UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549









FORM
10-K





[
      X ]
            
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the fiscal year ended December 31, 2010OR[    ]
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the transition period from_________ to
  __________


Commission
File Number 001-14498


BLUEFLY,
INC.


(Exact
name of registrant as specified in its charter)





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


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


Securities
registered pursuant to Section 12(b) of the Securities Exchange Act of
1934:


Title of each class
                Common
      stock, par value $.01 per share
              
              Name of Exchange on Which
      Registered
                The
      Nasdaq Stock Market LLC (Nasdaq Capital
Market)




Securities
registered under Section 12(g) of the Exchange
Act:               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) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes
[X]        No
[   ]




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




Indicate
by check mark whether 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.     [   ]




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




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


(Do
not check if a smaller reporting company)




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





As of
February 11, 2011, there were 24,606,588 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, 2010, based
upon the last sale price of such equity reported on the Nasdaq Capital Market,
was approximately $5.1 million.  For purposes of this disclosure,
shares of common stock held by persons who hold more than 10% of the outstanding
shares of common stock and shares held by officers and directors of the
registrant have been excluded as these persons may be deemed
affiliates.  This determination is not conclusive for other
purposes.




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 2011 Annual Stockholders Meeting, which
will be filed with the Securities and Exchange Commission.











BLUEFLY, INC.




ANNUAL
REPORT ON FORM 10-K




INDEX




PagePart I.Special
      Note Regarding Forward-Looking Statements and Associated
    Risks
                    
                    3Item
      1.
                    
                    Business.
                    
                    3Item
      1A.
                    
                    Risk
      Factors.
                    
                    6Item
      1B.
                    
                    Unresolved
      Staff Comments.
                    
                    11Item
      2.
                    
                    Properties.
                    
                    12Item
      3.
                    
                    Legal
      Proceedings.
                    
                    12Item
      4.
                    
                    (Removed
      and Reserved).
                    
                    12Part II.Item
      5.
                    
                    Market
      for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities.
                    
                    12Item
      6.
                    
                    Selected
      Financial Data.
                    
                    12Item
      7.
                    
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                    
                    13Item
      7A.
                    
                    Quantitative
      and Qualitative Disclosures About Market Risk.
                    
                    22Item
      8.
                    
                    Financial
      Statements and Supplementary Data.
                    
                    22Item
      9.
                    
                    Change
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure.
                    
                    22Item
      9A.
                    
                    Controls
      and Procedures.
                    
                    22Item
      9B.
                    
                    Other
      Information.
                    
                    23Part III.Item
      10.
                    
                    Directors,
      Executive Officers and Corporate Governance.
                    
                    23Item
      11.
                    
                    Executive
      Compensation.
                    
                    23Item
      12.
                    
                    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.
                    
                    23Item
      13.
                    
                    Certain
      Relationships and Related Transactions, and Director
      Independence.
                    
                    23Item
      14.
                    
                    Principal
      Accounting Fees and Services.
                    
                    23Part IV.Item
      15.
                    
                    Exhibits,
      Financial Statement Schedules.
                    
                    24Signatures
                    
                    29Financial
      Statements
                    
                    F –
      1








2





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, as amended, and Section 21E of the
Securities Exchange Act of 1934 (the “Exchange Act”). 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. The risks and uncertainties include, but are not limited to, those
matters addressed herein under “Risk Factors” And the other risks and
uncertainties set forth from time to time in our reports filed with the
Securities and Exchange Commission (the “SEC”) (collectively, the “Cautionary
Statements”).  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.  Business.




Recent
Developments




On
January 4, 2011, Bluefly (as defined below) and A + D Labs LLC (“A + D Labs”
and, collectively with Bluefly, the “Members”) entered into a Limited Liability
Company Operating Agreement (the “Operating Agreement”) in connection with the
formation of Eyefly LLC (“Eyefly”), a newly formed Delaware limited liability
company, which is initially owned 52% by us and 48% by A + D
Labs.  Eyefly was formed for the purposes of developing and operating
an e-commerce Web site and related online and mobile applications focused on
selling fashionable prescription eyewear directly to consumers.





Pursuant
to the Operating Agreement, the Members made an aggregate $700,000 of initial
capital contribution ($364,000 from us and $336,000 from A + D Labs) and agreed
to make an additional $600,000 of capital contributions ($312,000 from us and
$288,000 from A + D Labs) as necessary.





In
connection with the formation of Eyefly, we agreed to amendments to our credit
facility with Wells Fargo pursuant to which (i) Wells Fargo agreed to our
investment in Eyefly and (ii) we granted Wells Fargo a security interest in our
equity interest in Eyefly.





Our
credit facility currently expires in July 2011.  However, we have
reached an agreement in principle regarding a renewal of the credit
facility.  Notwithstanding this agreement, there is no assurance that
we will be able to renew the credit facility on favorable terms, or at
all.




General




Bluefly,
Inc. is a leading online retailer of designer brands, fashion trends and
superior value.  During 2010, we offered over 50,000 different styles
for sale in categories such as men’s, women’s and 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 one and a half million customers.




Our
common stock is listed on the Nasdaq Capital Market under the symbol “BFLY” and
we are incorporated in the state of 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.







3





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 discounted
prices. 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 Web Site is also one of the
key factors to our marketing strategy, as it gives our shoppers reason to visit
the Web Site often.




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 seasons, 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
believe that the Internet is the optimal medium to support our retail
strategy.  We are able to communicate frequently and in a timely
manner with our customer base.  We are also able to apply direct
marketing customer file management principles that allow us to optimize sales
opportunities from the customer file and to augment that response by offering
our loyal customers targeted promotions including previews and early access to
special product assortment and exclusive offers.  Additionally, we can
offer our customers a wide range of products as 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 our
offerings 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 competes with full-price
retailers and is fundamentally better than that offered by traditional off-price
retailers.  Similarly, we believe that the upscale atmosphere,
professional photography and premium merchandise offerings of our Web Site
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.




E-Commerce
And The Online Apparel Market




The
continued growth of e-commerce has been widely reported.  According to
projections published by Forrester Research, U.S. online retail sales are
expected to grow steadily at 7% to $191 billion in 2011, with continued
increases through 2014 to over $248 billion.




Marketing




Our
marketing efforts are focused both on acquiring new customers and retaining
existing customers. Active Bluefly customers visit the Web 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.




During
2010, we have increased awareness by targeting general advertising efforts to a
more fashion-focused customer. We have also further refined our marketing
strategy by aligning ourselves with entertainment properties, such as Project
Runway, BravoTV, Lifetime TV and targeted shows on The CW including Gossip Girl
and America’s Next Top Model, and integrated marketing programs and initiatives
with Facebook and YouTube such as Closet Confessions.




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 developing
vendor relationships, in part, because we have devoted substantial resources to
establishing our Web Site 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.  In 2010 and 2009, we
purchased approximately 42% and 31% of our inventory from one supplier,
respectively.







4







Warehousing
And Fulfillment




When we
receive an order, the information is transmitted to our third party warehouse
and fulfillment center located in Ohio, 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 2010, 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, chat or telephone
assistance, customer service representatives are available seven days a week to
provide assistance.  We utilize customer service representatives from
a third party call center that has a team dedicated to our
business.  We also maintain a supervisor in our corporate office who
provides special services and assists 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 60 days of
the date of sale for a full refund.




Technology




We have
implemented a broad array of technologies that facilitate Web Site management,
complex database search functionality, customer interaction and personalization,
transaction processing 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
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 facility in New York.




In the
event of a natural disaster, fire, power failure or other emergency disrupts our
IT infrastructure, Web Site or transaction processing, we have prepared and
tested a business continuity plan, which includes fully equipped critical IT
infrastructure and access to on-demand hardware and services maintained within a
third party facility.




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 Web Site features.




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 our services are made available online.




We also
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, if at all.  As a result, we may be required to obtain
substitute technology of lower







5





quality
and/or 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.  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 the conduct of 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.




Seasonality
And Fashion Trends




Our
business is affected by seasonality, which historically has resulted in higher
sales volume during our fourth quarter, which ends December 31.  We
recognized 32%, 30% and 29% of our annual net sales during the fourth quarter of
2010, 2009 and 2008, respectively.  In addition, our business
fluctuates according to changes in customer preferences dictated in part by
fashion trends.  The cyclical nature of our business requires us to
carry a significant amount of inventory, especially prior to peak selling
seasons when we generally build up our inventory levels.  As a result,
we are vulnerable to demand and pricing shifts and to errors in selection and
timing of merchandise purchases.




Employees




As of
February 11, 2011, we had 83 full-time employees and 1 part-time employee, as
compared to 79 full-time employees and 1 part-time employee as of February 11,
2010. None of our employees are represented by a labor union.




Item
1A.  Risk Factors.




We Have A History Of Losses And
Losses May Continue In The Future.  As of December 31, 2010, we
had an accumulated deficit of $151,501,000.  We incurred net losses of
$4,033,000, $4,369,000 and $11,340,000 for the years ended December 31, 2010,
2009 and 2008, respectively.  We have incurred negative cash flows and
cumulative net losses since inception.  Although we had experienced a
decline in net sales growth in recent years, this decline should not be
considered indicative of future performance. See “Risk Factors – The Continuing
Unfavorable General Economic Environment Could Have an Adverse Effect on Our
Operating Results.”






Rho, 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 11,
2011, Rho Ventures VI, L.P. (“Rho”) owned approximately 36% of our Common Stock,
affiliates of Soros Fund Management, LLC (“Soros”) owned approximately 25% of
our Common Stock, private funds associated with Maverick Capital, Ltd.
(“Maverick”) owned approximately 15% of our Common Stock and investment entities
and accounts managed and advised by Prentice Capital Management, LP (“Prentice”)
owned approximately 12% of our Common Stock.  We entered into an
Amended and Restated Voting Agreement with Rho, Soros, Maverick and Prentice
(the “Voting Agreement”), pursuant to which Rho and Soros each has the right to
designate two designees to our Board, and Maverick and Prentice each has the
right to designate one designee to our Board, in each case, subject to minimum
ownership thresholds and compliance with applicable rules of the Nasdaq Stock
Market LLC. The Voting Agreement also provides that one designee of each of Rho,
Soros, Maverick and Prentice has the right to serve on each committee of our
Board.  If we establish an Executive Committee, a designee of each of
Rho, Soros, Maverick and Prentice will be entitled to serve on such
committee.




In view
of their large percentage of ownership, Rho, 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







6





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 or a going private transaction.




The Continuing Unfavorable General
Economic Environment Could Have an Adverse Effect on Our Operating
Results.  Our business, prospects, financial condition and
results of operations has been, and may continue to be, negatively affected by
unfavorable general economic conditions. These conditions have affected our
business as our business is dependent on consumer demand for our
products.  While our net sales during the fourth quarter of 2010
increased by approximately 17% and 4%, compared to the fourth quarters of 2009
and 2008, respectively, our net sales declined by approximately 11% during the
fourth quarter of 2009 compared to the fourth quarter of 2008.  If the
general economic environment continues to be unfavorable, there will likely be a
negative effect on our net sales and earnings for the current fiscal year and
continuing into fiscal 2012.  See “Risk Factors – We Will Be Subject
To Cyclical Variations In The Apparel And E-Commerce Markets.”




Our Lender Has Liens On Substantially
All Of Our Assets And Could Foreclose In The Event That We Default Under Our
Credit Facility.  Under the terms of our credit facility, our
lender has a first priority lien on substantially all of our assets, including
our cash balances.  If we default under the credit facility, our
lender would be entitled to, among other things, foreclose on our assets
(whether inside or outside a bankruptcy proceeding) in order to satisfy our
obligations under the credit facility.




Our Ability To Maintain And Pay Our
Indebtedness Under Our Credit Facility Is Dependent Upon Meeting Our Business
Plan.  We are required to pay interest under our credit
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 there can be no assurance that based on our business plan
we will generate sufficient cash flow from operations to enable us to pay our
indebtedness under the credit facility and maintain our minimum availability
requirement throughout the term of the credit facility.  If we fall
short of our business plan and are unable to raise additional capital, we could
default under our credit facility. In the event of a default under the credit
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 credit facility.  See “Risk Factors – Our
Lender Has Liens On Substantially All Of Our Assets And Could Foreclose In The
Event That We Default Under Our Credit 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 credit facility.  See “Risk Factors – Our Ability To Maintain And
Pay Our Indebtedness Under Our Credit Facility Is Dependent Upon Meeting Our
Business Plan.”




Our Online, Offline 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 to direct customers to our Web Site. Such services are
expensive and may not result in the cost effective acquisition of
customers.  We are relying on the offline and online marketing
initiatives as a source of traffic to our Web Site and new customers. If these
initiatives are not successful, our results of operations will be adversely
affected.




We Purchase a Substantial Portion of
Our Inventory from One Supplier.In
both 2010 and 2009, we purchased approximately 42% and 31% of our inventory from
one supplier, respectively.  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 net sales and/or gross profit margin
percentage.




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







7







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” and
“Risk Factors – We Purchase a Substantial Portion of Our Inventory from One
Supplier.”




Unexpected Changes In Fashion Trends
Could Cause Us To Have Either Excess or Insufficient
Inventory.  Fashion trends can change rapidly, and our business
is highly 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, prospects,
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. The
unfavorable general economic conditions have affected retailers especially hard.
Declines, whether real or perceived, in economic conditions or prospects could
adversely affect consumer spending habits and, therefore, have a material
adverse effect on our net sales, 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 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 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 remediate 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 Our Vendors And Therefore The Availability Of
Merchandise Is At Risk.”




