sheet.

Our  inventory  levels as of December 31, 2006 were  approximately  $7.3 million
higher than at December 31, 2005. The increase in inventory generally reflects a
ramp up in connection with our sales growth as well as  opportunistic  buying of
fresh  inventory  that has not  previously  been  available  to us However,  the
increased  inventory  level could  adversely  affect our  flexibility  in taking
advantage of other buying  opportunities  that may become  available in the near
term.

On June 15, 2006, we raised $50 million of additional  capital  through the sale
of 60,975,610  shares of our Common  Stock.  We used $25 million of the proceeds
from such sale to pay all accrued but unpaid  dividends on the  Preferred  Stock
converted by Soros in  connection  with such sale and to payoff the  convertible
promissory  notes held by Soros.  The  remaining  proceeds from the sale will be
used for general corporate purposes. We believe that our current funds, together
with working  capital,  and  operating  cash flow,  and  availability  under our
existing  Credit  Facility  will be  sufficient to enable us to meet our planned
expenditures through at least the next twelve months.

Credit Facility

In July  2005,  we  entered  into a new three  year  revolving  credit  facility
("Credit  Facility")  with Wells Fargo  Retail  Finance,  LLC  ("Wells  Fargo").
Pursuant to 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 all of our  assets.  Historically,  the Credit
Facility had also been secured by a letter of credit issued by Soros ("the Soros
LC").  In August  2006,  Wells Fargo agreed to release the Soros LC, and that it
would no longer require an availability reserve (although it has the right under
the  Credit  Facility  to  establish   reserves  in  the  future,  as  it  deems
appropriate).  In  return,  we agreed to  maintain  a minimum  cash  balance  of
$5,000,000.  Availability  under the Credit  Facility is determined by a formula
that takes into account the amount of our inventory and 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 December 31,
2006, total availability under the Credit Facility was approximately  $7,500,000
of which $3,200,000 was committed,  leaving  approximately  $4,300,000 available
for further borrowings.

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 2.75%. We also pay a monthly  commitment fee
on the unused portion of the facility (i.e., $7,500,000 less the amount of loans
outstanding)  equal to  0.35%.  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.

Under the terms of the Credit  Facility,  Soros has the right to purchase all of
our obligations from Wells Fargo at any time if we are then in default under the
Credit Facility.

Commitments and Long Term Obligations

As of  December  31,  2006,  we had the  following  commitments  and  long  term
obligations:

<TABLE>
<CAPTION>
                                                                                            More
                                                  Less than          1-3           3-5     than 5
                                    Total          1 year           years         years     years
                                -------------   -------------   -------------   --------   --------
<S>                             <C>             <C>             <C>                 <C>        <C>
Marketing and Advertising           1,068,000       1,068,000            --         --         --
Purchase Orders                     6,010,000        6,010,00            --         --         --
Operating Leases                    1,421,000         381,000       1,040,000       --         --
Capital Leases                         13,000          13,000            --         --         --
Employment Contracts                3,778,000       1,990,000       1,788,000       --         --
Technology                            208,000         208,000            --         --         --
                                -------------   -------------   -------------   --------   --------
  Grand total                   $  12,498,000   $   9,670,000   $   2,828,000       --         --
</TABLE>

                                       23
<PAGE>

We believe that in order to grow our business,  we will need to make  additional
marketing and advertising  commitments in the future. In addition,  we expect to
hire and train  additional  employees  for the  operations  and  development  of
Bluefly.com.  However,  our  marketing  budget  and our  ability  to  hire  such
employees is subject to a number of factors, including our results of operations
as well as the amount of additional capital that we raise.

Off Balance Sheet Arrangements

Certain  warrants issued in conjunction  with certain  preferred stock financing
transactions  are equity linked  derivatives  and  accordingly  represent an off
balance sheet  arrangement.  Each of these warrants meet the scope  exception in
paragraph  11(a) of FAS 133 and are accordingly not accounted for as derivatives
for  purposes of FAS 133,  but instead  included as a component  of equity.  See
Footnote 9 to the financial statements and the Statement of Shareholders' Equity
for more information.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Statement No. 157,  Fair Value  Measurements  ("SFAS  157"),  which defines fair
value,  establishes a framework for measuring  fair value in generally  accepted
accounting  principles,  and expands  disclosures about fair value measurements.
SFAS 157 is effective for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal years.  Earlier
application is encouraged, provided that the reporting entity has not yet issued
financial statements for that fiscal year, including financial statements for an
interim  period within that fiscal year. The Company is evaluating the potential
effects  of  adopting  SFAS 157,  and does not  expect  the  adoption  to have a
material impact on its financial condition and results of operations.

In September 2006 the Securities  and Exchange  Commission  ("SEC") issued Staff
Accounting Bulletin No. 108 ("SAB 108") which provides  interpretive guidance on
how the effects of the carryover or reversal of prior year misstatements  should
be considered in quantifying a current year  misstatement.  SAB 108 is effective
for  fiscal  years  ending  after  November  15,  2006.  The  adoption  of  this
pronouncement will not have an impact on the Company's financial statements.

In  July  2006,  the  Financial   Accounting  Standards  Board  ("FASB")  issued
Interpretation   No.  48,   "Accounting  for  Uncertainty  in  Income  Taxes--an
interpretation  of FASB  Statement  No. 109" ("FIN  48"),  which  clarifies  the
accounting for  uncertainty in tax positions.  This  Interpretation  requires an
entity to recognize the impact of a tax position in its financial  statements if
that  position  is more likely  than not to be  sustained  on audit based on the
technical  merits of the position.  The provisions of FIN 48 are effective as of
the beginning of fiscal year 2007,  with the cumulative  effect of the change in
accounting  principle  recorded as an adjustment to opening  retained  earnings.
Early  application of FIN 48 is encouraged.  The Company is still evaluating the
timing of its adoption of FIN 48 and the potential  effects of implementing this
Interpretation on its financial condition and results of operations but does not
expect its adoption to have a material  effect on its results of operations  due
to the fact that the Company has significant historical losses.

ITEM 7A. 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  investments  we  have
determined that the risks associated with interest rate fluctuations  related to
these financial instruments do not pose a material risk to us.

                                       24
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The  financial  statements  and  supplementary  data  required  by this item are
included in Part IV, Item 15 of this Form 10-K and are  presented  beginning  on
page F-1.

                                       25
<PAGE>

ITEM  9.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
FINANCIAL DISCLOSURE.

None.

ITEM 9A.  CONTROLS AND PROCEDURES

DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the  period  covered  by this  Form  10-K,  we  carried  out an
evaluation,  under the supervision and with the participation of our management,
including our Chief Executive Officer along with our 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 along with our Chief Financial
Officer  concluded that our disclosure  controls and procedures are effective in
ensuring that information  required to be disclosed by us in the reports that we
file or submit under the Exchange Act are recorded,  processed,  summarized  and
reported,  within the time  periods  specified  in the  Securities  and Exchange
Commission's rules and forms.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There have been no changes in our internal control over financial reporting that
occurred  during the Company's  most recent fiscal  quarter that has  materially
affected,  or is reasonably likely to materially  affect, the Company's internal
control over financial reporting.

ITEM 9B.  OTHER INFORMATION

None.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The  information  required  by this Item is  incorporated  by  reference  to the
Company's   definitive   proxy   statement  for  the  2007  annual   meeting  of
stockholders.

ITEM 11.  EXECUTIVE COMPENSATION

The  information  required  by this Item is  incorporated  by  reference  to the
Company's   definitive   proxy   statement  for  the  2007  annual   meeting  of
stockholders.

ITEM 12.  SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The  information  required  by this Item is  incorporated  by  reference  to the
Company's   definitive   proxy   statement  for  the  2007  annual   meeting  of
stockholders.

ITEM  13.  CERTAIN   RELATIONSHIPS   AND  RELATED   TRANSACTIONS   AND  DIRECTOR
INDEPENDENCE

The  information  required  by this Item is  incorporated  by  reference  to the
Company's   definitive   proxy   statement  for  the  2007  annual   meeting  of
stockholders.

                                       26
<PAGE>

ITEM 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

The  information  required  by this Item is  incorporated  by  reference  to the
Company's   definitive   proxy   statement  for  the  2007  annual   meeting  of
stockholders.

ITEM 15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) 1.  Financial Statements:

        Report of Independent Registered Public Accounting Firm
        Balance Sheets as of December 31, 2006 and 2005
        Statements  of Operations  for the three years ended  December 31, 2006,
        2005 and 2004
        Statements of Changes in Shareholders'  Equity for the three years ended
        December 31, 2006,  2005 and 2004 Statements of Cash Flows for the three
        years  ended  December  31,  2006,  2005  and 2004  Notes  to  Financial
        Statements

2.  Financial Statement Schedules:
         Schedule II - Valuation and Qualifying Accounts

3.  Exhibits:

EXHIBIT NO.  DESCRIPTION
-----------  ------------------------------------------------------------------
3.1 (e)      Certificate of Incorporation of the Company.

3.2 (e)      By-Laws of the Company.

3.6 (n)      Certificate of Powers,  Designations,  Preferences  and rights of
             Series F Preferred Stock of the Company.

10.1 (c)     Amended and Restated 1997 Stock Option Plan.

10.2 (a)     Lease  Agreement by and between the Company and John R.  Perlman,
             et al., dated as of May 5, 1997.

10.3 (b)     Lease by and between  the  Company  and Adams & Co. Real  Estate,
             Inc., dated March 22, 1999.

10.4 (c)     Lease by and between  the  Company  and Adams & Co. Real  Estate,
             Inc., dated May 4, 2000.

10.5 (d)     Bluefly, Inc. 2000 Stock Option Plan.

10.6 (d)     Investment  Agreement,  dated November 13, 2000, by and among the
             Company,  Bluefly Merger Sub, Inc., Quantum  Industrial  Partners
             LDC and SFM Domestic Investments LLC.

*10.7 (e)    Software License and Services Agreement, dated March 12, 2002, by
             and among the Company and Blue Martini Software, Inc.

10.8 (f)     Warrant No. 1 dated March 27, 2002, issued to Quantum Industrial
             Partners LDC.

10.9 (f)     Warrant No. 2 dated March 27, 2002, issued to SFM Domestic
             Investments LLC.

10.10 (f)    Warrant No. 3 dated March 30, 2002, issued to Quantum Industrial
             Partners LDC.

10.11 (f)    Warrant No. 4 dated March 30, 2002, issued to SFM Domestic
             Investments LLC.

10.12 (g)    Common Stock and Warrant Purchase Agreement, dated May 24,
             2002, by and between the Registrant and the investors listed
             on Schedule 1 thereto.

10.13        Employment Agreement, dated as of November 14, 2006, by and between
             the Company and Patrick Barry.

10.14 (h)    Note and Warrant Purchase Agreement, dated January 28, 2003, by and
             between the Registrant and the investors listed on Schedule 1
             thereto.

                                       27
<PAGE>

10.15 (h)    Warrant No. 1 dated January 28, 2003, issued to Quantum Industrial
             Partners LDC.

10.16 (h)    Warrant No. 2 dated January 28, 2003, issued to SFM Domestic
             Investments LLC.

10.17 (h)    Warrant No. 4 dated March 17, 2003, issued to Quantum Industrial
             Partners LDC.

10.18 (h)    Warrant No. 5 dated March 17, 2003, issued to SFM Domestic
             Investments LLC.

10.19        Employment Agreement dated as of November 14, 2006 by and between
             Bluefly, Inc. and Melissa Payner-Gregor.

10.20 (i)    Common Stock and Warrant  Purchase  Agreement  dated  January 9,
             2004 by and among the Company and the Investors listed on
             Schedule 1 thereto.

*10.21 (j)   CallTech Master Agreement for Outsourcing Contact Center Support,
             dated as of August 5, 2004, by and between the Registrant and
             CallTech Communications, LLC.

10.22 (k)    Bluefly, Inc. 2005 Stock Incentive Plan.

*10.23 (l)   Master Service Agreement,  dated as of February 28, 2005, by and
             between the Company and Level 3 Communications, LLC.

*10.24 (l)   Customer Order Addendum,  dated as of February 28, 2005, by and
             between the Company and Level 3 Communications, LLC.

*10.25 (m)   Master Services Agreement, dated as of March 21, 2005, by and
             between the Company and NewRoads, Inc.

*10.26 (m)   Statement of Work 1 by and between the Company and NewRoads, Inc.

10.27 (n)    Preferred  Stock and Warrant  Purchase  Agreement,  dated as of
             June 24, 2005, by and among the Company and the Investors listed
             on the signature page thereto.

10.28 (o)    Loan and Security  Agreement,  dated July 26, 2005,  by and between
             the Company and Wells Fargo Retail Finance, LLC.

10.29 (p)    Employment Agreement, dated as of September 19, 2005, by and
             between the Company and Bradford Matson.