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 and the United States Postal
Service, and credit card processing companies such as Litle, Paypal and
Cybersource to service our customers' needs.  To the extent that there
is a slowdown in







8







mail
service or package delivery services, whether as a result of labor difficulties,
terrorist activity or otherwise, our cash flow and results of operations would
be negatively impacted during such slowdown, and the results of such slowdown
would 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 would cause similar effects.




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 dynamic, high-growth
market and is rapidly changing and intensely competitive.  Our
competition for customers comes from a variety of sources
including:




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




·
            less
      established online companies;




·
            internet
      sites;




·
            traditional
      direct marketers; and




·
            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:




·
            brand
      recognition;




·
            merchandise
      selection;




·
            price;




·
            convenience;




·
            customer
      service;




·
            order
      delivery
performance;  and




·
            Web
      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 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 our Web Site 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 our Web Site 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 our Web Site, or if we incur excessive expenses in an attempt to
promote and maintain our Web Site, 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.  The satisfactory performance, reliability
and availability of our Web Site, 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 net sales depend on the number of visitors who shop on
our Web Site 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 our Web Site 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 our
Web Site or expand and upgrade our systems and infrastructure to accommodate
such









9










increases
on a timely basis. In order to remain competitive, we must continue to enhance
and improve the responsiveness, functionality and features of our Web Site,
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.




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 2010, 2009 and 2008 has been 38.7%, 37.8% and 39.1%,
respectively, of gross sales. 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 and Chief Financial Officer run through January 1, 2013
and our agreements with our Chief Marketing Officer and SVP of eCommerce run
through September 2012. 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.




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, patents 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.  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 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







10





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 existing laws and regulations to the Internet and online commerce
could also increase our cost of doing business. In addition, some of the
products we sell, including the prescription eyewear products that we plan to
sell through our newly formed Eyefly subsidiary, may be subject to federal,
state or foreign regulation.  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 Colorado, New York and Ohio.  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 us, that
engage in online commerce. In particular, certain states have recently enacted
or are considering enacting laws, which would require an e-commerce retailer to
collect sales tax on sales to customers in that state if it uses any marketing
affiliates in such states.  The enactment of any such law in any state
will require us to either collect sales tax from customers in such state (which
could decrease customer demand) or to stop using marketing affiliates in such
state (which could have a negative impact on our marketing efforts). In
addition, any new operation in states outside Colorado, New York and Ohio 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 Board has the authority to issue up
to 1,000,000 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 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.




Our Ability To Utilize Our Net
Operating Loss Carryforwards May Be Limited.  Our federal net
operating loss carryforwards are subject to limitation on how much may be
utilized on an annual basis.  The use of the net operating loss
carryforwards may have additional limitations resulting from certain future
ownership changes or other factors pursuant to Section 382 of the Internal
Revenue Code (the “Code”), including the consummation of the sale of 8,823,529
shares of our common stock to Rho in 2010 and 2009, which made us vulnerable to
an ownership change for purposes of Section 382 of the
Code.  Transfers of shares by shareholders who own 5% or more of our
outstanding common stock could also have the effect of limiting our ability to
utilize our net operating loss carryforwards.  We have not performed a
recent analysis of our ownership changes under Section 382 of the
Code.  If our net operating loss carryforwards are further limited,
and we have taxable income which exceeds the available net operating loss
carryforwards for that period, we would incur an income tax liability even
though net operating loss carryforwards may be available in future years prior
to their expiration, which may adversely affect our future financial position,
results of operations and cash flows.




Item
1B.  Unresolved Staff Comments.




None.






11




Item
2.  Properties.




We lease
approximately 18,000 square feet of office space in New York City. The property
is in good operating condition. The lease covering such office space will expire
on December 31, 2020. Our total lease expense for such office space during 2010
was approximately $595,000.




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.  (Removed and Reserved).









PART II.




Item
5.  Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.




Market
Information




Our
Common Stock is quoted on the Nasdaq Capital Market. The following table sets
forth the high and low sales prices for the Common Stock for the periods
indicated, as reported by the Nasdaq Capital Market:




Year
      Ended December 31,2010
                
                2009Quarter
                
                High
                
                Low
                
                High
                
                LowFirst
                
                $
                3.14
                
                $
                2.00
                
                $
                0.99
                
                $
                0.32Second
                
                $
                3.03
                
                $
                1.79
                
                $
                1.79
                
                $
                0.98Third
                
                $
                2.50
                
                $
                1.52
                
                $
                2.24
                
                $
                1.00Fourth
                
                $
                3.00
                
                $
                2.15
                
                $
                2.65
                
                $
                1.59


Holders




As of
February 11, 2011, there were less than 500 holders of record of the Common
Stock. We believe that there were less 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 prohibit us from paying cash dividends without the
consent of our lender. 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.




Item
6.  Selected Financial Data.




The
following selected financial data should be read in conjunction with the
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, 2007 and
2006 and at December 31, 2008, 2007 and 2006 are derived from our audited
financial statements not included in this report. All data is in thousands,
except share data:




12





Statements of
      Operations Data:
                            
                            Year Ended
      December 31,2010
                            
                            2009
                            
                            2008
                            
                            2007
                            
                            2006Net sales
                            
                            $
                            88,563
                            
                            
                            $
                            81,222
                            
                            
                            $
                            95,774
                            
                            
                            $
                            91,493
                            
                            
                            $
                            77,062Cost of
    sales
                            
                            
                            55,360
                            
                            
                            
                            49,665
                            
                            
                            
                            60,288
                            
                            
                            
                            58,754
                            
                            
                            
                            46,153Gross
profit
                            
                            
                            33,203
                            
                            
                            
                            31,557
                            
                            
                            
                            35,486
                            
                            
                            
                            32,739
                            
                            
                            
                            30,909Selling and fulfillment
      expenses
                            
                            
                            16,881
                            
                            
                            
                            16,675
                            
                            
                            
                            19,620
                            
                            
                            
                            18,898
                            
                            
                            
                            15,808Marketing
      expenses
                            
                            
                            12,576
                            
                            
                            
                            8,661
                            
                            
                            
                            15,359
                            
                            
                            
                            16,063
                            
                            
                            
                            14,196General and administrative
      expenses
                            
                            
                            7,592
                            
                            
                            
                            8,882
                            
                            
                            
                            11,355
                            
                            
                            
                            13,848
                            
                            
                            
                            13,001Total operating
      expenses
                            
                            
                            37,049
                            
                            
                            
                            34,218
                            
                            
                            
                            46,334
                            
                            
                            
                            48,809
                            
                            
                            
                            43,005Operating loss(1)
                            
                            
                            (3,846
                            )
                            
                            
                            (2,661
                            )
                            
                            
                            (10,848
                            )
                            
                            
                            (16,070
                            )
                            
                            
                            (12,096
                            )Interest expense(2)
                            
                            
                            (226
                            )
                            
                            
                            (1,733
                            )
                            
                            
                            (554
                            )
                            
                            
                            (260
                            )
                            
                            
                            (599
                            )Interest and other
      income
                            
                            
                            39
                            
                            
                            
                            25
                            
                            
                            
                            62
                            
                            
                            
                            501
                            
                            
                            
                            502Net loss(3)
                            
                            $
                            (4,033
                            )
                            
                            $
                            (4,369
                            )
                            
                            $
                            (11,340
                            )
                            
                            $
                            (15,829
                            )
                            
                            $
                            (12,193
                            )Basic
      and diluted net loss percommon share(4)
                            
                            $
                            (0.17
                            )
                            
                            $
                            (0.31
                            )
                            
                            $
                            (0.90
                            )
                            
                            $
                            (1.21
                            )
                            
                            $
                            (2.28
                            )Basic and diluted
      weightedaverage common
      sharesoutstanding(4)(5)
                            
                            
                            23,685,338
                            
                            
                            
                            14,003,534
                            
                            
                            
                            13,369,257
                            
                            
                            
                            13,091,130
                            
                            
                            
                            8,017,053Balance
      Sheet Data:
                            
                            As
      of December 31,2010
                            
                            
                            2009
                            
                            
                            2008
                            
                            
                            2007
                            
                            
                            2006Cash and cash
      equivalents
                            
                            $
                            10,429
                            
                            
                            $
                            10,049
                            
                            
                            $
                            4,004
                            
                            
                            $
                            6,730
                            
                            
                            $
                            20,188Inventories,
      net
                            
                            
                            25,128
                            
                            
                            
                            17,668
                            
                            
                            
                            23,157
                            
                            
                            
                            28,492
                            
                            
                            
                            24,189Other current
      assets
                            
                            
                            3,304
                            
                            
                            
                            4,278
                            
                            
                            
                            4,347
                            
                            
                            
                            3,589
                            
                            
                            
                            4,229Total
assets
                            
                            
                            42,144
                            
                            
                            
                            35,646
                            
                            
                            
                            37,750
                            
                            
                            
                            45,019
                            
                            
                            
                            52,430Current
      liabilities
                            
                            
                            12,320
                            
                            
                            
                            12,611
                            
                            
                            
                            16,250
                            
                            
                            
                            17,922
                            
                            
                            
                            14,603Long-term liabilities(6)
                            
                            
                            183
                            
                            
                            
                            --
                            
                            
                            
                            3,106
                            
                            
                            
                            60
                            
                            
                            
                            --Total
      liabilities
                            
                            
                            12,503
                            
                            
                            
                            12,611
                            
                            
                            
                            19,356
                            
                            
                            
                            17,982
                            
                            
                            
                            14,603Stockholders’
      equity
                            
                            
                            29,641
                            
                            
                            
                            23,035
                            
                            
                            
                            18,394
                            
                            
                            
                            27,037
                            
                            
                            
                            37,827





(1)
            This
      amount includes non-cash expenses of approximately $634,000, $612,000,
      $2.7 million, $6.2 million and $4.5 million for the years ended December
      31, 2010, 2009, 2008, 2007 and 2006, respectively, relating to stock-based
      compensation expense.




(2)
            This
      amount includes approximately $1.4 million in interest expense to related
      party stockholders in connection with our subordinated notes for the year
      ended December 31, 2009.




(3)
            Excludes
      preferred stock dividends of $37,000, $44,000 and $2.2 million for the
      years ended December 31, 2008, 2007 and 2006, respectively, and excludes
      beneficial conversion feature expenses of $712,000 and $3.9 million for
      the years ended December 31, 2008 and 2006,
  respectively.




(4)
            All
      share amounts, including per share amounts, have been restated to reflect
      a one for ten reverse stock-split that occurred in
  2008.




(5)
            In
      2010, weighted average shares outstanding increased to approximately 23.7
      million as a result of an equity financing that was completed in February
      2010.  In 2007, weighted average shares outstanding increased to
      approximately 13.1 million as a result of the conversion of our preferred
      stock into common stock in connection with an equity financing during June
      2006.




(6)
            As
      of December 31, 2010, long-term liabilities include $183,000 of deferred
      rent.  As of December 31, 2008, long-term liabilities include
      approximately $3.0 million and $106,000 of notes and interest payable to
      related party stockholders,
respectively.




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







13





following
discussion should be read in conjunction with the audited 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 and accessories at discounts of up to 75% off of retail
value.  We launched our Web Site in September 1998.




Our net
sales increased approximately 9% to $88,563,000 for the year ended December 31,
2010, from $81,222,000 for the year ended December 31, 2009. Our gross profit
margin percentage decreased to 37.5% for the year ended December 31, 2010, from
38.9% in 2009. The decrease in gross profit margin percentage was primarily
related to our shift in our merchandise mix towards luxury and designer, and an
increase in our provision for inventory obsolescence as a result of larger
inventory balances necessary to support the increased sales demand in the fourth
quarter of 2010. Our gross profit increased by approximately 5% to $33,203,000
for the year ended December 31, 2010 from $31,557,000 for the year ended
December 31, 2009.




During
2010, we refined our merchandising mix to shift towards more luxury designer
merchandise, as compared to our focus on contemporary merchandise in 2009 (which
we focused on in 2009 in response to general economic conditions).  We
believe this shift in 2010 resulted in an increase in the return rate, but also
increased average order size.  In this respect, gross profit margin
percentage for 2010 is more comparable to the 37.1% gross profit margin
percentage that we generated in 2008, when our merchandise mix also shifted more
towards luxury designer items.




Total
marketing expenses (including staff related costs) increased by approximately
45% to $12,576,000 for the year ended December 31, 2010, from $8,661,000 for
year ended December 31, 2009. We increased our spending in marketing (excluding
staff related costs) by 49% to $11,298,000 for the full year 2010 from
$7,603,000 for the full year 2009. This planned increase consisted primarily of
equal increases in variable costs related to online programs and fixed costs
relating to offline programs of approximately 50%.  This investment in
marketing expenses reflects our efforts to drive top-line growth through online
and offline marketing initiatives. Marketing expenses as a percentage of net
sales increased to 14.2% for the year ended December 31, 2010, from 10.7% for
the year ended December 31, 2009.




We
incurred an operating loss of $3,846,000 for the year ended December 31, 2010,
as compared to our operating loss of $2,661,000 for the year ended December 31,
2009.  The increase in operating loss was primarily a result of
increases in marketing expenses, which were partially offset by decreases in
selling and fulfillment expenses, and general and administrative
expenses.




Our
reserve for returns and credit card chargebacks for the year ended December 31,
2010 increased to 38.7% compared to 37.8% of gross sales for the year ended
December 31, 2009.




A portion
of our inventory includes merchandise acquired on a pack and hold basis, where
we either purchased with the intention of holding for the appropriate season or
to take advantage of opportunities in the market.




We
recorded total stock-based compensation expenses of $634,000, $612,000 and
$2,706,000 for the years ended December 31, 2010, 2009 and 2008,
respectively.




At
December 31, 2010, we had an accumulated deficit of $151,501,000. The net losses
and accumulated deficit resulted primarily from operating losses including, but
not limited to, 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,
payment of dividends to holders of Preferred Stock and non-cash interest
expenses resulting from an embedded derivative in convertible debt.




Critical
Accounting Policies




Management
Estimates




The
preparation of the 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 disclosures of
contingent assets and liabilities at the dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Significant estimates and assumptions include useful lives of property and
equipment, recoverability of inventories, the realization of deferred tax
assets, the adequacy of the allowances for sales returns and the calculations
related to stock-based compensation expense.  Actual amounts could
differ significantly from these estimates.




In
addition, we currently estimate that we will have adequate liquidity to fund
operations beyond December 31, 2011. Such estimate is based on projected
revenues, expenses and timing of various payments. Should unforeseen events
occur or should actual results differ from current estimates, we may be unable
to meet payment obligations as they come due which would have a material adverse
impact on our operations.







14





Revenue
Recognition




We
recognize revenue when the earnings process is complete and revenue is
measurable. Gross sales consist primarily of revenue from product sales and
shipping and handling charges and are net of promotional discounts. Net sales
represent gross sales, less provision for returns, credit card chargebacks, and
adjustments for uncollected sales taxes. Revenue is recognized when all the
following criteria are met:




·
            A
      customer executes an order.




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




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




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




Deferred revenue, which consists
primarily of goods shipped to customers but not yet received and customercredits is classified as
current liabilities on our Balance Sheets.




Shipping
and handling billed to customers are classified as revenue and freight cost
incurred in connection with purchasing merchandise is classified as cost of
goods sold.




Provision
for Sales Returns and Doubtful Accounts




We now
permit returns for any reason within 60 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,
could have a material adverse effect on our business, prospects, cash flows,
financial condition and results of operations.  For the years ended
December 31, 2010, 2009 and 2008, our returns reserves were 38.7%, 37.8% and
39.1%, respectively, of gross sales.  Actual charges have not varied
materially from historical percentages.




Stock-Based
Compensation




Authoritative
guidance relating to stock-based compensation 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.




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 judgments based on currently available
information, about the salability of such merchandise and the selling price,
among other factors. 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 of 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.




Authoritative
guidance relating to uncertainty in income taxes prescribes a comprehensive
model for the manner in which a company should recognize, measure, present and
disclose in its financial statements all material uncertain tax positions that
they have taken or expect to take on a tax return. As of December 31, 2010 and
2009, the only tax authorities to which we are subject toare the U.S. federal tax authorities
and various state tax authorities in the United States. Open tax years
that are subject to examination by the U.S. federal tax authorities and various
state tax authorities, which extend back to 1998, relate to years in which
unused net operating losses were generated. In the event that we conclude that
we are subject to interest and/or penalties arising from uncertain tax
positions, we will present interest and penalties as a component of income
taxes. No amounts of







15





interest
or penalties were recognized in our Balance Sheets or Statements of Operations
as of and for the years ended December 31, 2010 and 2009.




Results
Of Operations




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




2010
                
                2009
                
                2008As
      a % of
                
                
                
                
                As
      a % of
                
                
                
                
                As
      a % ofNet
      Sales
                
                
                
                
                Net
      Sales
                
                
                
                
                Net
      SalesNet
      sales
                
                $
                88,563
                
                100.0
                %
                
                $
                81,222
                
                100.0
                %
                
                $
                95,774
                
                100.0
                %Cost
      of sales
                
                
                55,360
                
                62.5
                
                
                
                49,665
                
                61.1
                
                
                
                60,288
                
                62.9Gross profit
                
                
                33,203
                
                37.5
                
                
                
                31,557
                
                38.9
                
                
                
                35,486
                
                37.1Selling
      and fulfillmentexpenses
                
                
                16,881
                
                19.0
                
                
                
                16,675
                
                20.5
                
                
                
                19,620
                
                20.5Marketing
      expenses
                
                
                12,576
                
                14.2
                
                
                
                8,661
                
                10.7
                
                
                
                15,359
                
                16.0General
      and administrativeexpenses
                
                
                7,592
                
                8.6
                
                
                
                8,882
                
                10.9
                
                
                
                11,355
                
                11.9Total operating
      expenses
                
                
                37,049
                
                41.8
                
                
                
                34,218
                
                42.1
                
                
                
                46,334
                
                48.4Operating loss
                
                
                (3,846
                )
                (4.3
                )
                
                
                (2,661
                )
                (3.3
                )
                
                
                (10,848
                )
                (11.3
                )Interest
      expense, net
                
                
                (187
                )
                (0.2
                )
                
                
                (1,708
                )
                (2.1
                )
                
                
                (492
                )
                (0.5
                )Net loss
                
                $
                (4,033
                )
                (4.5
                )%
                
                $
                (4,369
                )
                (5.4
                )%
                
                $
                (11,340
                )
                (11.8
                )%





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:




2010
                        
                        
                        2009
                        
                        
                        2008Averageordersize (including shipping &
      handling)
                        
                        $
                        299.98
                        
                        
                        $
                        266.66
                        
                        
                        $
                        279.72Newcustomersadded during theyear*
                        
                        
                        174,795
                        
                        
                        
                        173,550
                        
                        
                        
                        201,044*Based
      on unique email addresses


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




For
The Year Ended December 31, 2010 Compared To The Year Ended December 31,
2009




Net sales: Gross sales for the
year ended December 31, 2010 increased by approximately 11% to $144,544,000,
from $130,531,000 for the year ended December 31, 2009.  The increase
in gross sales was primarily attributable to our decision to invest in inventory
levels to support the growth in sales demand and our increased marketing
efforts.  The primary increase in sales demand growth was due to our
luxury designer merchandise, which also resulted in an increase in average order
size.




The
provision for returns and credit card chargebacks and other credits was
approximately 38.7% and 37.8% for 2010 and 2009, respectively, resulting in a
provision of approximately $55,981,000 and $49,309,000 for the years ended
December 31, 2010 and 2009, respectively. The increase in this provision, as a
percentage of gross sales, resulted from an increase in the return rate, which
was, in part, caused by a planned shift in our merchandise mix towards luxury
designer merchandise.  These items historically have higher return
rates.


16


After the
necessary provisions for returns, credit card chargebacks and adjustments for
uncollected sales taxes, our net sales for the year ended December 31, 2010 was
$88,563,000.  This represents an increase of approximately 9% compared
to the year ended December 31, 2009, in which net sales totaled
$81,222,000.  The increase in net sales resulted primarily from a 12%
increase in average order size compared to the prior year. Shipping and handling
revenue (which is included in net sales) decreased by 9% to $4,037,000 for the
year ended December 31, 2010, from $4,420,000 for the year ended December 31,
2009. Shipping and handling revenue decreased as a result of a decrease in
overall shipping and handling charges to customers to support the growth of
sales demand.




Cost of sales:  Cost
of sales consists of the cost of products 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, 2010 totaled $55,360,000,
resulting in a gross profit margin percentage of approximately 37.5%. Cost of
sales for the year ended December 31, 2009 totaled $49,665,000, resulting in a
gross profit margin percentage of 38.9%. The decrease in gross profit margin
percentage was attributable to our shift in our merchandise mix towards the
growth of our luxury designer merchandise and an increase in our provision for
inventory obsolescence as a result of the larger inventory balances necessary to
support the increased sales demand.




Gross Profit:  As a
result of the increase in net sales, gross profit increased by approximately 5%
to $33,203,000 for the year ended December 31, 2010, from $31,557,000 for the
year ended December 31, 2009.




Selling and fulfillment
expenses:  Selling and fulfillment expenses increased by
slightly over 1% for the year ended December 31, 2010 compared to the year ended
December 31, 2009. Selling and fulfillment expenses were comprised of the
following:




Year
      Ended December 31,
                            
                            Percentage(All data
      in thousands)
                            
                            2010
                            
                            2009
                            
                            DifferenceAs
      a % of
                            
                            
                            
                            
                            
                            As
      a % of
                            
                            IncreaseNet
      Sales
                            
                            
                            
                            
                            
                            Net
      Sales
                            
                            (Decrease)Operating
                            
                            $
                            7,976
                            
                            
                            9.0
                            %
                            
                            $
                            7,857
                            
                            
                            9.6
                            %
                            
                            1.5
                            
                            %Technology
                            
                            
                            5,426
                            
                            
                            6.1
                            
                            
                            
                            5,602
                            
                            
                            6.9
                            
                            
                            (3.1
                            )E-Commerce
                            
                            
                            3,479
                            
                            
                            3.9
                            
                            
                            
                            3,216
                            
                            
                            4.0
                            
                            
                            8.2Total selling and fulfillment
      expenses
                            
                            $
                            16,881
                            
                            
                            19.0
                            %
                            
                            $
                            16,675
                            
                            
                            20.5
                            %
                            
                            1.2
                            
                            %


As a
percentage of net sales, our selling and fulfillment expenses decreased to 19.0%
for the year ended December 31, 2010 from 20.5% for the year ended December 31,
2009.




Operating
expenses include all costs related to inventory management, fulfillment,
customer service, and credit card processing. Operating expenses for the year
ended December 31, 2010 increased by approximately 2% compared to the year ended
December 31, 2009 as a result of decreased variable costs associated with order
fulfillment (e.g., picking and packing orders and processing returns), which
were offset by an increase in credit card fees associated with an increase in
average order size and net sales.




Technology
expenses consist primarily of staff related costs, amortization of capitalized
costs and Web Site hosting expenses. For the year ended December 31, 2010,
technology expenses decreased by approximately 3% compared to the year ended
December 31, 2009. This decrease was attributable to a decrease in salary and
salary related expenses of approximately $271,000, a decrease in depreciation
expenses, included in technology expenses, of approximately $106,000 and a
decrease in consulting fees of $47,000, and was partially offset by an increase
in Web Site hosting and software support expenses of approximately
$274,000.




E-Commerceexpenses include expenses
related to our photo design studio, image processing, and Web Site design. For
the year ended December 31, 2010, e-commerce expenses increased by approximately
8% compared to the year ended December 31, 2009 primarily as a result of
increases in consulting fees relating to the development of new Web Site
features and functionalities of $205,000 and short-term staffing expenses of
$92,000, which were partially offset by a decrease in salary and salary related
expenses of $63,000.




Marketing
expenses:Marketing expenses increased by 45% to $12,576,000
for the year ended December 31, 2010 from $8,661,000 for the year ended December
31, 2009.




Marketing
expenses include expenses related to (a) online marketing programs, which
consist of social media programs, online integration partnerships, paid search,
fees to marketing affiliates and comparison engines and (b) offline marketing
programs, which consist of direct mail campaigns, television advertising and
production costs, as well as staff related costs.  As a





17





percentage
of net sales, our marketing expenses increased to 14.2% for the year ended
December 31, 2010 from 10.7% for the year ended December 31, 2009.




Total
marketing expenses (excluding staff related costs) related to online advertising
for the year ended December 31, 2010 totaled $7,213,000, compared to $5,300,000
for the year ended December 31, 2009.  This investment in marketing
spend resulted in planned increases in online marketing programs from fees to
social media programs of $765,000, fees to comparison engines of $556,000, fees
to marketing affiliates of $353,000 and paid search fees of
$239,000.  These planned increases in online marketing programs
represent an investment in top-line growth marketing initiatives such as the
Closet Confessions campaign, which was initially developed for distribution on
social media outlets and based upon its success later aired on Bravo
TV.




Total
marketing expenses (excluding staff related costs) related to offline
advertising for the year ended December 31, 2010 totaled $4,120,000 compared to
$2,270,000 for the year ended December 31, 2009.  This planned
increase of approximately $1,850,000 was primarily a result of an increase in
television advertising with entertainment properties, such as Bravo TV, Lifetime
TV and targeted shows on the CW, and an increase in fixed production costs
related to television advertising of approximately $130,000.  Our
online and offline marketing programs have been successful in bringing new
visitors to our Web Site since it launched.




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, 2010 decreased by
approximately 15% to $7,592,000, as compared to $8,882,000 for the year ended
December 31, 2009.  The decrease in general and administrative
expenses was primarily the result of a decrease in salary and salary related
expenses of $783,000, a decrease in amortization expenses related to leasehold
improvements and internally-developed software costs related to product
application systems of $303,000 and a decrease in overall professional fees of
$276,000.




As a
percentage of net sales, general and administrative expenses for the year ended
December 31, 2010 decreased to approximately 8.6% from 10.9% for the year ended
December 31, 2009.




Loss from
operations:  Operating loss increased to $3,846,000 for the
year ended December 31, 2010, from $2,661,000 for the year ended December 31,
2009.




Interest expense, net:Interest income increased to $39,000 for the year ended December 31,
2010, from $25,000 for the year ended December 31, 2009. These amounts related
primarily to interest income earned on our increased cash balances as a result
of receiving proceeds from the completion of the private placement in February
2010.




We did
not have any interest expense to related party stockholders for the year ended
December 31, 2010, because our subordinated convertible notes were converted
into equity in December 2009.  By comparison, we had $1,413,000 of
interest expense to related party stockholders for the year ended December 31,
2009, which are further discussed below.