10.30 (q)    Stock Purchase  Agreement,  dated as of June 5, 2006, by and among
             Bluefly, Inc., Quantum Industrial Partners LDC, SFM Domestic
             Investments, LLC and the investors listed on the signature pages
             attached thereto.

10.31 (q)    Form of Voting Agreement by and among Bluefly,  Inc., Quantum
             Industrial Partners LDC, SFM Domestic Investments, LLC, Maverick
             Fund USA, Ltd., Maverick Fund, L.D.C., Maverick Fund II, Ltd. And
             Prentice-Bluefly, LLC.

10.32 (q)    Fee Letter,  dated June 5, 2006, by and among Bluefly,  Inc.,
             Quantum Industrial Partners LDC and SFM Domestic Investments,
             LLC.

10.33 (q)    Waiver Letter, dated June 5, 2006, by and between Bluefly, Inc.
             and Wells Fargo Retail Finance, LLC.

10.34 (r)    First  Amendment to Loan and  Security  Agreement,  dated as of
             August 14, 2006, by and between the Company and Wells Fargo
             Retail Finance, LLC

10.35 (s)    Master License  Agreement,  dated as of September 28, 2006, by and
             between the Company and Art Technology Group, Inc.

                                       28
<PAGE>

23.1         Consent of PricewaterhouseCoopers LLP.

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.

*    Confidential treatment has been granted as to certain portions of this
     Exhibit. Such portions have been redacted.

(a)  Incorporated by reference to the Company's Quarterly report filed on Form
     10-QSB for the quarterly period ended March 31, 1997.
(b)  Incorporated by reference to the Company's Quarterly report filed on Form
     10-QSB for the quarterly period ended June 30, 1999.
(c)  Incorporated by reference to the Company's Quarterly report filed on Form
     10-Q for the quarterly period ended June 30, 2000.
(d)  Incorporated by reference to the Company's Quarterly report filed on Form
     10-Q for the quarterly period ended September 30, 2000.
(e)  Incorporated by reference to the Company's Annual report filed on Form 10-K
     for the year ended December 31, 2000.
(f)  Incorporated by reference to the Company's Annual report filed on Form 10-K
     for the year ended December 31, 2001.
(g)  Incorporated by reference to the Company's Quarterly report filed on Form
     10-Q for the quarterly period ended June 30, 2002.
(h)  Incorporated by reference to the Company's Annual Report filed on Form 10-K
     for the year ended December 31, 2002.
(i)  Incorporated by reference to the Company's current report on Form 8-K,
     dated January 13, 2004.
(j)  Incorporated by reference to the Company's quarterly report on Form 10-Q
     for the quarterly period ended June 30, 2004.
(k)  Incorporated by reference to the Company's annual report on Form 10-K for
     the year ended December 31, 2005.
(l)  Incorporated by reference to the Company's current report on Form 8-K,
     dated March 4, 2005.
(m)  Incorporated by reference to the Company's current report on Form 8-K,
     dated March 23, 2005.
(n)  Incorporated by reference to the Company's current report on Form 8-K,
     dated June 28, 2005.
(o)  Incorporated by reference to the Company's current report on Form 8-K,
     dated July 29, 2005.
(p)  Incorporated by reference to the Company's current report on Form 8-K,
     dated September 22, 2005.
(q)  Incorporated by reference to the Company's current report on Form 8-K,
     dated June 7, 2006.
(r)  Incorporated by reference to the Company's current report on Form 8-K,
     dated August 14, 2006.
(s)  Incorporated by reference to the Company's current report on Form 8-K,
     dated October 3, 2006.

                                       29
<PAGE>

                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) 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 and
                                                     President

February 28, 2007

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report  has  been  signed  below  by the  following  persons  on  behalf  of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
Signature                   Title                                                    Date
-------------------------   ------------------------------------------------------   -----------------
<S>                         <C>                                                      <C>
/s/ David Wassong           Interim Chairman of Board                                February 28, 2007
-------------------------
David Wassong

/s/ Melissa Payner-Gregor   Chief Executive Officer (Principal Executive Officer),   February 28, 2007
-------------------------   President and Director
Melissa Payner-Gregor

/s/ Patrick C. Barry        Chief Financial Officer and Chief Operating              February 28, 2007
-------------------------   Officer (Principal Accounting Officer)
Patrick C. Barry

/s/ Barry Erdos
-------------------------   Director                                                 February 28, 2007
Barry Erdos

s/Michael Gross
-------------------------   Director                                                 February 28, 2007
Michael Gross

/s/ Ann Jackson
-------------------------   Director                                                 February 28, 2007
Ann Jackson

/s/ Martin Miller
-------------------------   Director                                                 February 28, 2007
Martin Miller

/s/ Neal Moszkowski
-------------------------   Director                                                 February 28, 2007
Neal Moszkowski

/s/Christopher McCann
-------------------------   Director                                                 February 28,2007
Christopher McCann

/s/ Alex Rafal
-------------------------   Director                                                 February 28, 2007
Alex Rafal
</TABLE>

                                       30
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders
of Bluefly, Inc.:

In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of Bluefly,
Inc. at December 31, 2006 and December 31, 2005, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2006 in conformity with accounting principles generally accepted in
the United States of America. In addition, in our opinion, the financial
statement schedule listed in the accompanying index presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 2 to the financial statements, the Company changed the
manner in which it accounts for stock-based compensation in 2006.


/s/ PricewaterhouseCoopers LLP

New York, New York
February 26, 2007

                                       F-1
<PAGE>

BLUEFLY, INC.
BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
(dollars rounded to the nearest thousand)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                       2006             2005
                                                                                  --------------   --------------
<S>                                                                               <C>              <C>
ASSETS
Current assets
    Cash and cash equivalents                                                     $   20,188,000   $    9,408,000
    Inventories, net                                                                  24,189,000       16,893,000
    Accounts receivable, net of allowance for doubtful accounts                        2,719,000        1,717,000
    Prepaid expenses and other current assets                                          1,510,000        1,819,000
                                                                                  --------------   --------------
         Total current assets                                                         48,606,000       29,837,000

Property and equipment, net                                                            3,573,000        2,895,000
Other assets                                                                             251,000          313,000
                                                                                  --------------   --------------
         Total assets                                                             $   52,430,000   $   33,045,000
                                                                                  ==============   ==============
LIABILITIES AND SHAREHOLDERS'  EQUITY
Current liabilities
    Accounts payable                                                              $    4,822,000   $    5,662,000
    Allowance for sales returns                                                        5,043,000        3,407,000
    Accrued expenses and other current liabilities                                     1,908,000        1,083,000
    Deferred revenue                                                                   2,830,000        1,784,000
                                                                                  --------------   --------------
         Total current liabilities                                                    14,603,000       11,936,000

Notes payable to related party shareholders                                                    -        4,000,000
Long-term interest payable to related party shareholders                                       -        1,217,000
Long-term obligations under capital lease                                                      -           27,000
                                                                                  --------------   --------------
         Total liabilities                                                            14,603,000       17,180,000
                                                                                  ==============   ==============
Commitments and contingencies (Note 8)

Shareholders' equity
Series A Preferred Stock - $.01 par value; 500,000 shares authorized, 0 and
 460,000 shares issued and outstanding as of December 31, 2006 and 2005,
 respectively (liquidation preference at December 31, 2005: $9.2 million plus
 $5.9 million of accrued dividends)                                                            -            5,000
Series B Preferred Stock - $.01 par value; 9,000,000 shares authorized, 0 and
 8,889,414 shares issued and outstanding as of December 31, 2006 and 2005,
 respectively (liquidation preference at December 31, 2005: $30 million plus
 $9.5 million of accrued dividends)                                                            -           89,000
Series C Preferred Stock - $.01 par value; 3,500 shares authorized, 0 and 1,000
 shares issued and outstanding as of December 31, 2006 and 2005, respectively
 (liquidation preference at December 31, 2005: $1 million plus $286,000 of
 accrued dividends)                                                                            -                -
Series D Preferred Stock - $.01 par value; 7,150 shares authorized, 0 and
 6,313.43 shares issued and outstanding as of December 31, 2006 and 2005,
 respectively (liquidation preference at December 31, 2005: $6.3 million plus
 $2.4 million of accrued dividends)                                                            -                -
Series E Preferred Stock - $.01 par value; 1,000 shares authorized, 0 and 1,000
 issued and outstanding as of December 31, 2006 and 2005, respectively
 (liquidation preference at December 31, 2005: $1.0 million plus $347,000 of
 accrued dividends)                                                                            -                -
Series F Preferred Stock - $.01 par value; 7,000 shares authorized, 571.43 and
 5,279.714 issued and outstanding as of December 31, 2006 and 2005,
 respectively (liquidation preference at December 31, 2006: $571,000 plus
 $62,000 of accrued dividends, at December 31, 2005: $5.3 million plus accrued
 dividends of $192,000)                                                                        -                -
Common Stock - $.01 par value; 152,000,000 and 92,000,000 shares authorized,
 130,484,854 and 19,059,166 shares issued and outstanding as of December 31,
 2006 and 2005, respectively                                                           1,305,000          191,000
Additional paid-in capital                                                           152,519,000      115,527,000
Accumulated deficit                                                                 (115,997,000)     (99,947,000)
                                                                                  --------------   --------------
         Total shareholders' equity                                                   37,827,000       15,865,000
                                                                                  --------------   --------------
         Total liabilities and shareholders' equity                               $   52,430,000   $   33,045,000
                                                                                  ==============   ==============
</TABLE>

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

                                       F-2
<PAGE>

BLUEFLY, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(dollars rounded to the nearest thousand)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                               2006            2005            2004
                                                           -------------   -------------   -------------
<S>                                                        <C>             <C>             <C>
Net sales                                                  $  77,062,000   $  58,811,000   $  43,799,000
Cost of sales                                                 46,153,000      35,816,000      27,393,000
                                                           -------------   -------------   -------------
     Gross profit                                             30,909,000      22,995,000      16,406,000

Marketing expenses                                            14,196,000       6,961,000       2,120,000

Selling and fulfillment expenses                              15,808,000      12,880,000      11,783,000
General and administrative expenses                           13,001,000       6,299,000       6,408,000
                                                           -------------   -------------   -------------
     Total operating expenses                                 43,005,000      26,140,000      20,311,000
                                                           -------------   -------------   -------------
     Operating loss                                          (12,096,000)     (3,145,000)     (3,905,000)

Interest expense                                                (599,000)       (856,000)       (733,000)

Interest income                                                  502,000         181,000         114,000

Other income (Note 6)                                                  -               -         733,000
                                                           -------------   -------------   -------------
     Net loss                                                (12,193,000)     (3,820,000)     (3,791,000)
                                                           -------------   -------------   -------------
Preferred stock dividends                                     (2,252,000)     (4,958,000)     (4,275,000)

Deemed dividend related to beneficial conversion
 feature on Series F Preferred Stock                          (3,857,000)              -               -
                                                           -------------   -------------   -------------
     Net loss available to common shareholders             $ (18,302,000)  $  (8,778,000)  $  (8,066,000)
                                                           =============   =============   =============
     Basic and diluted loss per common share               $       (0.23)  $       (0.54)  $       (0.55)
                                                           =============   =============   =============
Weighted average number of shares outstanding used in
 calculating basic and diluted loss per common share          80,170,532      16,153,020      14,586,752
                                                           =============   =============   =============
</TABLE>

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

                                       F-3
<PAGE>

BLUEFLY, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(Dollars rounded to the nearest thousand)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                            SERIES A                         SERIES B
                                                         PREFERRED STOCK                  PREFERRED STOCK
                                                         $.01 PAR VALUE                   $.01 PAR VALUE
                                                -------------------------------   -------------------------------
                                                   NUMBER OF                         NUMBER OF
                                                    SHARES           AMOUNT           SHARES           AMOUNT
                                                --------------   --------------   --------------   --------------
<S>                                                   <C>        <C>                  <C>          <C>
Balance at January 1, 2004                             460,000   $        5,000        8,889,414   $       89,000
                                                --------------   --------------   --------------   --------------
Sale of Common Stock and Warrants in
 connection with the January 2004 financing
 (net of issuance costs of $423,000)                         -                -                -                -
Change in Value of Warrants                                  -                -                -                -
Exercise of Employee Stock Options                           -                -                -                -
Expense recognized in connection with
 Issuance of Options                                         -                -                -                -
Net loss                                                     -                -                -                -
                                                --------------   --------------   --------------   --------------
Balance at December 31, 2004                           460,000   $        5,000        8,889,414   $       89,000
                                                --------------   --------------   --------------   --------------
Sale of Series F Preferred Stock
 ($1,000 per share net of expenses of $249,000)              -                -                -                -
Shares Of Series D Preferred Stock
 Converted into Common Stock                                 -                -                -                -
Shares Of Series F Preferred Stock
 Converted into Common Stock                                 -                -                -                -
Expense recognized in connection with
 Issuance of Options                                         -                -                -                -
Exercise of Employee Options                                 -                -                -                -
Net Loss                                                     -                -                -                -
                                                ==============   ==============   ==============   ==============
Balance at December 31, 2005                           460,000            5,000        8,889,414           89,000
                                                ==============   ==============   ==============   ==============
Conversion of Preferred Stock                         (460,000)          (5,000)      (8,889,414)         (89,000)
Stock based compensation                                     -                -                -                -
Sale of Common Stock, net of issuance
 expenses of approximately $2.0 million                      -                -                -                -
Issuance of Common Stock to Placement Agent                  -                -                -                -
Warrants Issued to Third-Party                               -                -                -                -
Dividends Paid to Related Party Shareholders                 -                -                -                -
Deemed Dividends related to beneficial
 conversion on Series F Preferred Stock                      -                -                -                -
Exercise of Employee Options                                 -                -                -                -
Issuance of Restricted Stock                                 -                -                -                -
Net Loss                                                     -                -                -                -
                                                ==============   ==============   ==============   ==============
Balance at December 31, 2006                                 -   $            -                -   $            -
                                                ==============   ==============   ==============   ==============