Other
interest expense for the year ended December 31, 2010 totaled $226,000 compared
to $320,000 for the year ended December 31, 2009.  Interest expense
consists of fees paid in connection with our credit facility.




Net loss per
share:Net loss per share decreased to $0.17 per share for the
year ended December 31, 2010 from $0.31 per share for the year ended December
31, 2009.  The decrease in net loss per share is primarily
attributable to an increase in weighted average common shares outstanding of
23,685,338 for the year ended December 31, 2010 as compared to the weighted
average common shares outstanding of 14,003,534 for the year ended December 31,
2009.  The increase in weighted average common shares outstanding
during 2010 is primarily attributable to the second closing of the private
placement transaction with Rho, in which we issued 6,037,192 in February
2010.




For
The Year Ended December 31, 2009 Compared To The Year Ended December 31,
2008




Net sales: Gross sales for the
year ended December 31, 2009 decreased by approximately 17% to $130,531,000 from
$157,248,000 for the year ended December 31, 2008.  The decrease in
gross sales was primarily attributable to our planned decrease in inventory
purchases in response to the overall decline in consumer spending and our
streamlined business plan prior to our recent private placement.  The
provision for returns and credit card chargebacks and other credits was
approximately 37.8% and 39.1% for 2009 and 2008, respectively, resulting in a
provision of approximately $49,309,000 and $61,474,000 for the years ended
December 31, 2009 and 2008, respectively. The decrease in this provision as a
percentage of gross sales resulted from a reduction in the return rate, which
was, in part, caused by a shift in our merchandise mix. In addition, we believe
that the reduction in return rate was partially caused by customers making fewer
impulse purchases, which are generally more likely to







18





be
returned.  We refined our merchandising mix in 2008 to shift to more
contemporary merchandise as part of our streamlined business plan prior to our
private placement completed in early 2010. Accordingly, we experienced a
corresponding decrease in the return rate.




After the
necessary provisions for returns, credit card chargebacks and adjustments for
uncollected sales taxes, our net sales for the year ended December 31, 2009 was
$81,222,000.  This represents a decrease of approximately 15% compared
to the year ended December 31, 2008, in which net sales totaled
$95,774,000.  The decrease in net sales resulted primarily from a 14%
decrease in the number of new customers acquired and a 5% decrease in average
order size compared to the prior year. We believe that the decrease in both of
these measures was primarily attributable to our planned decrease in inventory
purchases in response to the overall decline in consumer
spending.  Shipping and handling revenue (which is included in net
sales) decreased by 18% to $4,420,000 for the year ended December 31, 2009, from
$5,380,000 for the year ended December 31, 2008. Shipping and handling revenue
decreased at a higher percentage than net sales as a result of a decreased
number of customer orders compared to the prior year.




Cost of sales:  Cost
of sales for the year ended December 31, 2009 totaled $49,665,000, resulting in
a gross profit margin percentage of approximately 38.9%. Cost of sales for the
year ended December 31, 2008 totaled $60,288,000, resulting in a gross profit
margin percentage of 37.1%. The increase in gross profit margin percentage was
attributable to improved product margins, a decrease in our provision for
inventory obsolescence and a decrease in the rate of returns caused by a shift
in our merchandise mix.




Gross Profit:  As a
result of the decrease in net sales, gross profit decreased by approximately
11%, to $31,557,000 for the year ended December 31, 2009, from $35,486,000 for
the year ended December 31, 2008. The decrease in gross profit was primarily the
result of a decrease in net sales attributable to our planned decrease in
inventory purchases in response to the overall decline in consumer spending and
our streamlined business plan prior to our private placement completed in early
2010, which was slightly offset by improved product margins.




Selling and fulfillment
expenses:  Selling and fulfillment expenses decreased by 15%
for the year ended December 31, 2009 compared to the year ended December 31,
2008. Selling and fulfillment expenses were comprised of the
following:




Year
      Ended December 31,
                      
                      Percentage(All data
      in thousands)
                      
                      2009
                      
                      2008
                      
                      DifferenceAs
      a % of
                      
                      
                      
                      
                      
                      As
      a % of
                      
                      IncreaseNet
      Sales
                      
                      
                      
                      
                      
                      Net
      Sales
                      
                      (Decrease)Operating
                      
                      $
                      7,857
                      
                      
                      9.6
                      %
                      
                      $
                      10,179
                      
                      
                      10.6
                      %
                      
                      (22.8
                      )
                      %Technology
                      
                      
                      5,602
                      
                      
                      6.9
                      
                      
                      
                      5,979
                      
                      
                      6.2
                      
                      
                      (6.3
                      )E-Commerce
                      
                      
                      3,216
                      
                      
                      4.0
                      
                      
                      
                      3,462
                      
                      
                      3.6
                      
                      
                      (7.1
                      )Total selling and fulfillment
      expenses
                      
                      $
                      16,675
                      
                      
                      20.5
                      %
                      
                      $
                      19,620
                      
                      
                      20.5
                      %
                      
                      (15.0
                      )
                      %


As a
percentage of net sales, our selling and fulfillment expenses remained unchanged
at 20.5% for the years ended December 31, 2009 and 2008.




Operating
expenses for the year ended December 31, 2009 decreased by approximately 23%
compared to the year ended December 31, 2008 as a result of decreased variable
costs associated with order fulfillment (e.g., picking and packing orders and
processing returns), decreased credit card fees and a decrease in salary
expenses and fees associated with our customer service call
center.  Operating expenses decreased at a higher percentage than net
sales as a result of our streamlined business plan, which included, among other
things, reductions in capital expenditures and delayed new hires.




For the
year ended December 31, 2009, technology expenses decreased by approximately 6%
compared to the year ended December 31, 2008. This decrease was attributable to
a decrease in salary and salary related expenses of approximately $478,000, a
decrease in consulting fees of approximately $281,000, and a decrease in web
hosting and software support expenses of approximately $149,000, which were
partially offset by an increase in depreciation expenses, included in technology
expenses, of approximately $618,000.




For the
year ended December 31, 2009, e-commerce expenses decreased by approximately 7%
compared to the year ended December 31, 2008.  This decrease was
attributable to decreases in salary and salary related expenses of approximately
$108,000 and expenses associated with photo shoots of approximately
$36,000.




Marketing
expenses:Marketing expenses decreased by 44% to $8,661,000
for the year ended December 31, 2009, from $15,359,000 for the year ended
December 31, 2008.





19





As a
percentage of net sales, our marketing expenses decreased to 10.7% for the year
ended December 31, 2009, from 16.0% for the year ended December 31,
2008.  Total expenses related to our national print and television
advertising campaign for the year ended December 31, 2009 totaled $1,877,000,
compared to $6,030,000 for the year ended December 31, 2008.  This
decrease of approximately $4,153,000 was primarily due to a reduction in offline
marketing spend, specifically, production costs and placement fees. Total
marketing expenses (excluding staff related costs) for the year ended December
31, 2009 decreased by approximately $5,959,000 as compared to December 31, 2008.
Expenses related to paid search, online integration and comparison engines
decreased by $992,000, $403,000 and $201,000, respectively.




General and administrative
expenses:
General and administrative expenses for the year ended December 31, 2009
decreased by approximately 22% to $8,882,000, as compared to $11,355,000 for the
year ended December 31, 2008.  The decrease in general and
administrative expenses was primarily the result of a decrease in stock-based
compensation related to equity awards of approximately $1,670,000, a decrease in
salary and salary related expenses of approximately $137,000 and a decrease in
overall professional fees of approximately $336,000.




As a
percentage of net sales, general and administrative expenses for the year ended
December 31, 2009 decreased to approximately 10.9%, from 11.9% for the year
ended December 31, 2008.




Loss from
operations:  Operating loss decreased to $2,661,000 for the
year ended December 31, 2009, from $10,848,000 for the year ended December 31,
2008.




Interest expense, net:Interest income decreased to $25,000 for the year ended December 31,
2009, from $62,000 for the year ended December 31, 2008. These amounts related
primarily to interest income earned on our cash balances.




Interest
expense to related party stockholders increased to $1,413,000 for the year ended
December 31, 2009, compared to $235,000 for the year ended December 31, 2008.
The increase in interest expense to related party stockholders was primarily the
result of the recognition of the embedded derivative financial liability
relating to the embedded conversion feature within the subordinated convertible
notes to related parties of approximately $785,000 (which were converted into
equity in December 2009), amortization of the debt discount of approximately
$343,000 and interest expense of approximately $241,000 relating to our
subordinated convertible notes.




Other
interest expense for the year ended December 31, 2009 totaled $320,000 compared
to $319,000 for the year ended December 31, 2008.  Interest expense
consists of fees paid in connection with our credit facility.




Net loss per
share:Net loss per share decreased to $0.31 per share for the
year ended December 31, 2009 from $0.90 per share for the year ended December
31, 2008.




Liquidity
And Capital Resources




General




At
December 31, 2010, we had approximately $10.4 million in cash and cash
equivalents compared to $10.0 million and $4.0 million at December 31, 2009 and
2008, respectively. Working capital, which is computed as total current assets
less total current liabilities and represents a measure of operating liquidity,
at December 31, 2010, 2009 and 2008 was $26.5 million, $19.4 million and $15.3
million, respectively.  As of December 31, 2010, we had an accumulated
deficit of $151.5 million.  We have incurred negative cash flows and
cumulative net losses since inception.




Changes
in cash and cash equivalents at December 31, 2010 compared to December 31, 2009
are primarily attributable to $10,020,000 in net proceeds we received from the
private placement financing described below, which was offset by decreases in
cash used in operations attributable to normal increases in working capital
requirements, related to changes in operating assets and liabilities including
increases in inventory purchases to support the growth of the luxury designer
merchandise of $7,819,000, and cash used to invest in property and equipment
primarily related to investing in internally-developed software purchases of
$2,139,000.




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




Private
placement




On
December 21, 2009, we entered into a Securities Purchase Agreement with Rho,
pursuant to which we agreed to issue and sell to Rho up to 8,823,529 shares of
our Common Stock, for an aggregate purchase price of $15,000,000, or $1.70 per
share, in







20





a private
placement transaction.  We issued and sold 2,786,337 of the shares to
Rho at an initial closing held on December 21, 2009 for an aggregate purchase
price of approximately $4,737,000.  At, and as a condition to, the
initial closing, Soros and Maverick converted $3,000,000 in aggregate principal
amount of subordinated notes into an aggregate of 1,764,706 shares of Common
Stock at a conversion price of $1.70 per share.  At conversion, we
paid in cash approximately $347,000 of interest on the subordinated convertible
notes.  In February 2010, we completed the second closing of the
private placement with Rho in which we received approximately $10,020,000, net
of $243,000 of issuance costs, in return for the issuance of 6,037,192 shares of
Common Stock.




Credit
facility




Pursuant
to the terms of our credit facility, as amended, Wells Fargo provides us with a
revolving loan and issues letters of credit in favor of suppliers or
factors.  The credit facility is secured by a lien on substantially
all of our assets. Availability under the credit facility is determined by a
formula that takes into account a certain percentage of our inventory and a
certain percentage of our accounts receivable. The maximum availability is
currently $7,500,000, but can be increased to $12,500,000 at our request,
subject to certain conditions.  As of December 31, 2010, total
availability under the credit facility was approximately $6.3 million, of which
$2.8 million was committed for letters of credit in favor of suppliers, leaving
approximately $3.5 million available for further borrowings.  The
terms of the credit facility contain a material adverse change
clause.  In the event of a material adverse change in our financial
condition, we would not be able to obtain additional borrowings under the credit
facility and existing borrowings would become due and payable.  The
credit facility expires in July 2011.  However, we have reached an
agreement in principle regarding a renewal of the credit
facility.  Notwithstanding this agreement, there is no assurance that
we will be able to renew our credit facility on favorable terms, or at
all.




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




Both
availability under our credit facility and our operating cash flows are affected
by the payment terms that we receive from suppliers and service providers, and
the extent to which suppliers require us to provide credit support under our
credit facility.  In some instances, new vendors may require
prepayments. We may make prepayments in order to open up these new
relationships, or to gain access to inventory that would not otherwise be
available to us. In addition, from time to time we make prepayments in
connection with our advertising campaign, as in some circumstances we need to
pay in advance of production. As of December 31, 2010, we had approximately
$893,000 of prepaid inventory and approximately $48,000 of prepaid
marketing on our Balance Sheet compared to $238,000 and $12,000 as of December
31, 2009 and $155,000 and $174,000 as of December 31, 2008.




Commitments
and long-term obligations




As of
December 31, 2010, we had the following commitments and long-term
obligations:




Less Than
                        
                        
                        
                        
                        
                        
                        
                        
                        More ThanTotal(1)
                        
                        
                        1 Year(1)
                        
                        
                        1-3 Years(1)
                        
                        
                        3-5 Years(1)
                        
                        
                        5 Years(1)Employment
      contracts
                        
                        $
                        4,126,000
                        
                        
                        $
                        2,076,000
                        
                        
                        $
                        2,050,000
                        
                        
                        $
                        --
                        
                        
                        $
                        --Operating
      leases
                        
                        
                        5,935,000
                        
                        
                        
                        386,000
                        
                        
                        
                        1,089,000
                        
                        
                        
                        1,167,000
                        
                        
                        
                        3,293,000Marketing and
      advertising
                        
                        
                        1,943,000
                        
                        
                        
                        1,583,000
                        
                        
                        
                        360,000
                        
                        
                        
                        --
                        
                        
                        
                        --Total commitments and long-term
      obligations
                        
                        $
                        12,004,000
                        
                        
                        $
                        4,045,000
                        
                        
                        $
                        3,499,000
                        
                        
                        $
                        1,167,000
                        
                        
                        $
                        3,293,000


___________________


(1)
            The
      table above excludes a cash commitment of $312,000 representing the
      remaining contribution amount, which is payable upon request, in the
      formation of Eyefly.





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


21


Off
balance sheet arrangements




Warrants
issued in conjunction with certain preferred stock financing transactions that
we entered into in prior years are equity linked derivatives and accordingly
represent an off balance sheet arrangement.  These warrants were not
classified as derivatives, but instead included as a component of stockholders’
equity. See Statements of Changes in Stockholders’ Equity for more
information.




Recent
Accounting Pronouncements




In February 2010, the FASB issued an
update to authoritative guidance relating to subsequent events, which was
effective upon the issuance of the update.Weadopted this authoritative guidance on
February 28, 2010.  The update to the authoritative guidance relating
to subsequent events removes the requirement for SEC filers to disclose the date
through which subsequent events have been evaluated in both issued and revised
financial statements.  The adoption of this update to the
authoritative guidance relating to subsequent events did nothave animpactupon our financial position or operating
resultsother than removing
the disclosure.




Recently
issued, but not yet effective, accounting pronouncements




We are not aware of any recently issued,
but not yet effective, accounting pronouncements that would have a significant
impact on our financial position or results of operations.




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.




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.




Item 9.  Change in and DisagreementsWith 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(the
“Evaluation Date”), we
carried out an evaluation, under the supervision and with the participation of
our management, including our Chief Executive OfficerandChief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based
upon that evaluation, our Chief Executive OfficerandChief Financial Officer concluded
that, as of the Evaluation
Date,our disclosure
controls and procedureswere effectiveinensuringthat information required to be
disclosedby usin the reports that we file
or submit under the Exchange Actwere recorded, processed, summarized and
reported,within the time periods specified in
the SEC’s rules and forms, andwere effective to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act was accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, to allow
timely decisions regarding required disclosure.




Internal Control Over Financial
Reporting




Management’s Report on Internal Control
Over Financial Reporting.




Our management is responsible for
establishing and maintaining adequate internal control over financial reporting
as defined in Rules 13a – 15(f) and 15d – 15(f) under the Securities Exchange
Act of 1934, as amended. Our management has assessed the effectiveness of our
internal control over financial reporting based on the criteria set forth in
Internal Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (“COSO”). Based on its
assessment under the criteria set forth in Internal Control — Integrated
Framework, our management concluded that our internal control over financial
reporting was effective as of December 31, 2010.  This annual report does
not include an attestation reportfromourregistered public accounting firm
regarding internal control over financial reporting.  Management’s
report was not  22


subject to attestation by theindependent registered
public accounting firm pursuant to rules of the SEC that permitusto provide only management’s report in
this annual report.




Changes in Internal Control Over
Financial Reporting




There have been no changes in our
internal control over financial reporting that occurred duringourmost recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect,ourinternal control over financial
reporting.




Item 9B.  Other
Information.




None.




PART
III.




Item
10.  Directors,Executive Officers and Corporate
Governance.




The information required by this Item is
incorporated by referencefromourdefinitive proxy statement for the
2011annual meeting of
stockholders.




Item 11.  Executive
Compensation.




The information required by this Item is
incorporated by referencefromourdefinitive proxy statement for the
2011annual 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 referencefromourdefinitive proxy statement for the
2011annual meeting of
stockholders.




Item 13.  Certain
Relationships and Related Transactions,and Director Independence.




The information required by this Item is
incorporated by referencefromourdefinitive proxy statement for the
2011annual meeting of
stockholders.




Item 14.  Principal
AccountingFees and Services.




The information required by this Item is
incorporated by referencefromourdefinitive proxy statement for the
2011annual meeting of
stockholders.







23





PART
IV.




Item 15.Exhibits, Financial Statement
Schedules.




(a)           (1)           Financial
Statements:




REPORT OF INDEPENDENT REGISTERED
      PUBLIC ACCOUNTING FIRMSFINANCIAL
      STATEMENTS:Balance Sheets as of
      December 31, 2010 and 2009Statements of Operations for the
      Years Ended December 31, 2010, 2009and 2008Statements of Changes inStockholders’ Equity for the Years Ended
      December 31, 2010, 2009and 2008Statements of Cash Flows for the
      Years Ended December 31, 2010, 2009and 2008Notes to Financial
      Statements







(2)
            Financial Statement
      Schedule:




SCHEDULE II — Valuation and
      Qualifying Accounts For the Three Years EndedDecember 31,
      2010




(3)
            Exhibits:




Exhibit No.
                Description3.1
                Certificate
      of Incorporation of the Company (incorporated by reference to the
      Company’s Annual Report on Form 10-K for the year ended December 31,
      2000).3.2
                Certificate
      of Amendment to Certificate of Incorporation of the Company, dated April
      3, 2008 (incorporated by reference to the Company’s Current Report on Form
      8-K, dated April 4, 2008).3.3
                Amended
      and Restated Certificate of Incorporation of the Company, dated February
      25, 2010 (incorporated by reference to the Company’s Current Report on
      Form 8-K, dated March 3, 2010).3.4
                By-Laws
      of the Company (incorporated by reference to the Company’s Annual Report
      on Form 10-K for the year ended December 31, 2007).3.5
                Amendment
      to Bylaws of the Company (incorporated by reference to the Company’s
      Annual Report on Form 10-K for the year ended December 31,
      2007).10.1
                Amended
      and Restated 1997 Stock Option Plan (incorporated by reference to the
      Company’s Definitive Proxy Statement on Schedule 14A, filed with
      the





24








Commission
      on June 29, 2004).10.2
                Bluefly,
      Inc. 2000 Stock Option Plan (incorporated by reference to the Company’s
      Quarterly Report on Form 10-Q for the quarterly period ended June 30,
      2000).10.3
                Investment
      Agreement, dated November 13, 2000, by and among the Company, Bluefly
      Merger Sub, Inc., Quantum Industrial Partners LDC and SFM Domestic
      Investments LLC (incorporated by reference to the Company’s Quarterly
      Report on Form 10-Q for the quarterly period ended September 30,
      2000).10.4
                Common
      Stock and Warrant Purchase Agreement, dated May 24, 2002, by and between
      the Registrant and the investors listed on Schedule 1 thereto
      (incorporated by reference to the Company’s Quarterly Report on Form 10-Q
      for the quarterly period ended June 30, 2002).10.5
                Note
      and Warrant Purchase Agreement, dated January 28, 2003, by and between the
      Registrant and the investors listed on Schedule 1 thereto (incorporated by
      reference to the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2002).10.6
                Common
      Stock and Warrant Purchase Agreement dated January 9, 2004 by and among
      the Company and the Investors listed on Schedule 1 thereto (incorporated
      by reference to the Company’s Current Report on Form 8-K, dated January
      13, 2004).*10.7
                Master
      Service Agreement, dated as of February 28, 2005, by and between the
      Company and Level 3 Communications, LLC (incorporated by reference to the
      Company’s Current Report on Form 8-K, dated March 4, 2005).*10.8
                Customer
      Order Addendum, dated as of February 28, 2005, by and between the Company
      and Level 3 Communications, LLC (incorporated by reference to the
      Company’s Current Report on Form 8-K, dated March 4, 2005).10.9
                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
      (incorporated by reference to the Company’s Current Report on Form 8-K,
      dated June 28, 2005).10.10
                Loan
      and Security Agreement, dated July 26, 2005, by and between the Company
      and Wells Fargo Retail Finance, LLC (incorporated by reference to the
      Company’s Current Report on Form 8-K, dated July 29, 2005).10.11
                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 (incorporated by
      reference to the Company’s Current Report on Form 8-K, dated June 7,
      2006).10.12
                First
      Amendment to Loan and Security Agreement, dated as of August 14, 2006, by
      and between the Company and Wells Fargo Retail Finance, LLC (incorporated
      by reference to the Company’s Current Report on Form 8-K, dated August 14,
      2006).10.13
                Master
      License Agreement, dated as of September 28, 2006, by and between the
      Company and Art Technology Group, Inc. (incorporated by reference to the
      Company’s Current Report on Form 8-K, dated October 3, 2006).





25








10.14
                  Bluefly,
      Inc. Amended and Restated 2005 Stock Incentive Plan (incorporated by
      reference to the Company’s Definitive Proxy Statement on Schedule 14A,
      filed with the Commission on April 16, 2007).*10.15
                  Fulfillment
      Services Agreement, dated as of April 11, 2007, by and between the Company
      and Fulfillment Technologies, LLC (incorporated by reference to the
      Company’s Current Report on Form 8-K, dated April 17, 2006).10.16
                  Service
      Agreement, dated as of May 9, 2007, by and between the Company and VIPdesk
      Connect, Inc. (incorporated by reference to the Company’s Current Report
      on Form 8-K, dated May 10, 2007).*10.17
                  Letter
      Agreement, dated as of December 21, 2007, by and between the Company and
      Fulfillment Technologies, LLC (incorporated by reference to the Company’s
      Current Report on Form 8-K, dated December 27, 2007).10.18
                  Second
      Amendment to Loan and Security Agreement, dated as of November 15, 2007,
      by and between the Company and Wells Fargo Retail Finance, LLC
      (incorporated by reference to the Company’s Annual Report on Form 10-K for
      the year ended December 31, 2007).10.19
                  Third
      Amendment to Loan and Security Agreement, dated as of January 17, 2008 and
      effective as of January 15, 2008, by and between the Company and Wells
      Fargo Retail Finance, LLC (incorporated by reference to the Company’s
      Annual Report on Form 10-K for the year ended December 31,
      2007).10.20
                  Fourth
      Amendment to Loan and Security Agreement, dated as of March 26, 2008 by
      and between the Company and Wells Fargo Retail Finance, LLC (incorporated
      by reference to the Company’s Annual Report on Form 10-K for the year
      ended December 31, 2007).10.21
                  Standby
      Commitment Agreement, dated as of March 26, 2008, by Quantum Industrial Partners LDC,
      SFM Domestic Investments LLC and private funds associated with Maverick
      Capital, Ltd. in favor of the Company (incorporated by reference to
      the Company’s Annual Report on Form 10-K for the year ended December 31,
      2007).10.22
                  Amended
      and Restated Warrant No. 1, dated April 8, 2008 and effective as of March
      26, 2008, issued to Quantum
      Industrial Partners LDC (incorporated by reference to the Company’s
      Quarterly Report on Form 10-Q for the quarter ended March 31, 2008).10.23
                  Amended
      and Restated Warrant No. 2 dated April 8, 2008 and effective as of March
      26, 2008, issued to SFM
      Domestic Investments LLC (incorporated by reference to the
      Company’s Quarterly Report on Form 10-Q for the quarter ended March 31,
      2008).
                    .10.24
                  Amended
      and Restated Warrant No. 3 dated April 8, 2008 and effective as of March
      26, 2008, issued to Maverick
      Fund USA, Ltd. (incorporated by reference to the Company’s
      Quarterly Report on Form 10-Q for the quarter ended March 31,
      2008).10.25
                  Amended
      and Restated Warrant No. 4 dated April 8, 2008 and effective as of March
      26, 2008, issued to Maverick
      Fund LDC (incorporated by reference to the Company’s Quarterly
      Report on Form 10-Q for the quarter ended March 31, 2008).10.26
                  Amended
      and Restated Warrant No. 5 dated April 8, 2008 and effective as of March
      26, 2008, issued to Maverick
      Fund II, Ltd. (incorporated by reference to the Company’s Quarterly
      Report on Form 10-Q for the quarter ended March 31, 2008).
   26
  10.27
                  Fifth
      Amendment, dated as of June 30, 2008, to Loan and Security Agreement,
      dated as of July 25, 2006, by and between the Company Wells Fargo Retail
      Finance, LLC (incorporated by reference to the Company’s Quarterly Report
      on Form 10-Q for the quarter ended June 30, 2008).*10.28
                  Letter
      Agreement, dated as of November 19, 2008, by and between the Company and
      Fulfillment Technologies, LLC (incorporated by reference to the Company’s
      Current Report on Form 8-K, dated November 24, 2008).10.29
                  Sixth
      Amendment, dated as of February 17, 2009, to Loan and Security Agreement,
      dated as of July 25, 2006, by and between the Company and Wells Fargo
      Retail Finance, LLC (incorporated by reference to the Company’s Current
      Report on Form 8-K, dated February 19, 2009).10.30
                  Securities
      Purchase Agreement, dated as of December 21, 2009, between Bluefly, Inc.
      and Rho Ventures VI, LP (incorporated by reference to the Company’s
      Current Report on Form 8-K, dated December 24, 2009).10.31
                  Amended
      and Restated Voting Agreement, dated as of December 21, 2009, among
      Bluefly, Inc., Quantum Industrial Partners LDC, SFM Domestic Investments,
      LLC, Maverick Fund USA, Ltd., Maverick Fund, L.D.C., Maverick Fund II,
      Ltd., Prentice Capital Partners, LP, Prentice Capital Partners QP, LP,
      Prentice Capital Offshore, Ltd., S.A.C. Capital Associates, LLC, GPC
      XLIII, LLC, PEC I, LLC and Rho Ventures VI, LP (incorporated by reference
      to the Company’s Current Report on Form 8-K, dated December 24,
      2009).10.32
                  Registration
      Rights Agreement, dated as of December 21, 2009, among Bluefly, Inc.,
      Quantum Industrial Partners LDC, SFM Domestic Investments, LLC, Maverick
      Fund USA, Ltd., Maverick Fund, L.D.C., Maverick Fund II, Ltd., Prentice
      Capital Partners, LP, Prentice Capital Partners QP, LP, Prentice Capital
      Offshore, Ltd., S.A.C. Capital Associates, LLC, GPC XLIII, LLC, PEC I, LLC
      and Rho Ventures VI, LP (incorporated by reference to the Company’s
      Current Report on Form 8-K, dated December 24, 2009).10.33
                  Consent
      and Seventh Amendment to Loan and Security Agreement, dated as of December
      21, 2009, between the Company and Wells Fargo Retail Finance, LLC
      (incorporated by reference to the Company’s Current Report on Form 8-K,
      dated December 24, 2009).10.34
                  Amendment
      No. 1 to the Amended and Restated Bluefly, Inc. 2005 Stock Incentive Plan
      (incorporated by reference to the Company’s Current Report on Form 8-K,
      dated March 3, 2010).10.35
                  Lease
      Agreement by and between the Company and 42-52 West 39 Street LLC, dated
      March 17, 2010 (incorporated by reference to the Company’s Current Report
      on Form 8-K, dated March 22, 2010).10.36
                  Amended
      and Restated Employment Agreement, dated as of April 27, 2010, by and
      between the Company and Melissa Payner-Gregor (incorporated by reference
      to the Company’s Current Report on Form 8-K, dated April 30,
      2010).