<CAPTION>
                                                           SERIES C                         SERIES D
                                                        PREFERRED STOCK                  PREFERRED STOCK
                                                         $.01 PAR VALUE                   $.01 PAR VALUE
                                                -------------------------------   -------------------------------
                                                   NUMBER OF                        NUMBER OF
                                                    SHARES           AMOUNT           SHARES           AMOUNT
                                                --------------   --------------   --------------   --------------
<S>                                                     <C>      <C>                      <C>      <C>
Balance at January 1, 2004                               1,000   $            -            7,136   $            -
                                                --------------   --------------   --------------   --------------
Sale of Common Stock and Warrants in
 connection with the January 2004 financing
 (net of issuance costs of $423,000)                         -                -                -                -
Change in Value of Warrants                                  -                -                -                -
Exercise of Employee Stock Options                           -                -                -                -
Expense recognized in connection with
 Issuance of Options                                         -                -                -                -
Net loss                                                     -                -                -                -
                                                --------------   --------------   --------------   --------------
Balance at December 31, 2004                             1,000   $            -            7,136   $            -
                                                --------------   --------------   --------------   --------------
Sale of Series F Preferred Stock
 ($1,000 per share net of expenses of $249,000)              -                -                -                -

Shares Of Series D Preferred Stock
 Converted into Common Stock                                 -                -             (823)  $            -
Shares Of Series F Preferred Stock
 Converted into Common Stock                                 -                -                -                -
Expense recognized in connection with
 Issuance of Options                                         -                -                -                -
Exercise of Employee Options                                 -                -                -                -
Net Loss                                                     -                -                -                -
                                                ==============   ==============   ==============   ==============
Balance at December 31, 2005                             1,000                -            6,313   $            -
                                                ==============   ==============   ==============   ==============
Conversion of Preferred Stock                           (1,000)               -           (6,313)               -
Stock based compensation                                     -                -                -                -
Sale of Common Stock, net of issuance
 expenses of approximately $2.0 million                      -                -                -                -
Issuance of Common Stock to Placement Agent                  -                -                -                -
Warrants Issued to Third-Party                               -                -                -                -
Dividends Paid to Related Party Shareholders                 -                -                -                -
Deemed Dividends related to beneficial
 conversion on Series F Preferred Stock                      -                -                -                -
Exercise of Employee Options                                 -                -                -                -
Issuance of Restricted Stock                                 -                -                -                -
Net Loss                                                     -                -                -                -
                                                ==============   ==============   ==============   ==============
Balance at December 31, 2006                                 -   $            -                -   $            -
                                                ==============   ==============   ==============   ==============

<CAPTION>
                                                           SERIES E                          SERIES F
                                                        PREFERRED STOCK                   PREFERRED STOCK
                                                         $.01 PAR VALUE                    $.01 PAR VALUE
                                                -------------------------------   -------------------------------
                                                  NUMBER OF                         NUMBER OF
                                                    SHARES          AMOUNT            SHARES           AMOUNT
                                                --------------   --------------   --------------   --------------
<S>                                                     <C>      <C>                      <C>      <C>
Balance at January 1, 2004                               1,000   $            -                -   $            -
                                                --------------   --------------   --------------   --------------
Sale of Common Stock and Warrants in
 connection with the January 2004 financing
 (net of issuance costs of $423,000)                         -                -                -                -
Change in Value of Warrants                                  -                -                -                -
Exercise of Employee Stock Options                           -                -                -                -
Expense recognized in connection with
 Issuance of Options                                         -                -                -                -
Net loss                                                     -                -                -                -
                                                --------------   ---------------  --------------   --------------
Balance at December 31, 2004                            1,000    $            -                -   $            -
                                                --------------   ---------------  --------------   --------------
Sale of Series F Preferred Stock
 ($1,000 per share net of expenses of $249,000)              -                -            7,000                -

Shares Of Series D Preferred Stock
 Converted into Common Stock                                 -                -                -                -
Shares Of Series F Preferred Stock
 Converted into Common Stock                                 -                -           (1,720)  $            -
Expense recognized in connection with
 Issuance of Options                                         -                -                -                -
Exercise of Employee Options                                 -                -                -                -
Net Loss                                                     -                -                -                -
                                                ==============   ==============   ==============   ==============
Balance at December 31, 2005                             1,000                -            5,280                -
                                                ==============   ==============   ==============   ==============
Conversion of Preferred Stock                           (1,000)               -           (4,709)               -
Stock based compensation                                     -                -                -                -
Sale of Common Stock, net of issuance
 expenses of approximately $2.0 million                      -                -                -                -
Issuance of Common Stock to Placement Agent                  -                -                -                -
Warrants Issued to Third-Party                               -                -                -                -
Dividends Paid to Related Party Shareholders                 -                -                -                -
Deemed Dividends related to beneficial
 conversion on Series F Preferred Stock                      -                -                -                -
Exercise of Employee Options                                 -                -                -                -
Issuance of Restricted Stock                                 -                -                -                -
Net Loss                                                     -                -                -                -
                                                ==============   ==============   ==============   ==============
Balance at December 31, 2006                                 -   $            -              571   $            -
                                                ==============   ==============   ==============   ==============

<CAPTION>
                                                        COMMON STOCK
                                                        $.01 PAR VALUE
                                                -------------------------------     ADDITIONAL                          TOTAL
                                                   NUMBER OF                         PAID-IN        ACCUMULATED     SHAREHOLDERS'
                                                    SHARES           AMOUNT          CAPITAL          DEFICIT           EQUITY
                                                --------------   --------------   --------------   --------------   --------------
<S>                                                <C>           <C>              <C>              <C>              <C>
Balance at January 1, 2004                          12,894,166   $      129,000   $  102,392,000   $  (92,336,000)  $   10,279,000
                                                --------------   --------------   --------------   --------------   --------------
Sale of Common Stock and Warrants in
 connection with the January 2004 financing
 (net of issuance costs of $423,000)                 1,543,209           15,000        4,562,000                -        4,577,000
Change in Value of Warrants                                  -                -         (564,000)               -         (564,000)
Exercise of Employee Stock Options                     804,381            8,000          733,000                -          741,000
Expense recognized in connection with
 Issuance of Options                                         -                -          147,000                -          147,000
Net loss                                                     -                -                -       (3,791,000)      (3,791,000)
                                                --------------   --------------   --------------   --------------   --------------
Balance at December 31, 2004                        15,241,756   $      152,000   $  107,270,000   $  (96,127,000)  $   11,389,000
                                                --------------   --------------   --------------   --------------   --------------
Sale of Series F Preferred Stock
 ($1,000 per share net of expenses of $249,000)              -                -        6,751,000                -        6,751,000
Shares Of Series D Preferred Stock
 Converted into Common Stock                         1,454,645           15,000          (15,000)               -                -
Shares Of Series F Preferred Stock
 Converted into Common Stock                           765,481            8,000           (8,000)               -                -
Expense recognized in connection with
 Issuance of Options                                         -                -           41,000                -           41,000
Exercise of Employee Options                         1,597,284           16,000        1,488,000                -        1,504,000
Net Loss                                                     -                -                -       (3,820,000)      (3,820,000)
                                                ==============   ==============   ==============   ==============   ==============
Balance at December 31, 2005                        19,059,166   $      191,000   $  115,527,000   $  (99,947,000)  $   15,865,000
                                                ==============   ==============   ==============   ==============   ==============
Conversion of Preferred Stock                       48,545,527          485,000         (391,000)               -                -
Stock based compensation                                                               4,454,000                -        4,454,000
Sale of Common Stock, net of issuance
 expenses of approximately $2.0 million             60,975,610          610,000       47,420,000                -       48,030,000
Issuance of Common Stock to Placement Agent          1,000,000           10,000        1,070,000                -        1,080,000
Warrants Issued to Third-Party                               -                -           67,000                -           67,000
Dividends Paid to Related Party Shareholders                 -                -      (19,512,000)               -      (19,512,000)
Deemed Dividends related to beneficial
 conversion on Series F Preferred Stock                      -                -        3,857,000       (3,857,000)               -
Exercise of Employee Options                            43,330                -           36,000                -           36,000
Issuance of Restricted Stock                           861,221            9,000           (9,000)               -                -
Net Loss                                                     -                -                -      (12,193,000)     (12,193,000)
                                                ==============   ==============   ==============   ==============   ==============
Balance at December 31, 2006                       130,484,854   $    1,305,000   $  152,519,000   $ (115,997,000)  $   37,827,000
                                                ==============   ==============   ==============   ==============   ==============
</TABLE>

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

                                       F-4
<PAGE>

BLUEFLY, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                     2006            2005            2004
                                                                 -------------   -------------   -------------
<S>                                                              <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss                                                         $ (12,193,000)  $  (3,820,000)  $  (3,791,000)
Adjustments to reconcile net loss to net cash used in
    operating activities
      Depreciation and amortization                                  1,532,000       1,259,000       1,342,000
      Loss on disposal of assets                                             -               -          35,000
      Non-cash expense related to warrants issued to supplier          153,000         347,000         264,000
      Change in value of warrants                                            -               -        (564,000)
      Provision for returns                                          1,636,000       1,233,000        (354,000)
      Bad debt expense                                                 643,000         270,000         237,000
      Reserve for inventory obsolesence                              1,000,000         659,000         100,000
      Stock based compensation                                       4,454,000          41,000         147,000
      Warrant issued to consultant                                      67,000               -               -
      Changes in operating assets and liabilities
        (Increase) decrease in
           Inventories                                              (8,449,000)     (4,941,000)     (1,982,000)
           Accounts receivable                                      (1,645,000)       (778,000)       (289,000)
           Other current assets                                       (134,000)        554,000        (269,000)
           Prepaid expenses                                            443,000      (1,020,000)       (127,000)
           Other assets                                                      -        (187,000)              -
        (Decrease) increase in:
           Accounts payable                                           (840,000)      1,472,000       1,068,000
           Accrued expenses                                          1,932,000        (171,000)        186,000
           Interest payable to related party shareholders           (1,217,000)        559,000         519,000
           Deferred revenue                                          1,046,000          87,000         445,000
                                                                 -------------   -------------   -------------
             Net cash used in operating activities                 (11,572,000)     (4,436,000)     (3,033,000)
                                                                 -------------   -------------   -------------
CASH FLOWS FROM INVESTING ACTIVITIES

Cash collateral in connection with Rosenthal
 Pledge Agreement                                                            -       1,250,000      (1,250,000)
Purchase of property and equipment                                  (2,148,000)     (2,194,000)     (1,486,000)
                                                                 -------------   -------------   -------------
             Net cash used in investing activities                  (2,148,000)       (944,000)     (2,736,000)
                                                                 -------------   -------------   -------------
CASH FLOWS FROM FINANCING ACTIVITIES

Net proceeds from June 2006 financing                               48,030,000               -               -
Net proceeds from June 2005 financing                                        -       6,751,000               -
Net proceeds from January 2004 financing                                     -               -       4,577,000
Net proceeds from exercise of Stock Options                             36,000       1,504,000         741,000
Payments of capital lease obligation                                   (54,000)       (152,000)       (349,000)
Dividends paid to related party shareholders                       (19,512,000)
Repayment of related party notes                                    (4,000,000)              -        (236,000)
                                                                 -------------   -------------   -------------
             Net cash provided by financing activities              24,500,000       8,103,000       4,733,000
                                                                 -------------   -------------   -------------
             Net increase (decrease) in cash and
              cash equivalents                                      10,780,000       2,723,000      (1,036,000)

CASH AND CASH EQUIVALENTS
Beginning of year                                                    9,408,000       6,685,000       7,721,000
                                                                 -------------   -------------   -------------
End of year                                                      $  20,188,000   $   9,408,000   $   6,685,000
                                                                 -------------   -------------   -------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

Cash paid during the year for interest                           $   1,658,000   $     147,000   $     175,000
                                                                 =============   =============   =============
Non-cash investing and financing activites
    Deemed dividend related to beneficial
     conversion feature on Series F Preferred Stock              $   3,857,000               -               -
                                                                 =============   =============   =============
    Issuance of Common Stock to placement agent                  $   1,080,000               -               -
                                                                 =============   =============   =============
    Conversion of Preferred Stock to Common Stock                $     391,000               -               -
                                                                 =============   =============   =============
    Equipment acquired under capital lease                       $           -               -         153,000
                                                                 =============   =============   =============
</TABLE>

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

                                       F-5
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

1.   THE COMPANY

     Bluefly,  Inc.,  a  Delaware  corporation,  (the  "Company"),  is a leading
     Internet   retailer  that  sells  over  350  brands  of  designer  apparel,
     accessories and home products at discount prices. The Company's  e-commerce
     Web site  ("Bluefly.com" or "Web site") was launched in September 1998. The
     Company operates in one business segment that has no operations outside the
     United States.

     The  Company  has  sustained  net  losses  and  negative  cash  flows  from
     operations  since the formation of  Bluefly.com.  The Company's  ability to
     meet its  obligations in the ordinary  course of business is dependent upon
     its  ability  to  establish  profitable   operations  or  raise  additional
     financing  through  public or private  debt or equity  financing,  or other
     sources of  financing to fund  operations.  The Company  believes  that its
     existing  resources,  together with working capital should be sufficient to
     satisfy its cash  requirements  through at least  December  31,  2007.  The
     Company may seek  additional  equity or debt  financings  to  maximize  the
     growth  of  its  business  or if  anticipated  operating  results  are  not
     achieved.

2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     REVENUE RECOGNITION

     The Company recognizes revenue in accordance with Staff Accounting Bulletin
     ("SAB 104") No. 104 "Revenue  Recognition."  Gross sales consists primarily
     of revenue from product sales and shipping and handling  charges and is net
     of promotional discounts.  Net sales represent gross sales, less provisions
     for returns,  credit card chargebacks and adjustments for uncollected sales
     tax. Revenue is recognized when all the following criteria are met:

     o    A customer executes an order.

     o    The  product  price  and the  shipping  and  handling  fee  have  been
          determined.

     o    Credit card  authorization  has occurred and  collection is reasonably
          assured.

     o    The product has been shipped and received by the customer.

     Shipping and  handling  billed to  customers  is  classified  as revenue in
     accordance with Financial  Accounting Standards Board ("FASB") Task Force's
     Emerging Issues Task Force ("EITF") No. 00-10, "Accounting for Shipping and
     Handling Fees and Costs" ("EITF No. 00-10").

     PROVISIONS FOR SALES RETURNS AND DOUBTFUL ACCOUNTS

     The Company  generally permits returns for any reason within 90 days of the
     sale.  The  Company  performs  credit  card  authorizations  and checks the
     verifications   of  its  customers   prior  to  shipment  of   merchandise.
     Accordingly,  the Company  establishes a reserve for estimated future sales
     returns and allowance for doubtful  accounts at the time of shipment  based
     primarily  on  historical  data.  Accounts  receivable  is presented on the
     consolidated  balance sheet net of the allowance for doubtful accounts.  As
     of December 31, 2006 and 2005,  the  allowance  for  doubtful  accounts was
     $397,000 and $78,000, respectively, and the allowance for sales returns was
     $5,043,000 and $3,407,000, respectively.

                                       F-6

<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     Deferred  revenue,  which consists  primarily of goods shipped to customers
     but not yet received and customer credits, totaled approximately $2,830,000
     and $1,784,000 as of December 31, 2006 and 2005, respectively.

     CASH AND CASH EQUIVALENTS

     The  Company  considers  all highly  liquid  investments  with an  original
     maturity of three months or less to be cash and cash equivalents.

     INVENTORIES

     Inventories,  which consist of finished  goods,  are stated at the lower of
     cost or market.  Cost is  determined by the  first-in,  first-out  ("FIFO")
     method.  The  Company  reviews  its  inventory  levels in order to identify
     slow-moving  merchandise  and  establishes a reserve for such  merchandise.
     Inventory   reserves  are   established   based  on  historical   data  and
     management's  best  estimate of excess  inventory.  Inventory may be marked
     down below cost if management  determines that the inventory stock will not
     sell at its currently marked price.  Inventory is presented net of reserves
     on the consolidated balance sheet.

     As of  December  31,  2006  and  2005,  inventories,  net  consists  of the
     following:

                                               2006           2005
                                           ------------   ------------
Inventory on hand                          $ 23,150,000   $ 15,811,000
Inventory to be received due to returns       2,094,000      1,864,000
Inventory reserves                           (1,055,000)      (782,000)
                                           ------------   ------------
             Total inventories, net        $ 24,189,000   $ 16,893,000
                                           ============   ============

     PROPERTY AND EQUIPMENT

     Property and  equipment are stated at cost net of  depreciation.  Equipment
     and software are  depreciated  on a  straight-line  basis over two to seven
     years.  Leasehold  improvements  are  amortized  over the  shorter of their
     estimated  useful  lives or the term of the lease.  Lease  amortization  is
     included in depreciation  expense.  Maintenance and repairs are expensed as
     incurred.

     Certain  equipment  held under capital leases is classified as property and
     equipment and amortized using the straight-line method over the lease terms
     and the related obligations are recorded as liabilities.

     Costs related to the upgrade and  development of the Web Site are accounted
     for in  accordance  with  EITF  Issue No.  00-02  "Accounting  for  Website
     Development  Costs", and to the extent they are capitalized,  are amortized
     over 36 months.

     LONG-LIVED ASSETS

     The  Company's  policy  is  to  evaluate  long-lived  assets  for  possible
     impairment  whenever events or changes in  circumstances  indicate that the
     carrying amount of such assets may not be  recoverable.  This evaluation is
     based on a number of factors,  including  expectations for operating income
     and  undiscounted  cash flows that will result from the use of such assets.
     The Company has not identified any such impairment of assets.

                                       F-7
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     INCOME TAXES

     The Company  recognizes  deferred  income tax assets and liabilities on the
     differences  between the  financial  statement  and tax bases of assets and
     liabilities  using  enacted  statutory tax rates in effect for the years in
     which the differences are expected to reverse. The effect on deferred taxes
     of a change in tax rates is  realized  in income or loss in the period that
     includes  the  enactment  date.  In  addition,   valuation  allowances  are
     established  when it is more likely than not that  deferred tax assets will
     not be realized.

     STOCK-BASED COMPENSATION

     The Company's  Board of Directors  has adopted  three stock based  employee
     compensation  plans,  one in April 2005,  one in July 2000 and the other in
     May 1997 (collectively the "Plans"), which are described more fully in Note
     9. The Plans, which provide for the granting of restricted stock,  deferred
     stock unit awards and stock options, and other equity and cash awards, were
     adopted for the  purpose of  encouraging  key  employees,  consultants  and
     directors who are not  employees to acquire a  proprietary  interest in the
     growth and performance of the Company,  and are similar in nature.  Vesting
     term for  restricted  stock  generally  range from one quarter to one year,
     while  deferred  stock unit awards vest  quarterly over one to three years.
     Options are granted in terms not to exceed ten years and become exercisable
     as  specified  when the  option is granted  and  vesting  terms  range from
     immediately to a ratable  vesting  period of four years.  The Plans have an
     aggregate of 15,700,000 shares authorized for issuance.

     Before January 1, 2006, the Company accounted for stock-based  compensation
     under the recognition and measurement  principles of Accounting  Principles
     Board Opinion  ("APB") No. 25,  "Accounting  for Stock Issued to Employees"
     ("APB 25"),  and  related  interpretations.  The Company did not  recognize
     compensation  expense  related to stock  options  granted to employees  and
     directors  where the exercise  price was at or above fair value at the date
     of grant.  Statement of Financial Accounting Standards No. 123, "Accounting
     for  Stock-Based   Compensation,"  established  accounting  and  disclosure
     requirements using a fair-value-based  method of accounting for stock-based
     employee  compensation  plans.  As  permitted  by SFAS No. 123, the Company
     elected to continue to apply the intrinsic-value-based method of APB No. 25
     described above,  and adopted only the disclosure  requirements of SFAS No.
     123, as amended by SFAS No. 148, "Accounting For Stock-Based Compensation -
     Transition and Disclosure."

     On January  1, 2006,  the start of the first  quarter of fiscal  2006,  the
     Company  adopted  the  provisions  of  Statement  of  Financial  Accounting
     Standards  No.  123  (revised  2004),   "Share-Based  Payment"  ("SFAS  No.
     123(R)"),  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  SFAS No.  123(R)  using the  modified
     prospective  application  method  under  which the  provisions  of SFAS No.
     123(R)  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 Statement
     of  Operations  over the remaining  service  period after the adoption date
     based on the award's  original  estimate  of fair value.  Results for prior
     periods have not been  restated.  Total  share-based  compensation  expense
     recorded in the  Statement of  Operations  for the year ended  December 31,
     2006 is $4,454,000.

     On March 29, 2005, the SEC published Staff Accounting  Bulletin ("SAB") No.
     107, which  provides the Staff's views on a variety of matters  relating to
     stock-based  payments.  SAB No. 107 requires  stock-based  compensation  be
     classified  in the  same  expense  line  items  as cash

                                       F-8
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     compensation. The application of SFAS No. 123(R) had an effect on full year
     2006  reported  amounts  relative to amounts that would have been  reported
     using the intrinsic value method under previous accounting.  As a result of
     adopting SFAS No. 123(R), the Company's operating loss and net loss for the
     year ended December 31, 2006 was $4,424,000 higher than if it had continued
     to account for share-based compensation under APB No. 25. Basic and diluted
     loss per share for the year ended  December  31, 2006 would have been $0.06
     per  share,  lower,  respectively,  if the  Company  had not  adopted  SFAS
     No.123(R). There was no effect on the Company's operating cash flows.

     The  following  table  illustrates  the effect on net loss and net loss per
     common share applicable to common stockholders for the years ended December
     31, 2005 and 2004 as if the Company had applied the fair value  recognition
     provisions  for  stock-based  employee  compensation  of SFAS No.  123,  as
     amended.  For the year  ended  December  31,  2005,  and 2004  compensation
     expense of $30,000 and $17,000,  respectively,  was recorded in  connection
     with certain  options  issued below  market  value to the  Company's  Chief
     Executive Officer in accordance with the terms of her employment agreement.
     In addition, for the year ended December 31, 2004, $113,000 in compensation
     expense was  recorded in  connection  with  certain  options  issued to the
     Company's  former  Chief  Executive  Officer  pursuant  to  his  separation
     agreement.  Except for these  options,  no  compensation  expense  has been
     recorded  for the year ended  December  31, 2005 and  December  31, 2004 in
     connection  with stock  option  grants to  employees,  because the exercise
     price of employee  stock options  equals or exceeds the market price of the
     underlying  stock on the  date of  grant.  For  purposes  of the pro  forma
     presentation,  option forfeitures are accounted for as they occurred and no
     amounts of  compensation  expense have been  capitalized  into inventory or
     other assets, but instead were considered as period expenses (in thousands,
     except per share data):

                                                  YEAR ENDED DECEMBER 31,
                                              -------------------------------
                                                   2005             2004
                                              --------------   --------------
Net loss, as reported                             (3,820,000)  $   (3,791,000)
Deduct: total stock-based employee
    compensation expense determined
    under fair value based methods for all
    awards, net of related tax effects            (2,731,000)      (4,617,000)
Add: Stock-based employee compensation
    expense included in reported net loss             30,000          130,000
Adjusted for Preferred Stock Dividends            (4,958,000)      (4,275,000)
                                              --------------   --------------
          Pro forma net loss available to
           common shareholders                   (11,479,000)     (12,553,000)
Loss per share
    Basic and diluted, as reported            $        (0.54)  $        (0.55)
    Basic and diluted, pro forma              $        (0.71)  $        (0.86)

     NET LOSS PER SHARE

     The Company  calculated net loss per share in accordance with SFAS No. 128,
     "Earnings  Per  Share."  Basic  loss per  share  excludes  dilution  and is
     computed by dividing loss available to common  shareholders by the weighted
     average number of common shares outstanding for the period. For purposes of
     calculating  basic and diluted  loss per share,  the Company  presents  the
     amount of  dividends  earned  but  unpaid on the face of the  statement  of
     operations.