27








10.37
                  Second
      Amended and Restated Employment Agreement, dated as of April 27, 2010, by
      and between the Company and Kara Jenny (incorporated by reference to the
      Company’s Current Report on Form 8-K, dated April 30, 2010).10.38
                  Amended
      and Restated Employment Agreement, dated as of December 31, 2010, by and
      between the Company and Bradford Matson.10.39
                  Amended
      and Restated Employment Agreement, dated as of December 31, 2010, by and
      between the Company and Martin Keane.23.1
                  Consent
      of WeiserMazars LLP.23.2
                  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 and were filed
      separately with the Securities and Exchange
  Commission.








28





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




February
16, 2011





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.





Signature
                              
                              Title
                              
                              Date/s/ David
      WassongDavid
    Wassong
                              
                              Interim Chairman of the
      Board
                              
                              February 16, 2011/s/ Melissa Payner
      GregorMelissa
      Payner-Gregor
                              
                              Chief Executive Officer (Principal
      Executive Officer)
                                Director
                              
                              February 16, 2011/s/ Kara B.
      JennyKara B.
    Jenny
                              
                              Chief Financial Officer (Principal
      Accounting Officer)
                              
                              February 16, 2011/s/ Mario
      CiampiMario
Ciampi
                              
                              Director
                              
                              February 16, 2011/s/ Michael
      HelfandMichael
    Helfand
                              
                              Director
                              
                              February 16, 2011/s/ Habib
      KairouzHabib
    Kairouz
                              
                              Director
                              
                              February 16, 2011/s/David JankeDavid Janke
                              
                              Director
                              
                              February 16, 2011/s/ Martin
      MillerMartin
    Miller
                              
                              Director
                              
                              February 16, 2011/s/ Anthony
      PlesnerAnthony
    Plesner
                              
                              Director
                              
                              February 16, 2011/s/ Denise
      SeegalDenise
    Seegal
                              
                              Director
                              
                              February 16, 2011








29




BLUEFLY,
INC.
 INDEX TO
FINANCIAL STATEMENTS AND SCHEDULE
 
 
 
 PageNumberREPORTOF INDEPENDENT REGISTERED PUBLIC
      ACCOUNTING FIRMS
                          
                          F – 1 to F –
    2FINANCIAL
      STATEMENTS:Balance Sheets as of
      December31,
      2010and2009
                          
                          F – 3Statements of Operations for the
      Years Ended December 31, 2010, 2009 and 2008
                          
                          F – 4Statements of Changes in
      Stockholders’ Equity for the Years Ended December 31, 2010, 2009 and
      2008
                          
                          F – 5Statements of Cash Flows for the
      Years Ended December31, 2010, 2009 and
      2008
                          
                          F – 6Notes to Financial
      Statements
                          
                          F – 7 to F –
    20SCHEDULE II — Valuation and
      Qualifying AccountsFor the Three Years Ended December 31, 2010
                          
                          S –
  1
 
  
  
 
 Report
of Independent Registered Public Accounting Firm
 
 To the Board of Directors andStockholders
 of Bluefly, Inc.
  We have audited the accompanying balance
sheetsof Bluefly, Inc. (the “Company”) as of
December 31, 2010and 2009, and the related statements of
operations,changes in
stockholders’ equity and
cash flows for the yearsthen ended.Our audits included the financial
statement schedule listed in Item 15(a)(2).These financial statementsand scheduleare the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
financial statements and
schedule based on our audits.
  We conducted our auditsin accordance with the standards of the
Public Company Accounting Oversight Board (United States).  Those
standards require that we plan and perform the auditsto obtain reasonable assurance about
whether the financial statements are free of material
misstatement.We
were not engaged to perform an audit of the Company’s internal control over
financial reporting.  Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting.  Accordingly, we express no such
opinion.An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We
believe that our auditsprovide a reasonable basis for our opinion.
  In our opinion, the financial statements
referred to above present fairly, in all material respects, the financial
position of Bluefly, Inc. as of December 31, 2010and 2009, and the results of their operations
and their cash flows for the yearsthen ended in conformity withU.S. generally acceptedaccounting
principles.Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forththerein.
 
 
 
  /s/
WeiserMazars LLP
  New York,
New York
 February
16, 2011
 
 
 
  F-1
  Report
of Independent Registered Public Accounting Firm
 To the Board of Directors andStockholders
 of Bluefly, Inc.
  In our opinion, the related statements
ofoperations,changes in stockholders’ equity and cash flows forthe yearended December 31, 2008 present fairly,
in all material respects, the results ofoperations of Bluefly, Inc.and itscash flows forthe yearended December 31, 2008, 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 index appearing under Item 15(a)(2) forthe yearended December 31, 2008 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
audit.  We conducted our audit 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 audit providesa reasonable basis for our
opinion.
 
  
  /s/
PricewaterhouseCoopers LLP
  New York,
New York
 March 5,
2009
 
  F-2
  Bluefly,
Inc.
 Balance
Sheets
 December
31, 2010 and 2009
  
 2010
                      
                      2009AssetsCurrentassets:Cash and cash
      equivalents
                      
                      $
                      10,429,000
                      
                      
                      $
                      10,049,000Accounts receivable,net of allowance for doubtful
      accounts
                      
                      
                      1,709,000
                      
                      
                      
                      3,319,000Inventories,
      net
                      
                      
                      25,128,000
                      
                      
                      
                      17,668,000Prepaid expenses and other current
      assets
                      
                      
                      1,595,000
                      
                      
                      
                      959,000Total current
      assets
                      
                      
                      38,861,000
                      
                      
                      
                      31,995,000Property and equipment,
      net
                      
                      
                      3,150,000
                      
                      
                      
                      3,506,000Otherassets
                      
                      
                      133,000
                      
                      
                      
                      145,000Totalassets
                      
                      $
                      42,144,000
                      
                      
                      $
                      35,646,000Liabilities and Stockholders’
      EquityCurrentliabilities:Accounts
      payable
                      
                      $
                      4,515,000
                      
                      
                      $
                      4,363,000Allowance for sales
      returns
                      
                      
                      3,142,000
                      
                      
                      
                      2,627,000Accrued expensesand other current
      liabilities
                      
                      
                      1,118,000
                      
                      
                      
                      2,105,000Deferred
      revenue
                      
                      
                      3,545,000
                      
                      
                      
                      3,516,000Total current
      liabilities
                      
                      
                      12,320,000
                      
                      
                      
                      12,611,000Deferred
    rent
                      
                      
                      183,000
                      
                      
                      
                      --Total
      liabilities
                      
                      
                      12,503,000
                      
                      
                      
                      12,611,000Commitments andcontingencies (Note7)Stockholders’equity:Common stock–$.01 par value; 50,000,000 and
      200,000,000 shares authorized as of December 31, 2010 and 2009,
      respectively; 24,944,986 and 18,885,239 shares issued as of December 31,
      2010 and 2009, respectively; and 24,606,588 and 18,552,737 shares
      outstanding as of December 31, 2010 and 2009,
      respectively.
                      
                      
                      246,000
                      
                      
                      
                      185,000Treasury
    stock
                      
                      
                      (1,824,000
                      )
                      
                      
                      (1,809,000
                      )Additional paid-in
      capital
                      
                      
                      182,720,000
                      
                      
                      
                      172,127,000Accumulateddeficit
                      
                      
                      (151,501,000
                      )
                      
                      
                      (147,468,000
                      )Total stockholders’
      equity
                      
                      
                      29,641,000
                      
                      
                      
                      23,035,000Totalliabilities andstockholders’equity
                      
                      $
                      42,144,000
                      
                      
                      $
                      35,646,000
 
 The
accompanying notes are an integral part of these financial
statements.
 
 F-3
 Bluefly,
Inc.
 Statements
of Operations
 Years
Ended December 31, 2010, 2009 and 2008
  2010
                      
                      2009
                      
                      2008Net
      sales
                      
                      $
                      88,563,000
                      
                      
                      $
                      81,222,000
                      
                      
                      $
                      95,774,000Cost
      of sales
                      
                      
                      55,360,000
                      
                      
                      
                      49,665,000
                      
                      
                      
                      60,288,000Gross profit
                      
                      
                      33,203,000
                      
                      
                      
                      31,557,000
                      
                      
                      
                      35,486,000Selling
      and fulfillment expenses
                      
                      
                      16,881,000
                      
                      
                      
                      16,675,000
                      
                      
                      
                      19,620,000Marketing
      expenses
                      
                      
                      12,576,000
                      
                      
                      
                      8,661,000
                      
                      
                      
                      15,359,000General
      and administrative expenses
                      
                      
                      7,592,000
                      
                      
                      
                      8,882,000
                      
                      
                      
                      11,355,000Total operating
      expenses
                      
                      
                      37,049,000
                      
                      
                      
                      34,218,000
                      
                      
                      
                      46,334,000Operating loss
                      
                      
                      (3,846,000
                      )
                      
                      
                      (2,661,000
                      )
                      
                      
                      (10,848,000
                      )Interest
      expense to related party stockholders
                      
                      
                      --
                      
                      
                      
                      (1,413,000
                      )
                      
                      
                      (235,000
                      )Other
      interest expense, net
                      
                      
                      (187,000
                      )
                      
                      
                      (295,000
                      )
                      
                      
                      (257,000
                      )Net loss
                      
                      
                      (4,033,000
                      )
                      
                      
                      (4,369,000
                      )
                      
                      
                      (11,340,000
                      )Preferred
      stock dividends
                      
                      
                      --
                      
                      
                      
                      --
                      
                      
                      
                      (37,000
                      )Deemed
      dividend related to beneficial conversion feature onSeries F Preferred
      Stock
                      
                      
                      --
                      
                      
                      
                      --
                      
                      
                      
                      (712,000
                      )Net loss available to common
      stockholders
                      
                      $
                      (4,033,000
                      )
                      
                      $
                      (4,369,000
                      )
                      
                      $
                      (12,089,000
                      )Basic
      and diluted net loss per common share
                      
                      $
                      (0.17
                      )
                      
                      $
                      (0.31
                      )
                      
                      $
                      (0.90
                      )Weighted
      average common shares outstanding (basic and diluted)
                      
                      
                      23,685,338
                      
                      
                      
                      14,003,534
                      
                      
                      
                      13,369,257
  The
accompanying notes are an integral part of these financial
statements.
  F-4
 Bluefly,
Inc.
 Statements
of Changes in Stockholders’ Equity
 Years
Ended December 31, 2010, 2009 and 2008
 
 Preferred
      Stock
                                          
                                          
                                          Common
      Stock$.01
      Par value
                                          
                                          
                                          $.01
      Par Value
                                          
                                          
                                          Treasury
      Stock
                                          
                                          
                                          Additional
                                          
                                          
                                          
                                          
                                          
                                          TotalNumber
      of
                                          
                                          
                                          
                                          
                                          
                                          Number
      of
                                          
                                          
                                          
                                          
                                          
                                          Number
      of
                                          
                                          
                                          
                                          
                                          
                                          Paid-in
                                          
                                          
                                          Accumulated
                                          
                                          
                                          Stockholders'Shares
                                          
                                          
                                          Amount
                                          
                                          
                                          Shares
                                          
                                          
                                          Amount
                                          
                                          
                                          Shares
                                          
                                          
                                          Amount
                                          
                                          
                                          Capital
                                          
                                          
                                          Deficit
                                          
                                          
                                          EquityBalance
      at January 1, 2008
                                          
                                          
                                          571
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          
                                          13,275,730
                                          
                                          
                                          $
                                          133,000
                                          
                                          
                                          
                                          151,073
                                          
                                          
                                          $
                                          (1,430,000
                                          )
                                          
                                          $
                                          160,160,000
                                          
                                          
                                          $
                                          (131,826,000
                                          )
                                          
                                          $
                                          27,037,000Stock-based
      compensation expense
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          2,706,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          2,706,000Issuance
      of Restricted Stock Units
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          301,454
                                          
                                          
                                          
                                          3,000
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          
                                          (3,000
                                          )
                                          
                                          
                                          
                                          
                                          