                                       F-9
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     Diluted  loss per share is computed by dividing  loss  available  to common
     shareholders  by the weighted  average number of common shares  outstanding
     for the period, adjusted to reflect potentially dilutive securities. Due to
     the loss,  the  following  shares  of Common  Stock  issuable  pursuant  to
     options, warrants,  Preferred Stock and Convertible Notes were not included
     in the computation of diluted earnings per share because the result of such
     inclusion would be antidilutive:

<TABLE>
<CAPTION>
                                           COMMON STOCK ISSUABLE
                            ---------------------------------------------------      EXERCISE
                                2006                2005             2004             PRICES
                            --------------      --------------   --------------   --------------
<S>                             <C>                 <C>              <C>           <C>
SECURITY
Options                          5,417,116           8,038,528        9,813,379    $0.69- $16.47
Restricted Stock Awards         10,723,488  (3)              -                -         n/a
Warrants                         1,695,893           1,883,393        1,704,945    $0.78 - $3.96
Preferred stock                    758,620  (1)     44,516,119       43,323,430
Convertible Notes(2)                     -                   -                -

</TABLE>

     (1)  At December  31, 2006,  there were 571 shares of Series F  Convertible
          Preferred Stock  outstanding that are convertible  into  approximately
          696,341 shares of Common Stock (excluding dividends).

     (2)  Represents  debt issued in connection with the July 2003 financing and
          October 2003 financing, which is convertible into equity securities of
          the Company sold in any subsequent round of financing, at the holder's
          at a price that is equal to the lowest price per share accepted by any
          investor in such subsequent  round of financing.  Until such financing
          occurs,  such debt is not  convertible  into Common Stock. At December
          31, 2005,  such debt was not  convertible  into Common Stock.  In June
          2006, all of the convertible notes were repaid.

     (3)  Includes both Restricted Stock and Restricted Stock Units

     MARKETING EXPENSES

     In addition to marketing salaries,  marketing expenses consist primarily of
     online  advertising,  print and media  advertising,  costs  associated with
     sweepstakes,  direct  mail  campaigns  as  well  as  the  related  external
     production  costs. The costs  associated with online and print  advertising
     are  expensed  as  incurred,  while the costs  associated  with direct mail
     campaigns are  capitalized  and charged to expense over the expected future
     revenue stream. There were no amounts associated with direct mail campaigns
     capitalized  at December  31, 2006 and 2005.  Production  costs  related to
     print and television are capitalized until they are released.

     FULFILLMENT EXPENSES

     The Company utilizes a third party to perform all of its order  fulfillment
     including  warehousing,  administrative  support,  returns  processing  and
     receiving  labor.  For the years ended  December 31,  2006,  2005 and 2004,
     fulfillment   expenses  totaled  $4,409,000,   $3,642,000  and  $2,914,000,
     respectively.   These  amounts  are  included  in  selling,  marketing  and
     fulfillment expenses in the statement of operations.

     FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying amounts of the Company's financial instruments, including cash
     and  cash  equivalents,   other  assets,   accounts  payable,  and  accrued
     liabilities, approximate fair value due to their short maturities.

     RECENT ACCOUNTING PRONOUNCEMENTS

     In September 2006, the Financial Accounting Standards Board ("FASB") issued
     FASB Statement No. 157, Fair Value Measurements ("SFAS 157"), which defines
     fair value,  establishes a

                                      F-10
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     framework  for  measuring  fair  value  in  generally  accepted  accounting
     principles, and expands disclosures about fair value measurements. SFAS 157
     is effective for  financial  statements  issued for fiscal years  beginning
     after  November 15, 2007,  and interim  periods  within those fiscal years.
     Earlier  application is encouraged,  provided that the reporting entity has
     not yet  issued  financial  statements  for  that  fiscal  year,  including
     financial  statements  for an interim  period within that fiscal year.  The
     Company is evaluating the potential  effects of adopting SFAS 157, and does
     not  expect  the  adoption  to  have a  material  impact  on its  financial
     condition and results of operations.

     In September  2006 the Securities  and Exchange  Commission  ("SEC") issued
     Staff Accounting  Bulletin No. 108 ("SAB 108") which provides  interpretive
     guidance  on how the  effects of the  carryover  or  reversal of prior year
     misstatements   should  be  considered   in   quantifying  a  current  year
     misstatement.  SAB 108 is effective for fiscal years ending after  November
     15,  2006.  The  adoption  of this  pronouncement  will not have a material
     impact on the Company's financial statements.

     In July 2006, the Financial  Accounting  Standards  Board  ("FASB")  issued
     Interpretation  No. 48,  "Accounting  for  Uncertainty in Income  Taxes--an
     interpretation  of FASB Statement No. 109" ("FIN 48"),  which clarifies the
     accounting for uncertainty in tax positions.  This Interpretation  requires
     an entity  to  recognize  the  impact of a tax  position  in its  financial
     statements  if that  position is more likely  than not to be  sustained  on
     audit based on the technical merits of the position.  The provisions of FIN
     48 are  effective  as of the  beginning  of  fiscal  year  2007,  with  the
     cumulative  effect of the change in  accounting  principle  recorded  as an
     adjustment to opening  retained  earnings.  Early  application of FIN 48 is
     encouraged.  The Company is still  evaluating the timing of its adoption of
     FIN 48 and the potential effects of implementing this  Interpretation,  but
     does not expect its  adoption  to have a material  effect on its  financial
     condition  and  results  of  operations  due to the  fact the  Company  has
     incurred significant losses.

     CONCENTRATION

     The Company  acquired  approximately  27.5% and 13.5% of its inventory from
     one supplier for fiscal 2006 and 2005, respectively.

     USE OF ESTIMATES

     The  preparation  of financial  statements  in  conformity  with  generally
     accepted  accounting  principles  requires management to make estimates and
     assumptions  that affect the reported amounts of assets and liabilities and
     disclosures  of  contingent  assets  and  liabilities  at the  date  of the
     financial  statements  and the  reported  amounts of revenues  and expenses
     during the reporting period.  Significant estimates and assumptions include
     the  adequacy  of the  allowances  for  sales  returns,  recoverability  of
     inventories,  useful  lives  of  property  and  equipment,  realization  of
     deferred    tax    assets,     and    the    calculations     related    to
     stock-basedcompensation. Actual results could differ from those estimates.

3.   PROPERTY AND EQUIPMENT

     As of December 31, 2006 and 2005,  property and  equipment  consists of the
     following:

                                      F-11
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

                                        2006             2005
                                   --------------   --------------
Leasehold improvements             $    1,814,000   $    1,658,000
Office equipment                          594,000          574,000
Computer equipment and software         9,101,000        7,129,000
                                   --------------   --------------
                                       11,509,000        9,361,000
Less:  Accumulated depreciation        (7,936,000)      (6,466,000)
                                   --------------   --------------
                                   $    3,573,000   $    2,895,000
                                   ==============   ==============

     Depreciation and  amortization of property and equipment was  approximately
     $1,419,000,  $1,145,000  and  $1,331,000,  for the years ended December 31,
     2006, 2005 and 2004, respectively.

4.   PREPAID EXPENSES AND OTHER CURRENT ASSETS

     As of December 31, 2006 and 2005, prepaid expenses and other current assets
     consist of the following:

                                        2006             2005
                                   --------------   --------------
Prepaid expenses                   $      341,000   $      915,000
Prepaid inventory                         616,000          485,000
Other current assets                      553,000          419,000
                                   --------------   --------------
                                   $    1,510,000   $    1,819,000
                                   ==============   ==============

5.   ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

     As of  December  31,  2006 and 2005,  accrued  expenses  and other  current
     liabilities consist of the following:

                                        2006             2005
                                   --------------   --------------
Salary, vacation and bonus accrual $      763,000   $      574,000
Current portion of capital
 lease liability                           13,000           40,000
Accrued media expenses                    667,000          328,000
Other accrued expenses                    465,000          141,000
                                   --------------   --------------
                                   $    1,908,000   $    1,083,000
                                   ==============   ==============

6.   OTHER INCOME

     In June 2002,  the Company  entered  into an  agreement  with a third party
     investor pursuant to which the investor committed to purchase approximately
     $7 million of Common  Stock and  warrants  from the  Company.  The investor
     breached the contract by failing to consummate the investment,  although it
     did provide the Company with $169,000 as a good faith  deposit.  In October
     2002, the Company filed an action against the investor based on its failure
     to  consummate  the  investment,  and in December  2003,  the court entered
     judgment in the  Company's  favor  against the third party  investor in the
     amount  of  $3,793,688.  In  the  first  quarter  of  2004,  following  the
     expiration of all

                                      F-12
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     applicable appeal periods, the Company recognized the good faith deposit of
     $169,000  as  other  income,   as  a  partial   recognition  of  litigation
     settlement.  Based on the information  currently  available to it regarding
     the  investor's  finances,  the Company  does not  believe  that it will be
     successful in collecting a material amount of additional  funds as a result
     of the damages award.

     In addition,  as discussed  in Note 9, the Company  recognized  $564,000 of
     other  income for the year ended  December  31,  2004 to adjust a liability
     associated with warrants issued by the Company to its fair value as of June
     17,  2004 (at  which  point the  liability  was  reclassified  as equity in
     accordance with EITF 00-19 and described in Note 9).

7.   INCOME TAXES

     Significant components of the Company's deferred tax assets and liabilities
     as of December 31, are summarized as follows:

<TABLE>
<CAPTION>
                                                        2006            2005
                                                   --------------   --------------
<S>                                                <C>              <C>
DEFERRED TAX ASSETS
Net operating losses                               $   33,437,000   $   29,252,000
Depreciation and amortization                             285,000         (137,000)
Accounts receivable and inventory reserves                587,000          348,000
Other accruals                                            313,000          528,000
Stock options                                          (2,201,000)               -
Deferred revenue                                                -          721,000
Returns reserve                                         2,038,000                -
                                                   --------------   --------------
                                                       34,459,000       30,712,000
Valuation Allowance                                   (34,459,000)     (30,712,000)
                                                   --------------   --------------
     Net deferred tax asset (liability)            $            -   $            -
                                                   ==============   ==============

</TABLE>

     The Company is in an  accumulated  loss  position  for both  financial  and
     income tax reporting  purposes.  The Company has U.S. Federal net operating
     loss carryforwards of approximately  $82,744,000 at December 31, 2006 which
     have expiration dates from 2018 through 2025. Approximately $6.4 million of
     these net operating loss  carryforwards  relate to the exercise of employee
     stock  options.  Pursuant to Section 382 of the Internal  Revenue Code, the
     usage of these net  operating  loss  carryforwards  may be  limited  due to
     changes in  ownership  that have  occurred or that may occur in the future.
     The Company has not yet  determined  the impact,  if any,  that  changes in
     ownership  have  had on  net  operating  loss  carryforwards.  The  Company
     provided  a full  valuation  allowance  on the  entire  deferred  tax asset
     balance to reflect the  uncertainty  regarding the  realizability  of these
     assets due to operating losses incurred since inception.

                                      F-13
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     The Company's  effective tax rate differs from the U.S. Federal  Statutory
     income tax rate of 35% as follows:

<TABLE>
<CAPTION>

                                                 2006           2005           2004
                                             ------------   ------------    -----------
<S>                                                <C>            <C>            <C>
Statutory federal income tax rate                  (35.00)%       (35.00)%       (35.00)%
State tax benefit, net of federal taxes             (5.41)%        (5.41)%        (5.41)%
Other                                                2.23%          0.27%          0.34%
Valuation allowance on deferred tax asset           38.18%         40.14%         40.07%
                                             ------------   ------------   ------------
             Effective tax rate                      0.00%          0.00%          0.00%
                                             ============   ============   ============
</TABLE>

8.   COMMITMENTS AND CONTINGENCIES

     EMPLOYMENT CONTRACTS

     During  2006,  the  Company  entered  into  thirty-six   month   employment
     agreements  with its Chief  Executive  Officer ("CEO ") and Chief Financial
     Officer  ("CFO").  These  employment  agreements  along with certain  other
     employment  agreements,  have  terms  expiring  through  July  2009.  As of
     December 31, 2006, the Company's  aggregate cash commitment for future base
     salary under these employment contracts is:

        2007         $  1,990,000
        2008            1,363,000
        2009              425,000
                     ------------
                     $  3,778,000
                     ============

     LEASES

     The Company leases  equipment and space under various capital and operating
     leases that expire at various  dates  through  2011.  Future  minimum lease
     payments under capital and operating leases, excluding utilities, that have
     initial  or  remaining  non-cancelable  terms in  excess of one year are as
     follows:

     Rent expense  (including amounts related to commercial rent tax) aggregated
     approximately $566,000,  $450,000 and $442,000 for the years ended December
     31, 2006, 2005, and 2004, respectively.

     MARKETING AND TECHNOLOGY COMMITMENTS

     As of  December  31,  2006,  the  Company  has  advertising  and  marketing
     commitments  in connection  with email  services,  agency fees and costs in
     connection with a national ad campaign of approximately  $1,068,000 through
     December 31, 2007.

     In September 2006, the Company entered into a Master License Agreement (the
     "Master License Agreement") with a service provider,  pursuant to which the
     Company will license certain technology to be used as a platform for future
     versions of the  Company's  Web site.  The service  provider  will  provide
     certain  support and consulting  services in connection  with this project.
     Beginning in January 2007, the Company will develop an improved  version of
     its Web site based

                                      F-14
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     on the new  software.  The new version of Bluefly's Web site is expected to
     launch in the third quarter of 2007 and will replace the older version.  In
     connection with this Master License Agreement, the Company has committed to
     spend $1,207,000,  of which $999,000 was incurred during the fourth quarter
     of 2006 and the balance of $208,000 will be paid during 2007.

     LEGAL PROCEEDINGS

     The Company is, from time to time, involved in litigation incidental to the
     conduct of its business.  However,  the Company is not party to any lawsuit
     or  proceeding  which,  in the  opinion of  management  is likely to have a
     material adverse effect on its financial condition.

9.   SHAREHOLDERS' EQUITY

     AUTHORIZED SHARES

     The Company is  incorporated  in Delaware  and has  152,000,000  authorized
     shares of common  stock,  $.01 par value per share  ("Common  Stock"),  and
     25,000,000  authorized  shares of preferred stock, $.01 par value per share
     (the  "Preferred  Stock").  The  Preferred  Stock is designated as follows:
     500,000  shares of Series A  Convertible  Preferred  Stock  (the  "Series A
     Preferred Stock"); 9,000,000 shares of Series B Convertible Preferred Stock
     (the  "Series B Preferred  Stock");  3,500  shares of Series C  Convertible
     Preferred  Stock (the "Series C Preferred  Stock");  2,100 shares of Series
     2002 Convertible  Preferred Stock (the "Series 2002  Convertible  Preferred
     Stock");  7,150 shares of Series D Convertible Preferred Stock (the "Series
     D Preferred Stock");  1,000 shares of Series E Convertible  Preferred Stock
     (the  "Series E Preferred  Stock");  7,000  shares of Series F  Convertible
     Preferred  Stock (the "Series F Preferred  Stock");  and 15,479,250  shares
     undesignated and available for issuance.

     PREFERRED STOCK
     OUTSTANDING SHARES

     The  Company's  currently  has 571.43  shares of Series F  Preferred  Stock
     outstanding  with a stated value of approximately  $571,430.  In June 2006,
     all of the Series A, B, C, D and E shares of Preferred  Stock, as well as a
     significant  portion of the Series F Preferred Stock,  were converted in to
     shares  of  Common  Stock,  as  more  fully  discussed  in the  "June  2006
     Financing" below.

     DIVIDENDS

     Each  share of Series F  Preferred  Stock  bears a  cumulative  compounding
     dividend, payable upon conversion in cash or Common Stock, at the Company's
     option, at the rate of 7% per annum.

     RANKING

     The Series F Preferred Stock ranks senior to the Common Stock, with respect
     to the payment of distributions  on liquidation,  dissolution or winding up
     of the Company and with respect to the payment of dividends.

     CONVERSION

     The Series F Preferred  Stock is convertible  into Common Stock at the rate
     of $2.32 in stated value per share of Common Stock.

     The Series F Preferred Stock contains anti-dilution  provisions pursuant to
     which, subject to certain exceptions,  in the event that the Company issues
     or sells its Common  Stock or new  securities  convertible  into its Common
     Stock in the  future  for less than the  conversion  price of the  Series F
     Preferred Stock, the conversion price of the Series F preferred stock would
     be  decreased  to the

                                      F-15
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     price at which such Common Stock or other new  securities are sold. As more
     fully described below, the conversion price of the Series F Preferred Stock
     was reduced from $2.32 per share to $0.82 per share in connection  with the
     June 2006 Financing as a result of these anti-dilution provisions.

     VOTING RIGHTS

     The Series F Preferred Stock votes with the Common Stock on an as-converted
     basis.

     REDEMPTION

     The Company is  entitled  to redeem the shares of Series F Preferred  Stock
     for cash at a price  equal to the stated  value,  plus  accrued  and unpaid
     dividends.

     JUNE 2006 FINANCING

     On June 15, 2006 (the  "Closing  Date"),  the  Company  completed a private
     placement (the "Private  Placement")  through the sale of 60,975,610 shares
     of its common stock, par value $0.01 per share (the "Common  Stock"),  at a
     price of $0.82 per share.  The Private  Placement was made to affiliates of
     Maverick Capital,  Ltd.  ("Maverick") and Prentice Capital  Management,  LP
     ("Prentice").  The aggregate  proceeds from the Private  Placement were $50
     million,  almost  half of  which  was  purchased  by each of  Maverick  and
     Prentice.  The purchase price of $0.82 per share represented an 11% premium
     to the closing bid price of the Common  Stock on June 5, 2006,  the date of
     signing of the definitive stock purchase agreement. The shares purchased in
     the Private  Placement  included  203,016  shares of Common Stock that were
     purchased by a holder of Series D Convertible Preferred Stock in connection
     with the exercise of such holder's  preemptive rights. The amount purchased
     by Maverick and Prentice in the Private Placement was reduced on a pro rata
     basis as a result of the exercise of such holder's preemptive rights.

     Concurrent with the closing of the Private  Placement,  affiliates of Soros
     Fund Management LLC ("Soros") converted all of their outstanding  Preferred
     Stock into 44,729,960  shares of the Company's  Common Stock. The remaining
     shares  of  Series  D  Convertible  Preferred  Stock,  which  were  held by
     investors  other than Soros,  automatically  converted into an aggregate of
     1,073,936  shares of Common  Stock.  The  placement  agent for the  Private
     Placement was paid a commission of 5% of the gross proceeds,  half of which
     was paid by the Company and the other half by Soros. Of the commission paid
     by the  Company,  $1 million was paid  through the issuance of Common Stock
     and the remainder was paid in cash.

     On the  Closing  Date,  the Company  paid Soros $25 million in cash,  which
     represented  $4,000,000  of the  principal  and  $1,488,376  of accrued but
     unpaid interest on the outstanding  convertible notes (the "Notes") held by
     Soros and the majority of the accrued but unpaid dividends on the shares of
     Preferred Stock that were converted by Soros in connection with the Private
     Placement,  with the remaining  accrued but unpaid dividends on such shares
     of Preferred Stock paid in shares of Common Stock.  The remaining  proceeds
     are being used by the Company for general corporate  purposes.  As a result
     of the Private  Placement and the conversion of the Preferred Stock,  Soros
     collectively owns approximately 39% of the Company's Common Stock, and each
     of Maverick and  Prentice own  approximately  24% of the  Company's  Common
     Stock.

     As a result of the Private Placement, the conversion price of the Company's
     Series F  Convertible  Preferred  Stock,  the majority of which was held by
     Soros, automatically decreased from $2.32 to $0.82. In accordance with FASB
     Emerging Issue Task Force Issue No. 00-27,  "Application  of Issue No. 98-5
     to Certain Convertible Instruments," this reduction in the conversion price
     of the Company's Series F Preferred Stock resulted in the Company recording
     a beneficial  conversion

                                      F-16
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     feature in the approximate  amount of approximately $3.9 million as part of
     its second  quarter  financial  results.  This  non-cash  charge,  which is
     analogous  to a  dividend,  resulted  in an  adjustment  to  the  Company's
     computation of Loss Per Share.

     The  Company  agreed  to use its  commercially  reasonable  efforts  to (i)
     prepare  and  file  with  the  Securities  and  Exchange   Commission  (the
     "Commission") a registration  statement (the  "Registration  Statement") to
     register  the shares of Common Stock sold in the Private  Placement  within
     120 days of the Closing Date and (ii) cause the  Registration  Statement to
     be  declared  effective  by the  Commission  within 180 days of the Closing
     Date.  The  Registration  Statement  has  since  been  filed  and  declared
     effective.

     JUNE 2005 FINANCING

     The Company  raised over  $7,000,000 in equity  financing in June 2005. The
     financing  was  effected  through  a  private  placement  (the  "June  2005
     Financing")  that closed on June 24, 2005.  The Company  raised  $7,075,431
     through  the sale of 7,000  shares of newly  designated  Series F Preferred
     Stock  for an  aggregate  purchase  price of  $7,000,000  and  warrants  to
     purchase an  additional  603,448  shares of its common stock at an exercise
     price of $2.87 per share.  The warrants have an expiration date of June 24,
     2008. The aggregate purchase price for the warrants was $75,431,  or $0.125
     per warrant,  and all of the warrants  were  purchased by the New Investors
     described  below.  The investors  participating  in the June 2005 Financing
     included eight private equity funds that had not previously participated in
     the Company's financing transactions (the "New Investors"), and two private
     equity  funds  affiliated  with  Soros.  In  connection  with the June 2005
     Financing,  the New Investors also purchased from Soros  previously  issued
     shares  of the  Company's  Series  D  Preferred  Stock  with  an  aggregate
     liquidation preference and accrued dividends of $3,000,000.

     JANUARY 2004 FINANCING

     In January  2004,  the Company  completed a private  placement  pursuant to
     which it raised $5,000,000 (the "January 2004 Financing").  Under the terms
     of the deal, the Company issued  1,543,209  shares of Common Stock at $3.24
     per share,  which was 90% of the trailing five-day average of the Company's
     volume-weighted  stock  price as of  December  29,  2003,  the date  that a
     preliminary  agreement  was  reached  as to the  pricing  of the deal.  The
     Company  also issued to the new  investors  warrants  to  purchase  385,801
     shares  of  Common  Stock at any time  during  the  next  five  years at an
     exercise  price  equal to $3.96  per  share.  After  professional  fees and
     finders fees paid to brokers,  the net proceeds from the  transaction  were
     approximately $4,577,000.

     WARRANTS TO PURCHASE COMMON STOCK
     WARRANTS TO SOROS

     The Company has issued warrants to Soros in connection with past and recent
     financings as well as in connection with the Rosenthal Loan Facility (which
     has  since  been  refinanced).  Warrants  issued  in  connection  with  the
     Company's  Loan  Facility are included in the table below and are described
     more fully in Note 11.

     In connection with the January 2003 Financing,  the Company issued warrants
     to purchase  25,000 shares of its common stock,  exercisable at any time on
     or prior to January  28,  2007 at $1.12 per share to Soros.  Subsequent  to
     year end the warrants were exercised.

     The Company  valued the warrants  using the Black  Scholes  option  pricing
     model using the  following  assumptions:  risk free interest  rate:  3.54%,
     volatility 113%,  expected life 4 years,  zero dividend yield.  Using these
     factors the warrants were valued at $21,000 and were expensed over the life
     of the note. The full amount was expensed in the first quarter of 2003.

                                      F-17
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     In exchange for the March 2002  Standby  Agreement,  the Company  issued to
     Soros  warrants to purchase  100,000  shares of Common Stock at an exercise
     price of $1.68 per share (the 20 day  trailing  average of the closing sale
     price of the Company's  Common Stock on the date of issuance),  exercisable
     at any time until March 27, 2007. The Company valued the warrants using the
     Black Scholes  option pricing model using the following  assumptions:  risk
     free interest rate:  5.22%,  volatility 183%,  expected life 3 years,  zero
     dividend  yield.  The  Company  accounted  for the  warrants  by  crediting
     additional paid in capital for approximately  $157,000 and capitalizing the
     amount on the  balance  sheet.  This  amount was then  netted  against  the
     proceeds from the  subsequent  May 2003  Financing and July 2003  Financing
     described above, on a pro rata basis.

     WARRANTS ISSUED TO CONSULTANT

     In February  2006, the Company issued a warrant to a consultant in exchange
     for investor relations services.  The Company used the Black-Scholes option
     pricing method  (assumption:  volatility  118%, risk free rate 4.49%,  five
     years expected life and zero dividend  yield) to calculate the value of the
     100,000   warrants  issued  in  connection  with  a  warrant  issued  to  a
     consultant.  Using those  assumptions a value of approximately  $67,000 was
     assigned to the warrant and charged to general and administrative expenses.
     These warrants expire in February 2011.

     WARRANTS ISSUED TO INVESTORS

     The Company  used the  Black-Scholes  option  pricing  method  (assumption:
     volatility  79%, risk free rate 3.86% one and a half year expected life and
     zero dividend yield) to calculate the value of the 603,448  warrants issued
     in connection with the June 2005 Financing. Using those assumptions a value
     of approximately  $423,000 was assigned to the warrant.  In accordance with
     EITF 00-27, Application of EITF Issue No. 98-5, "Accounting for Convertible
     Securities with Beneficial  Conversion Features or Contingently  Adjustable
     Conversion  Ratios" the Company  evaluated the total value  ascribed to the
     warrants  under  Black-Scholes  and  compared  that to the  total  proceeds
     raised.  In  connection  with  that the  Company  recognized  a  beneficial
     conversion feature of approximately $87,000.