                                          
                                          -Shares
      of Series F Preferred StockConverted
      into Common Stock
                                          
                                          
                                          (571
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          254,766
                                          
                                          
                                          
                                          2,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (2,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Warrants
      Issued to Third-Party
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          173,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          173,000Issuance
      of Treasury Stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          78,214
                                          
                                          
                                          
                                          (182,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (182,000
                                          )Deemed
      Dividends related to beneficial conversion
onSeries
      F Preferred Stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          712,000
                                          
                                          
                                          
                                          (712,000
                                          )
                                          
                                          
                                          -Net
      Loss
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (11,340,000
                                          )
                                          
                                          
                                          (11,340,000
                                          )Balance
      at December 31, 2008
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          13,831,950
                                          
                                          
                                          
                                          138,000
                                          
                                          
                                          
                                          229,287
                                          
                                          
                                          
                                          (1,612,000
                                          )
                                          
                                          
                                          163,746,000
                                          
                                          
                                          
                                          (143,878,000
                                          )
                                          
                                          
                                          18,394,000Stock-based
      compensation expense
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          612,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          612,000Issuance
      of restricted stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          10,312
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Retirement
      of unvested restricted stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (750
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Cumulative
      effect of a change in accounting principle
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          779,000
                                          
                                          
                                          
                                          779,000Delivery
      of deferred stock units
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          160,182
                                          
                                          
                                          
                                          2,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (2,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Purchase
      of treasury stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          103,215
                                          
                                          
                                          
                                          (197,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (197,000
                                          )Conversion
      of subordinated notes
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          1,764,706
                                          
                                          
                                          
                                          17,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          3,331,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          3,348,000Sale
      of common stock in connection with 2009private
      placement (net of $269,000 issuance costs)
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          2,786,337
                                          
                                          
                                          
                                          28,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          4,440,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          4,468,000Net
      Loss
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (4,369,000
                                          )
                                          
                                          
                                          (4,369,000
                                          )Balance
      at December 31, 2009
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          18,552,737
                                          
                                          
                                          
                                          185,000
                                          
                                          
                                          
                                          332,502
                                          
                                          
                                          
                                          (1,809,000
                                          )
                                          
                                          
                                          172,127,000
                                          
                                          
                                          
                                          (147,468,000
                                          )
                                          
                                          
                                          23,035,000Stock-based
      compensation expense
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          634,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          634,000Issuance
      of restricted stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          8,062
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Retirement
      of unvested restricted stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (1,500
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Delivery
      of deferred stock units
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          10,097
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Purchase
      of treasury stock
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          5,896
                                          
                                          
                                          
                                          (15,000
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (15,000
                                          )Sale
      of common stock in connection with secondclosing
      of 2009 private placement(net
      of $243,000 issuance costs)
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          6,037,192
                                          
                                          
                                          
                                          61,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          9,959,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          10,020,000Net
      Loss
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (4,033,000
                                          )
                                          
                                          
                                          (4,033,000
                                          )Balance
      at December 31, 2010
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          
                                          24,606,588
                                          
                                          
                                          $
                                          246,000
                                          
                                          
                                          
                                          338,398
                                          
                                          
                                          $
                                          (1,824,000
                                          )
                                          
                                          $
                                          182,720,000
                                          
                                          
                                          $
                                          (151,501,000
                                          )
                                          
                                          $
                                          29,641,000
  The
accompanying notes are an integral part of these financial
statements.
  F-5
 Bluefly,
Inc.
 Statements
of Cash Flows
 Years
Ended December 31, 2010, 2009 and 2008
  2010
                              
                              2009
                              
                              
                              2008Cash
      flows from operating activities:Net
      loss
                              
                              $
                              (4,033,000
                              )
                              
                              $
                              (4,369,000
                              )
                              
                              $
                              (11,340,000
                              )Adjustments
      to reconcile net loss to net cash (used in) provided by operating
      activities:Depreciation
      and amortization
                              
                              
                              2,507,000
                              
                              
                              
                              2,943,000
                              
                              
                              
                              2,476,000Provisions
      for returns
                              
                              
                              515,000
                              
                              
                              
                              (1,080,000
                              )
                              
                              
                              (496,000
                              )Bad
      debt expense
                              
                              
                              324,000
                              
                              
                              
                              350,000
                              
                              
                              
                              553,000Reserve
      for inventory obsolescence
                              
                              
                              359,000
                              
                              
                              
                              (534,000
                              )
                              
                              
                              290,000Stock-based
      compensation
                              
                              
                              634,000
                              
                              
                              
                              612,000
                              
                              
                              
                              2,706,000Deferred
      rent
                              
                              
                              183,000
                              
                              
                              
                              --
                              
                              
                              
                              --Amortization
      of discount on notes payable to related party stockholders
                              
                              
                              --
                              
                              
                              
                              343,000
                              
                              
                              
                              --Change
      in fair value of embedded derivative financial liability to relatedparty
      stockholders
                              
                              
                              --
                              
                              
                              
                              785,000
                              
                              
                              
                              --Change
      in operating assets and liabilities:(Increase)
      decrease in:Accounts
      receivable
                              
                              
                              1,286,000
                              
                              
                              
                              (369,000
                              )
                              
                              
                              (1,751,000
                              )Inventories
                              
                              
                              (7,819,000
                              )
                              
                              
                              6,023,000
                              
                              
                              
                              5,045,000Prepaid
      expenses and other current assets
                              
                              
                              (651,000
                              )
                              
                              
                              (51,000
                              )
                              
                              
                              446,000Other
      assets
                              
                              
                              --
                              
                              
                              
                              --
                              
                              
                              
                              (198,000
                              )Increase
      (decrease) in:Accounts
      payable
                              
                              
                              152,000
                              
                              
                              
                              (3,981,000
                              )
                              
                              
                              (176,000
                              )Accrued
      expenses and other current liabilities
                              
                              
                              (972,000
                              )
                              
                              
                              943,000
                              
                              
                              
                              (548,000
                              )Interest
      payable to related party stockholders
                              
                              
                              --
                              
                              
                              
                              (106,000
                              )
                              
                              
                              106,000Deferred
      revenue
                              
                              
                              29,000
                              
                              
                              
                              640,000
                              
                              
                              
                              (330,000
                              )Net
      cash (used in) provided by operating activities
                              
                              
                              (7,486,000
                              )
                              
                              
                              2,149,000
                              
                              
                              
                              (3,217,000
                              )Cash
      flows from investing activities:Purchases
      of property and equipment
                              
                              
                              (2,139,000
                              )
                              
                              
                              (375,000
                              )
                              
                              
                              (2,327,000
                              )Net
      cash used in investing activities
                              
                              
                              (2,139,000
                              )
                              
                              
                              (375,000
                              )
                              
                              
                              (2,327,000
                              )Cash
      flows from financing activities:Purchase
      of treasury stock
                              
                              
                              (15,000
                              )
                              
                              
                              (197,000
                              )
                              
                              
                              (182,000
                              )Proceeds
      from notes issued to related party stockholders
                              
                              
                              --
                              
                              
                              
                              --
                              
                              
                              
                              3,000,000Net
      proceeds from common stock issuance
                              
                              
                              10,020,000
                              
                              
                              
                              4,468,000
                              
                              
                              
                              --Net
      cash provided by financing activities
                              
                              
                              10,005,000
                              
                              
                              
                              4,271,000
                              
                              
                              
                              2,818,000Net
      increase (decrease) in cash and cash equivalents
                              
                              
                              380,000
                              
                              
                              
                              6,045,000
                              
                              
                              
                              (2,726,000
                              )Cash
      and cash equivalents – beginning of year
                              
                              
                              10,049,000
                              
                              
                              
                              4,004,000
                              
                              
                              
                              6,730,000Cash
      and cash equivalents – end of year
                              
                              $
                              10,429,000
                              
                              
                              $
                              10,049,000
                              
                              
                              $
                              4,004,000Supplemental
      disclosure of cash flow information:Cash
      paid during the year for interest expense
                              
                              $
                              219,000
                              
                              
                              $
                              239,000
                              
                              
                              $
                              264,000Cash
      paid during the year for interest to related party
      stockholders
                              
                              $
                              --
                              
                              
                              $
                              347,000
                              
                              
                              $
                              --Supplemental
      non-cash financing disclosure of cash flow information:Conversion
      of notes payable to related party stockholders
                              
                              $
                              --
                              
                              
                              $
                              3,348,000
                              
                              
                              $
                              --Deemed
      dividend related to beneficial conversion feature onSeries
      F Preferred Stock
                              
                              $
                              --
                              
                              
                              $
                              --
                              
                              
                              $
                              712,000Warrants
      issued to related party stockholders
                              
                              $
                              --
                              
                              
                              $
                              --
                              
                              
                              $
                              173,000Conversion
      of preferred stock to common stock
                              
                              $
                              --
                              
                              
                              $
                              --
                              
                              
                              $
                              2,000
   The
accompanying notes are an integral part of these financial
statements.
 F-6
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
  NOTE 1 – THE COMPANY
  Bluefly, Inc., a Delaware corporation,
(the “Company”), is a leading Internet retailer that sells over 350 brands of
designer apparelandaccessories at discount
prices.  The Company’s e-commerce Web site (“Bluefly.com” or “WebSite”) was launched in
September 1998.  The Company operates in one business segmentandhas no operations outside the United
States.
   NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
  Basis of Presentation andUse ofestimates
  The preparation of financial statements
in conformity with accounting principlesgenerally accepted in the United States
of Americarequires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosures of contingent assets and liabilities
at the dates of the financial statements and the reported amounts of revenues
and expenses during the reporting periods.  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-based
compensationexpense.  Actual
results could differ from those estimates.
  The
Company has sustained cumulative net losses and negative cash flows from
operations since inception.  As of December 31, 2010, the Company had
an accumulated deficit of $151,501,000.  The Company’s ability to meet
its obligations in the ordinary course of business is dependent on its ability
to establish profitable operations, or find sources to fund
operations.  The Company believes that its existing cash balance,
combined with working capital and the funds available from the Company’s
existing credit facility, will be sufficient to enable the Company to meet
planned expenditures through at least the next 12 months.  Such estimate is based on projected
revenues, expenses and timing of various payments.  Should unforeseen
events occur or should actual results differ from current estimates, the Company
maybe unable to meet payment obligations as
they come due which would have a material adverse impact onthe Company’soperations.
  The Company’s credit facility expires in
July 2011.  However, the Company has reached an agreement in principle
regarding a renewal of the credit facility.  Notwithstanding this
agreement, there is no assurance that the Company will be able to renew its
credit facility on favorable terms, or at all.
  Reclassifications
  Certain amounts in the financial
statements of the prior periods have been reclassified to conform to the current
period presentation for comparative purposes.
  Concentration
  The Company acquired approximately42%and 31%of its inventory from one supplierfor the years ended
December 31, 2010 and 2009, respectively.
  Revenuerecognition
  The Company recognizes revenuewhen the earnings process
is complete and revenue is measurable. Gross sales consist primarily of
revenue from product sales and shipping and handling charges andarenet of promotional
discounts.  Net sales represent gross sales, less provision for
returns, credit card chargebacks and adjustments for uncollected sales
tax.  Revenue is recognized when all the following criteria are
met:
  ·
              A
      customer executes an order.
  ·
              The
      product price and the shipping and handling fee have been
      determined.
  ·
              Credit
      card authorization has occurred and collection is reasonably
      assured.
  ·
              The
      product has been shipped and received by the
  customer.
   F-7
 Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 Deferred revenue, which consists
primarily of goods shipped to customers but not yet received and customer
credits, totaled approximately $3,545,000and $3,516,000 as of December 31,
2010 and 2009, respectively, which is classified as current
liabilities in the Balance Sheets.
  Shipping and handling billed to
customers is classified as revenueand freight cost incurred in connection
with purchasing merchandise is classified as cost of goods in the Statements of
Operations.
  Provisions forsalesreturns anddoubtfulaccounts
  The Company generally permits returns
for any reason within60 days of the sale.  The
Company performs credit card authorizations and checks the verifications of its
customers prior to shipment ofthemerchandise.  Accordingly, the
Company establishes a reserve for estimated future sales returns and allowance
fordoubtful accounts at
the time of shipment based primarily on historical data.  Accounts
receivable is presented on the BalanceSheets net of the allowance for
doubtful accounts.  As of December 31, 2010 and 2009, the allowance for doubtful accounts
was $73,000and $91,000, respectively, and the allowance
for sales returns was $3,142,000and $2,627,000,respectively, which is classified as current
liabilities in the Balance Sheets.
  Fulfillmentexpenses
  The Company utilizes a third-partyservice providerto perform all of its order fulfillment
including warehousing, administrative support, returns processing and receiving
labor.  For the years ended December 31, 2010, 2009 and
2008, fulfillment expenses
totaled $3,765,000, $4,020,000 and $5,352,000, respectively.
  Marketingexpenses
  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 advertising, which includes programs related to
social media, offline and print, are expensed as incurred, with the exception of
production costs related to print and television advertising which are expensed
entirely the first time the advertising takes place. For the years ended
December 31, 2010, 2009 and 2008 marketing expenditures (excluding staff related
costs) were approximately $11,298,000, $7,603,000 and $13,562,000,
respectively.
  Stock-basedcompensation
  The
Company’s Board of Directors has adopted three stock-based employee compensation
plans, one in April 2005, one in July 2000 and one in May 1997
(collectively the “Plans”), which are described more fully in Note 9 –
Stockholders’ Equity.  The Plans, which provide for the granting of
restricted stock, deferred stock unit awards, 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 terms for restricted stock generally range from three months to
one year, while deferred stock unit awards vest every three months over a period
of 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.  As of December 31, 2010, the Plans have an aggregate of
2,379,411 shares remaining available for future issuance. Total stock-based
compensation expense recorded in the Statements of Operations for the years
ended December 31, 2010, 2009 and 2008 was $634,000, $612,000 and $2,706,000,
respectively.
  Incometaxes
  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 periodofthe enactment date.  In
addition, valuation allowances are established when it is more likely than not
that deferred tax assets will not be realized.
  Authoritative guidancerelating touncertainty in income
taxesprescribes a comprehensive
model for the manner in which a company should recognize, measure, present and
disclose in its financial statements all material uncertain tax positions thatthey havetaken or expect to take on a tax
return. As of December 31, 2010 and 2009, the only taxauthoritiesto which the
Company
   F-8
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 is subjectto are the U.S. federal tax authorities
and various state tax authoritiesinthe United States. Open tax yearsthat are subject to
examination by the U.S. federal and state tax authorities, which extend back to
1998,relate to years in
which unused net operating losses were generated. In the event that the Company
concludes that it is subject to interest and/or penalties arising from uncertain tax positions, the Company
will present interest and penalties as a component of income taxes. No amounts
of interest or penalties were recognized in the Company’sBalance Sheets orStatements of Operationsasof and for the years ended December 31,
2010 and 2009.
  Net
loss per share
  Basic net
loss per share excludes dilution and is computed by dividing net loss available
to common stockholders by the weighted average number of common shares
outstanding for the period.
  Diluted
net loss per share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares outstanding for the
period, adjusted to reflect potentially dilutive securities using the treasury
stock method for options, warrants, restricted stock awards and deferred stock
unit awards, and the if-converted method for preferred stock and the
Subordinated Notes, as defined in Note 8 – Subordinated Convertible Notes. Due
to the Company’s net loss, (i) options and warrants to purchase shares of Common
Stock, (ii) preferred stock and Subordinated Notes convertible into shares of
Common Stock, (iii) restricted stock awards that have not yet vested and (iv)
deferred stock unit awards for shares that have not yet been delivered were not
included in the computation of diluted loss per share, as the effects would be
anti-dilutive. Accordingly, basic and diluted weighted average shares
outstanding are equal for the following periods presented:
  2010
                    