     In  accordance  with EITF  00-19,  the  Company  accounted  for the 385,801
     warrants  issued in  connection  with the January  2004  Financing  at fair
     market value and classified the warrants as a liability because the Company
     may have been required to make cash payments to the investors who purchased
     the  warrants in the event that the  registration  statement  covering  the
     offer and sale of the shares  underlying  the warrants were to no longer be
     effective.  The  Company  used  the  Black-Scholes  option  pricing  method
     (assumption:  volatility  147%, risk free rate 3.76% two year expected life
     and zero dividend yield) to calculate the value of the warrants. At January
     12, 2004, the date of transaction (the  "Transaction  Date"),  the warrants
     had a value of  $1,096,000.  The value of the warrants was marked to market
     in each subsequent reporting period as a derivative gain or loss until June
     17, 2004 (the "End Date"), at which time EITF 00-19 called for the warrants
     to be  re-classified  as equity  because the maximum  potential cash amount
     payable to the  investors had decreased to the point where it was no longer
     considered significant.

     During the period  beginning on the Transaction  Date and ending on the End
     Date, the value of the warrants decreased from $1,096,000 to $532,000, and,
     accordingly  the Company  recognized  $564,000 of other income for the year
     ended December 31, 2004.

                                      F-18
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     The following table represents  warrants issued to purchase Common Stock as
     of December 31, 2006:

                 NUMBER OF         EXERCISE
PARTY             WARRANTS       PRICE RANGE         EXPIRATION DATES
------------   --------------   --------------   -------------------------
Investors             989,249   $2.87 - $3.96    June 2008 - January 2009
Soros                 606,644   $0.78 - $2.34    January 2007 - March 2013
Consultant            100,000       $1.00              February 2011
               --------------
                    1,695,893
               ==============

     STOCK-BASED COMPENSATION PLANS

     The Company's  Board of Directors  has adopted  three stock based  employee
     compensation plans. The Plans, which provide for the granting of restricted
     stock,  restricted  stock  units,  stock  options and other equity and cash
     awards,  were  adopted  for  the  purpose  of  encouraging  key  employees,
     consultants  and  directors  who are not employees to acquire a proprietary
     interest in the growth and performance of the Company.

     In November 2006, the Company entered into three year employment  contracts
     with its CEO and CFO. In connection with these agreements,  the CEO and CFO
     were entitled to, among other things, (i) restricted stock awards under our
     Plans for a total of 861,221  shares of our Common Stock,  (which vested in
     full on  January  1,  2007) plus cash  bonuses  of  $517,890  (intended  to
     compensate  them for the  income  taxes  payable on such  restricted  stock
     awards) in exchange  for the  forfeiting  of their  right to certain  fully
     vested and out-of-the-money  stock options that would have been exercisable
     to purchase an aggregate of 2,518,458 shares of Common Stock; (ii) deferred
     stock unit awards  under the Plan for 172,741  underlying  shares of Common
     Stock (which vest  quarterly  over a two year period),  in exchange for the
     forfeiting of their right to certain  unvested and  out-of-the-money  stock
     options  that would have been  exercisable  to  purchase  an  aggregate  of
     326,454  shares of Common  Stock;  and (iii) subject to the approval of the
     Company's  stockholders of certain amendments to the Plans,  deferred stock
     unit awards representing 8,264,524 shares of Common Stock with one-third of
     such  deferred  stock units vesting  quarterly,  in equal  amounts,  over a
     twelve month period,  one-third vesting quarterly, in equal amounts, over a
     twenty-four  month  period,  and  one-third  vesting  quarterly,  in  equal
     amounts,  over a thirty-six month period. The vesting period for all awards
     commences on October 1, 2006.

     The Company  recorded the exchange of the options for restricted  stock and
     deferred stock unit awards as replacement  awards, and therefore under SFAS
     No. 123R treated the  exchange as a  modification  of the  original  option
     grant and recorded incremental  compensation cost measured as the excess of
     the fair  value  of the  replacement  awards,  measured  immediately  after
     modification,  over  the  fair  value  of  the  cancelled  award,  measured
     immediately   before   modification,   at  the  modification   date.  Total
     incremental  compensation expense was approximately $507,000. In connection
     with  these new  awards,  the  Company  will  recognize  an expense of $9.3
     million  over three years.  Approximately  $2.1 million of this expense was
     recognized in 2006.

     RESTRICTED STOCK AND DEFERRED STOCK UNIT AWARDS

     The following  table is a summary of activity  related to restricted  stock
     and deferred stock units grants for key employees at December 31, 2006:

                                      F-19
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                           RESTRICTED      DEFERRED STOCK
                                                              STOCK          UNIT AWARDS
                                                         ---------------   ---------------
<S>                                                         <C>            <C>
Balance at January 1, 2006                                     --                --
Shares/Units Granted                                         861,221         9,862,267
Shares/Units Forfeited                                         --                --
Balance at December 31, 2006                                 861,221         9,862,267

Weighted Average Grant Date Fair Value Per share              $0.95             $0.94
Aggregate Grant Date Fair Value                             $818,160         $9,270,531

Vesting Service Period of Shares Granted                    3 months       12 - 36 months
Number of shares/units vested at December 31, 2006             --                --
Number of shares/units unvested at December 31, 2006         861,221          9,862,267
</TABLE>

     For the year ended  December 31, 2006 the Company  recognized an expense of
     approximately $2,159,000 in connection with these awards.

     As of December 31, 2006 the total  compensation  cost related to non-vested
     restricted  stock and  deferred  stock  units not yet  recognized  was $8.3
     million.  Total compensation cost is expected to be recognized over a three
     year period beginning on October 1, 2006.

     STOCK OPTIONS
     The following table summarizes the Company's stock option activity:

<TABLE>
<CAPTION>
                                                             NUMBER           WEIGHTED
                                                               OF              AVERAGE
                                                             SHARES        EXERCISE PRICE
                                                         ---------------   ---------------
<S>                                                            <C>         <C>
Balance at January 1, 2004                                     8,508,370   $          2.04

Options granted                                                2,629,750   $          2.74
Options canceled                                                (534,360)  $          2.57
Options exercised                                               (790,381)  $          0.95
                                                         ---------------
Balance at December 31, 2004                                   9,813,379   $          2.28

Options granted                                                2,039,000   $          1.39
Options canceled                                              (2,216,567)  $          3.56
Options exercised                                             (1,597,284)  $          0.94
                                                         ---------------
Balance at December 31, 2005                                   8,038,528   $          1.97
                                                         ---------------
Options granted                                                  521,000   $          0.96
Options canceled                                              (3,099,082)  $          2.32
Options exercised                                                (43,330)  $          0.82
                                                         ---------------
Balance at December 31, 2006                                   5,417,116   $          1.68
                                                         ---------------
Vested at December 31, 2004                                    6,512,125   $          2.44
Vested at December 31, 2005                                    4,969,929   $          2.15
Vested at December 31, 2006                                    3,682,877   $          1.83
</TABLE>

                                      F-20
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     The stock  options are  exercisable  in  different  periods  through  2016.
     Additional  information  with  respect  to the  outstanding  options  as of
     December 31, 2006, is as follows:

<TABLE>
<CAPTION>
                         OPTIONS OUTSTANDING                        OPTIONS EXERCISABLE
                  --------------------------------                ------------------------
                                      WEIGHTED        WEIGHTED                   WEIGHTED
   RANGE OF                           AVERAGE         AVERAGE                    AVERAGE
   EXERCISE           OPTIONS        REMAINING        EXERCISE      OPTIONS      EXERCISE
    PRICES         OUTSTANDING    CONTRACTUAL LIFE     PRICE      EXERCISABLE     PRICE
---------------   -------------   ----------------   ----------   -----------   ----------
<S>                   <C>            <C>                 <C>        <C>             <C>
  $0.00 - $1.66       3,985,116      7.2 Years            $1.09     2,645,881        $1.06
  $1.66 - $3.32       1,192,500      7.2 Years            $2.30       819,091        $2.43
  $3.32 - $4.98          75,000      7.1 Years            $3.92        53,405        $3.92
  $4.98 - $6.64          22,250      2.0 Years            $5.11        22,250        $5.11
  $6.64 - $9.96          52,750      2.6 Years            $9.17        52,750        $9.17
 $9.96 - $11.62          54,250      3.0 Years           $11.18        54,250       $11.18
$11.62 - $14.94           6,250      2.9 Years           $14.04         6,250       $14.04
$14.94 - $16.60          29,000      2.1 Years           $15.19        29,000       $15.19

 $0.69 - $16.60       5,417,116      7.0 YEARS            $1.68     3,682,877        $1.83
</TABLE>

     The total fair value of the  1,427,008  options that vested during the year
     was approximately $2,198,000. At December 31, 2006, the aggregate intrinsic
     value of the fully vested  options was  $683,000  and the weighted  average
     remaining  contractual  life of the options was 6.2 years.  The Company has
     not capitalized any compensation  cost, or modified any of its stock option
     grants for the years  ended  December  31,  2006 and 2005.  Other  selected
     information is as follows:

<TABLE>
<CAPTION>
                                                       2006            2005            2004
                                                   -------------   -------------   -------------
<S>                                                <C>             <C>             <C>
Aggregate intrinsic value of outstanding options   $     881,000   $     399,000   $   6,573,000
Aggregate intrinsic value of options exercised     $       7,000   $   1,088,000   $   1,210,000
Weighted average fair value of options granted     $        0.79   $        1.24   $        2.60
</TABLE>

     As of December 31, 2006 the total  compensation  cost related to non-vested
     stock option awards not yet recognized was $2,252,000.  Total  compensation
     cost is  expected  to be  recognized  over 1.5 years on a weighted  average
     basis.

     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  of the  Company's  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  note  in  effect  on the  date  of the  grant.  The  Company  had
     previously  recorded  expense  in  accordance  with APB No. 25 for  certain
     options  issued to its CEO and  President  that were issued  below  market.
     Prior  to the  adoption  of  FAS  123(R),  the  Company  recognized  actual
     forfeitures  when they  occurred but has not  recorded a cumulative  effect
     adjustment to record  estimated  forfeitures  related to these below market
     options as the balance was immaterial.

     The table below presents the  assumptions  used to calculate the fair value
     of options  granted for the year ended  December  31,  2006,  2005 and 2004
     respectively:

                                      F-21
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

                               YEAR ENDED DECEMBER 31,
                           ------------------------------
                             2006       2005       2004
                           --------   --------   --------
Risk-free interest rates       4.65%      4.22%      3.63%
Expected life (in years)          6          6          6
Dividend yield                    0%         0%         0%
Expected volatility             101%       138%       139%

     In January 2007, the Company  commenced an exchange offer pursuant to which
     it is offering to exchange  certain  outstanding  stock  options  issued to
     employees and  non-employee  directors for  restricted  stock awards and/or
     deferred stock unit awards. See Note 15.

10.  NOTES PAYABLE TO RELATED PARTY SHAREHOLDERS

     In connection  with the June 2006 Financing  described  above,  the Company
     repaid the Convertible Promissory Notes issued to Soros in July and October
     2003 (the "Notes"). The Company paid $4,000,000 of principal and $1,488,376
     of interest.  The Notes were set to mature in May 2007 and bore interest at
     12% per annum.

     In addition to the $4,000,000 of promissory notes issued in connection with
     the July  2003  Financing  and  October  2003  Financing  (see Note 9 ), on
     December 15, 2001,  the Company  issued  promissory  notes in the amount of
     $182,000 to  affiliates  of Soros in exchange for legal  services  provided
     during the course of the year.  The notes bore interest at 9% per annum and
     had a maturity  date of December  15,  2004.  In December  2004 the Company
     repaid the notes with accrued interest of $54,000 for a total of $236,000.

11.  FINANCING AGREEMENT

     In July 2005, the Company  entered into a new three year  revolving  credit
     facility ("Credit  Facility") with Wells Fargo Retail Finance,  LLC ("Wells
     Fargo").  The Credit  Facility  refinanced  the Company's  previous  credit
     facility  (the  "Rosenthal  Facility")  with  Rosenthal &  Rosenthal,  Inc.
     ("Rosenthal"). Under the terms of the Credit Facility, Wells Fargo provides
     the Company with a revolving  credit  facility and issues letters of credit
     in favor of suppliers or factors.  The Credit Facility is secured by a lien
     on all of the Company's assets. Historically,  the Credit Facility has also
     been secured by a $2,000,000  letter of credit  issued by Soros in favor of
     Wells Fargo (the "Soros LC"). In August 2006, Wells Fargo agreed to release
     the Soros LC, and no longer requires an availability  reserve  (although it
     has the right  under the  Credit  Facility  to  establish  reserves  in the
     future,  as it deems  appropriate).  In  return,  the  Company,  agreed  to
     maintain a minimum  cash  balance  of  $5,000,000.  Availability  under the
     Credit  Facility is  determined  by a formula  that takes into  account the
     amount of the Company's inventory and accounts  receivable,  as well as the
     Soros LC. The maximum  availability  is  currently  $7,500,000,  but can be
     increased  to  $12,500,000  at the  Company's  request,  subject to certain
     conditions.  As of December 31, 2006, total  availability  under the Credit
     Facility,  was approximately  $7,500,000 of which $3,200,000 was committed,
     leaving approximately $4,300,000 available for further borrowings.

     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 2.75%.  The Company also pays a monthly
     commitment fee on the unused portion of the facility (i.e., $7,500,000 less
     the amount of loans  outstanding)  equal to 0.35%.  We also pay Wells Fargo
     certain

                                      F-22
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     fees to open  letters  of credit  and  guarantees  in an amount  equal to a
     certain  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.
     For the years ended December 31, 2006, 2005 and 2004 total interest expense
     and fees related to the credit facilities totaled  approximately  $170,000,
     $196,000 and $112,000, respectively.

     Under the terms of the Credit Facility, Soros has the right to purchase all
     of our  obligations  from Wells Fargo at any time if we are then in default
     under the Credit Facility.

     SOROS WARRANTS IN CONNECTION WITH ROSENTHAL LOAN FACILITY
     Prior to April 2004,  Soros  guaranteed  repayment  of the  Rosenthal  Loan
     Facility (the "Soros  Guarantee").  The Company issued warrants to Soros in
     consideration  for the establishment and continuance of the Soros Guarantee
     as described below.

     The following  table  represents the warrants issued to Soros in connection
     with the Loan Facility:

<TABLE>
<CAPTION>
Number of      Date       Exercise      Expiration        Assumptions Under
 Warrants     Issued        Price          Date             Black-Scholes             Reason
---------   -----------   ---------   ---------------   ----------------------   ----------------
 <S>         <C>           <C>         <C>              <C>                      <C>
 100,000     March 31,     $0.88(1)    September 11,    Risk Free Rate - 4.86%   As consideration
                2001                       2011            Volatility - 117%         for Soros
                                                            Term - 5 years       establishing the
                                                                                  Soros Guarantee

  60,000     March 22,     $1.66(1)      March 22,      Risk Free Rate - 5.25%   In consideration
                2002                       2007            Volatility - 184%        for Soros
                                                            Term - 3 years        extending the
                                                                                 Soros Guarantee
                                                                                 until 11/15/2003

  25,000     March 17,     $0.78(2)      March 17,      Risk Free Rate - 3.31%   In consideration
                2003                       2013            Volatility - 123%        for Soros
                                                            Term - 4 years         extending the
                                                                                  Soros Guarantee
                                                                                 until 11/15/2004
</TABLE>

     (1)  represents  the 20 day  trailing  average of the closing sale price of
          the Company's Common Stock on the date of issuance

     (2)  represents  the 10 day  trailing  average of the closing sale price of
          the Company's Common Stock on the date of issuance

     The Company  accounted  for the  warrants  in  accordance  with  Accounting
     Principles  Board  Opinion No. 14 ("APB No.  14") by valuing  the  warrants
     using the Black-Scholes  option pricing model and crediting additional paid
     in capital for $74,000,  $98,000 and $21,000,  during the years 2001,  2002
     and 2003,  respectively.  These amounts were amortized to interest  expense
     over the life of the Loan Facility.

                                      F-23
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

12.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

     Amounts in thousands, except per share data:

<TABLE>
<CAPTION>
                                                                     QUARTER ENDED
                                                ---------------------------------------------------------
2006                                              MARCH 31        JUNE 30     SEPTEMBER 30   DECEMBER 31
---------------------------------------------   ------------   ------------   ------------   ------------
<S>                                             <C>            <C>            <C>            <C>
Net Sales                                       $     16,876   $     16,793   $     16,322   $     27,071
                                                ============   ============   ============   ============
Gross Profit                                    $      6,839   $      7,046   $      6,111   $     10,913
                                                ============   ============   ============   ============
Net Loss (1)                                    $     (3,264)  $     (1,901)  $     (3,485)  $     (3,543)
                                                ============   ============   ============   ============
Preferred stock dividends                       $     (1,231)  $       (990)  $        (16)  $        (15)
                                                ============   ============   ============   ============
Net loss available to common shareholders       $     (4,495)  $     (6,748)  $     (3,501)  $     (3,558)
                                                ============   ============   ============   ============
Loss per common share - basic and diluted (2)   $      (0.22)  $      (0.17)  $      (0.03)  $      (0.03)
                                                ============   ============   ============   ============

<CAPTION>
                                                                     QUARTER ENDED
                                                ---------------------------------------------------------
2005                                              MARCH 31        JUNE 30     SEPTEMBER 30   DECEMBER 31
---------------------------------------------   ------------   ------------   ------------   ------------
<S>                                             <C>            <C>            <C>            <C>
Net Sales                                       $     13,502   $     12,029   $     12,045   $     21,235
                                                ============   ============   ============   ============
Gross Profit                                    $      4,885   $      4,651   $      4,575   $      8,884
                                                ============   ============   ============   ============
Net loss                                        $       (893)  $     (1,169)  $     (1,703)  $        (55)
                                                ============   ============   ============   ============
Preferred stock dividends                       $     (1,115)  $     (1,169)  $     (1,387)  $     (1,287)
                                                ============   ============   ============   ============
Net loss available to common shareholders       $     (2,008)  $     (2,338)  $     (3,090)  $     (1,342)
                                                ============   ============   ============   ============
Loss per common share - basic and diluted       $      (0.13)  $      (0.15)  $      (0.20)  $      (0.07)
                                                ============   ============   ============   ============
</TABLE>

     (1)  Included  in net  loss is a  non-cash  charge  of  approximately  $4.5
          million  for  the  year  ended   December  31,  2006  to   stock-based
          compensation recorded in accordance with SFAS No. 123( R), this amount
          was  recorded as follows:  $612,  $611,  $597 and $2.6  million in the
          first, second, third and fourth quarter, respectively

     (2)  Weighted  average shares  increased to 80.2 million for the year ended
          December  31,  2006 as a result  of the June  2006  financing  and the
          conversion  of the  Company's  preferred  stock into  common  stock in
          connection with the financing.

13.  RELATED PARTY TRANSACTION

     In August 2004,  the Company  entered into a Separation  Agreement with its
     former Chief Executive  Officer in connection with his  resignation.  Under
     the terms of the agreement,  he agreed to remain employed by the Company in
     a non-executive capacity through November 30, 2004 (the "Termination Date")
     at his then-current  salary and to extend the period of the non-competition
     and  non-solicitation  covenants contained in his employment agreement from
     one year to two years after the  Termination  Date.  In  consideration  for
     these agreements,  the Company,  among other things,  agreed to (i) to make
     salary continuation  payments equal to his salary until June 30, 2005, (ii)
     to continue to provide his then-current  employee  benefits for a period of
     one year following the  Termination  Date, and (iii) to issue him an option
     to purchase  100,000  shares of Common Stock at an exercise  price equal to
     the fair  market  value of the  Common  Stock on the date of grant and (iv)
     that  all  outstanding  stock  options  held by him  would  vest  upon  the
     Termination  Date.  The Company valued the warrants using the Black Scholes
     option  pricing model using the following  assumptions:  risk free interest
     rate:  3.88%,  volatility 137%,  expected life 1 year, zero dividend

                                      F-24
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

     yield,  and  charged  $113,000  for the  options  and  $212,000  related to
     severance and benefits to general and  administrative  expense in the third
     quarter of 2004.

14.  NASDAQ COMPLIANCE

     In November 9, 2006,  the Company was  notified by Nasdaq Staff that it was
     not in compliance with the continued  listing  requirements  for the Nasdaq
     Capital  Market (the "Listing  Requirements")  because shares of its Common
     Stock had  closed at a per share bid price of less than  $1.00 for at least
     30 trading  days.  On December 21, 2006,  the Company was advised by Nasdaq
     that,  because the closing bid price of the Company's common stock has been
     at $1.00 per share or greater for at least 10 consecutive trading days, the
     Company has regained compliance with the Listing Requirements.

15.  SUBSEQUENT EVENTS

     In January  2007,  the Company  commenced an exchange  offer (the  "Offer")
     pursuant  to which it is offering to  exchange  certain  outstanding  stock
     options issued to employees and non-employee directors for restricted stock
     awards and/or deferred stock unit awards.

     Employees (other than the CEO and CFO, who already had exchanged certain of
     their options  pursuant to their  employment  agreements) and  non-employee
     directors who held stock options with an exercise  price greater than $1.50
     were  eligible to  participate  in the Offer.  Eligible  options  that were
     vested as of August  31,  2006  could be  exchanged  for  restricted  stock
     awards,  and eligible options that were not vested as of that date could be
     exchanged for deferred stock unit awards.  Both the restricted stock awards
     and the deferred stock unit awards are subject to vesting  provisions.  The
     number of restricted  stock awards and/or deferred stock unit awards issued
     in exchanged  for an eligible  option grant was  determined by the exchange
     ratio applicable to that particular option.

     The Company has instituted the exchange offer because a considerable number
     of its employees are holding  options that have exercise prices higher than
     the current and recent trading  prices of its common stock.  The purpose of
     the  exchange   offer  is  to  promote  the   interests  of  the  Company's
     stockholders  by  strengthening  its ability to motivate and retain  valued
     employees.

     The  exchange  offer began on January  25,  2007 and ended on February  23,
     2007. In connection with the Offer, an aggregate of 1,562,000  options were
     tendered in exchange for an aggregate of 472,471 shares of restricted stock
     and  394,405  shares  of  deferred  stock  unit  awards.  This  represented
     approximately 95% of the total options that were eligible for exchange. The
     Company will account for the exchange of Options for  restricted  stock and
     deferred  stock unit awards as replacement  awards in accordance  with SFAS
     No. 123(R).

                                      F-25
<PAGE>

BLUEFLY, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2006
--------------------------------------------------------------------------------

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE THREE YEARS ENDED DECEMBER 31, 2006

<TABLE>
<CAPTION>
                                                                Column C
                                                   -----------------------------------
           Column A                Column B               (1)                (2)          Column D           Column E
----------------------------------------------------------------------------------------------------------------------------
                              Beginning Balance    Charged to Costs   Charged to other                 Balance end of Period
Description                   at January 1, 2006     and Expenses         Accounts       Deductions      December 31, 2006
---------------------------   ------------------   ----------------   ----------------   -----------   ---------------------
<S>                                  <C>                <C>                    <C>        <C>                    <C>
Allowance for Sales Returns           (3,407,000)       (50,126,000)                --    48,490,000              (5,043,000)

Allowance for Doubtful
 Accounts                                (78,000)          (643,000)                --       324,000                (397,000)

Inventory Reserves                      (782,000)        (1,000,000)                --       727,000              (1,055,000)

Deferred Tax Valuation
 Allowance                           (30,712,000)        (4,656,000)           909,000            --             (34,459,000)

<CAPTION>
                                                                Column C
                                                   -----------------------------------
           Column A                Column B               (1)                (2)          Column D           Column E
----------------------------------------------------------------------------------------------------------------------------
                              Beginning Balance    Charged to Costs   Charged to other                 Balance end of Period
Description                   at January 1, 2005     and Expenses         Accounts       Deductions      December 31, 2005
---------------------------   ------------------   ----------------   ----------------   -----------   ---------------------
<S>                                  <C>                <C>                   <C>         <C>                    <C>
Allowance for Sales Returns           (2,174,000)       (34,820,000)                 -    33,587,000              (3,407,000)

Allowance for Doubtful
 Accounts                                (44,000)          (270,000)                 -       236,000                 (78,000)

Inventory Reserves                      (835,000)          (659,000)                 -       712,000                (782,000)

Deferred Tax Valuation
 Allowance                           (28,738,000)        (1,533,000)          (441,000)            -             (30,712,000)

<CAPTION>
                                                                Column C
                                                   -----------------------------------
           Column A                Column B               (1)                (2)          Column D           Column E
----------------------------------------------------------------------------------------------------------------------------
                              Beginning Balance    Charged to Costs   Charged to other                 Balance end of Period
Description                   at January 1, 2004     and Expenses         Accounts       Deductions      December 31, 2004
---------------------------   ------------------   ----------------   ----------------   -----------   ---------------------
<S>                                  <C>                 <C>                  <C>         <C>                    <C>
Allowance for Sales Returns           (2,528,000)       (24,186,000)                 -    24,540,000              (2,174,000)

Allowance for Doubtful
 Accounts                                (40,000)          (237,000)                 -       233,000                 (44,000)

Inventory Reserves                      (673,000)          (100,000)                 -       (62,000)               (835,000)

Deferred Tax Valuation
 Allowance                           (26,872,000)        (1,518,000)          (348,000)            -             (28,738,000)
</TABLE>

                                       S-1