                    2009
                    
                    2008Net
      loss
                    
                    $
                    (4,033,000
                    )
                    
                    $
                    (4,369,000
                    )
                    
                    $
                    (11,340,000
                    )Preferred stock
      dividends
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    (37,000
                    )Deemed dividend related to
      beneficial conversion feature onSeries F Preferred
      Stock
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    (712,000
                    )Net
      loss available to common stockholders
                    
                    $
                    (4,033,000
                    )
                    
                    $
                    (4,369,000
                    )
                    
                    $
                    (12,089,000
                    )Weighted
      average common shares outstanding (basic)
                    
                    
                    23,685,338
                    
                    
                    
                    14,003,534
                    
                    
                    
                    13,369,257Options and warrants(1),
      (2)
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    --Preferred stock and
      subordinated notes(1)
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    --Restricted stock and deferred
      stock awards(1)
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    --Weighted
      average common shares outstanding (diluted)
                    
                    
                    23,685,338
                    
                    
                    
                    14,003,534
                    
                    
                    
                    13,369,257
  (1)
                  As
      of December 31, 2010, 2009 and 2008, respectively, the Company had
      weighted average shares of the following potentially dilutive securities
      that were excluded from the computation of net loss per share as the
      effects would be anti-dilutive:
  Options and
      warrants
                          
                          
                          3,873
                          
                          
                          
                          2,849
                          
                          
                          
                          --Preferred stock and
      subordinated notes
                          
                          
                          --
                          
                          
                          
                          --
                          
                          
                          
                          364,231Restricted stock and deferred
      stock awards
                          
                          
                          11,529
                          
                          
                          
                          227,382
                          
                          
                          
                          1,134,312
  (2)
                              Under
      the treasury-stock method, the Company excluded all options and warrants
      from the computation of weighted average shares as a result of the average
      market price of the Company’s Common Stock being greater than the exercise
      price of the options and
warrants.
 F-9
 Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 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.The
Company is exposed to risk in the event of default by financial institutions to
the extent that cash balances with financial institutions are in excess of
insured limits.
  Fairvalue offinancialinstruments
  The
Company’s financial instruments consist of cash and cash equivalents, other
assets, accounts payable and accrued expenses.  The carrying amounts
of these financial instruments approximate fair value due to their short
maturities.
  Inventories,net
  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 Balance Sheets.
  As of December 31, 2010 and 2009, inventories, net consist of the
following, respectively:
  2010
                  
                  2009Inventory on
      hand
                  
                  $
                  24,527,000
                  
                  
                  $
                  17,566,000Inventory to be recovered due to
      returns
                  
                  
                  1,694,000
                  
                  
                  
                  1,388,000Inventory
      reserves
                  
                  
                  (1,093,000
                  )
                  
                  
                  (1,286,000
                  )Total inventories,
      net
                  
                  $
                  25,128,000
                  
                  
                  $
                  17,668,000
  Property andequipment,net
  Property and equipment are stated at
cost net ofaccumulateddepreciationexpenses.Leasehold improvements are amortized
over the shorter of their estimated useful lives or theremainingterm of the lease. Lease amortization is
included in depreciation expense. Equipment and software are depreciated on a
straight-line basis over two to seven years. Maintenance and repairs are
expensed as incurred.
  Websitedevelopmentcosts
  Costs related to the upgrade and
development of the Web Site,to the extent they are capitalized, are
amortized over 36 months.
  Long-livedassets
  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.
  Deferred rent
  The Company recognizes and records rent
expense related to its lease agreement, which includes scheduled rent increases,
on a straight-line basis beginning on the commencement date over the life of the
lease.  The Company also recognizes and records rent concessions, in
the form of reduced rent payments, on a straight-line basis over the life of the
lease agreement.  Differences between the straight-line rent expense
and actual rent payments is recorded as deferred rent and classified as a
long-term liability in the Balance Sheet.
  F-10
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 Treasury stock
  Treasury stock represents CommonStock withheld by the Company to satisfy
income tax withholding obligations of certain officers and employees of the
Company in connection with the distribution ofCommonStock in respect of deferred stock units
held by such officers and employees.
  Recentaccountingpronouncements
  In February 2010, theFASBissued an update to authoritative
guidance relating to subsequent events, which was effective upon the issuance of
the update.  The Company adopted this authoritative guidance on
February 28, 2010.  The update to the authoritative guidance relating
to subsequent events removes the requirement for Securities and Exchange
Commission filers to disclose the date through which subsequent events have been
evaluated in both issued and revised financial statements.  The
adoption of this update to the authoritative guidance relating to subsequent
events did not impact the Company’s financial position or operating results
other than removing the disclosure.
  Recently issued, but not yet effective,
accounting pronouncements
  The Company is not aware of any recently
issued, but not yet effective, accounting pronouncements that would have a
significant impact on the Company’s financial position or results of
operations.
  NOTE
3 – PROPERTY AND EQUIPMENT
  As of
December 31, 2010 and 2009, property and equipment, net consist of the
following:
  2010
                  
                  2009Capitalized web site development
      costs
                  
                  $
                  5,299,000
                  
                  
                  $
                  5,299,000Computer equipment and
      software
                  
                  
                  5,004,000
                  
                  
                  
                  2,938,000Leasehold
      improvements
                  
                  
                  1,145,000
                  
                  
                  
                  1,140,000Office
      equipment
                  
                  
                  220,000
                  
                  
                  
                  151,00011,668,000
                  
                  
                  
                  9,528,000Less: accumulated
      depreciation
                  
                  
                  (8,518,000
                  )
                  
                  
                  (6,022,000
                  )$
                  3,150,000
                  
                  
                  $
                  3,506,000
 Depreciation and amortization of
property and equipment wasapproximately $2,496,000,$2,927,000 and $2,288,000, for the years ended December 31,
2010, 2009and 2008, respectively.
  NOTE
4 – PREPAID EXPENSES AND OTHER CURRENT ASSETS
  As of
December 31, 2010 and 2009, prepaid expenses and other current assets consist of
the following:
 
 2010
                    
                    2009Prepaid
      inventory
                    
                    $
                    893,000
                    
                    
                    $
                    238,000Prepaid
      expenses
                    
                    
                    199,000
                    
                    
                    
                    208,000Other current
      assets
                    
                    
                    503,000
                    
                    
                    
                    513,000$
                    1,595,000
                    
                    
                    $
                    959,000
 
  F-11
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 NOTE
5 – ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
  As of
December 31, 2010 and 2009, accrued expenses and other current liabilities
consist of the following:
 
 2010
                    
                    2009Salary, vacation and bonus
      accrual
                    
                    $
                    703,000
                    
                    
                    $
                    1,496,000Accrued media
      expenses
                    
                    
                    383,000
                    
                    
                    
                    184,000Other accrued
      expenses
                    
                    
                    32,000
                    
                    
                    
                    425,000$
                    1,118,000
                    
                    
                    $
                    2,105,000
 NOTE
6 – INCOME TAXES
  Significant
components of the Company’s deferred tax assets and liabilities as of December
31, 2010 and 2009 are summarized as follows:
 2010
                  
                  2009Net operating
      losses
                  
                  $
                  43,467,000
                  
                  
                  $
                  43,867,000Accounts receivable and inventory
      reserves
                  
                  
                  1,705,000
                  
                  
                  
                  1,465,000Deferred
      revenue
                  
                  
                  1,351,000
                  
                  
                  
                  1,368,000Returns
    reserve
                  
                  
                  1,197,000
                  
                  
                  
                  1,023,000Accrued
      expenses
                  
                  
                  130,000
                  
                  
                  
                  --Stock
    options
                  
                  
                  10,000
                  
                  
                  
                  204,000Other
    accruals
                  
                  
                  26,000
                  
                  
                  
                  45,000Depreciation and
      amortization
                  
                  
                  (169,000
                  )
                  
                  
                  (584,000
                  )47,717,000
                  
                  
                  
                  47,388,000Valuation
      allowance
                  
                  
                  (47,717,000
                  )
                  
                  
                  (47,388,000
                  )Net deferred tax asset
      (liability)
                  
                  $
                  --
                  
                  
                  $
                  --
 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 $114,071,000 at December 31, 2010 which have
expiration dates from 2020 through 2030.  Section 382 of the Internal
Revenue Code (the “Code”) limits the utilization of net operating losses when
ownership changes, as defined by that section, occur.  The Company has
performed an analysis of its historical Section 382 ownership changes prior to
2001 and has determined that the utilization of certain of its net operating
loss carryforwards may be limited in connection with pre-2001 net operating
losses.  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
at December 31, 2010 and 2009.  The benefits generated from these net
operating losses for the years ended December 31, 2010, 2009 and 2008 have also
been fully offset by a valuation allowance.
  The use
of the net operating loss carryforwards may have additional limitations
resulting from certain additional ownership changes, including the consummation
of the sale of 8,823,529 shares of the Company’s common stock to Rho (as defined
in Note 9 – Stockholders’ Equity) in 2010 and 2009, which made the Company
vulnerable to an ownership change for purposes of the Code.  Transfers
of shares by shareholders who own 5% or more of the Company’s outstanding common
stock could also have the effect of limiting the Company’s ability to utilize
our net operating loss carryforwards.  The Company has not performed a
recent analysis of its ownership changes under the Code.
 F-12
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 The
Company’s effective tax rate differs from the U.S. federal statutory income tax
rate of 35% as follows:
 2010
                    
                    2009
                    
                    2008Statutory
      federal income tax rate
                    
                    
                    (35.00
                    )%
                    
                    
                    (35.00
                    )%
                    
                    
                    (35.00
                    )%State
      tax benefit, net of federal taxes
                    
                    
                    (3.11
                    )%
                    
                    
                    (3.92
                    )%
                    
                    
                    (4.06
                    )%Other
                    
                    
                    0.25
                    %
                    
                    
                    0.14
                    %
                    
                    
                    1.16
                    %Adjustment
      for prior year taxes
                    
                    
                    2.65
                    %
                    
                    
                    1.99
                    %
                    
                    
                    5.24
                    %Equity
      compensation
                    
                    
                    6.29
                    %
                    
                    
                    17.11
                    %
                    
                    
                    8.95
                    %Valuation
      allowance on deferred tax asset (liability)
                    
                    
                    28.92
                    %
                    
                    
                    19.68
                    %
                    
                    
                    23.71
                    %Effective tax
    rate
                    
                    
                    00.00
                    %
                    
                    
                    00.00
                    %
                    
                    
                    00.00
                    %
 NOTE
7 – COMMITMENTS AND CONTINGENCIES
 
 Employment
contracts
  The
Company has employment agreements with certain of its executive officers and
other employees. These employment agreements have terms expiring through July
12, 2013.  As of December 31, 2010, the Company's aggregate cash
commitment for future base salary under these employment contracts is as
follows:
  2011
                      
                      $
                      2,076,0002012
                      
                      
                      1,904,0002013
                      
                      
                      146,000$
                      4,126,000
 Leases
  In March
2010, the Company entered into a lease agreement extending the term of the lease
for space it already occupies for an additional ten years ending on December 31,
2020. Future minimum lease payments under the Company’s operating lease,
excluding utilities, that have initial or remaining non-cancelable terms in
excess of one year are as follows:
  2011
                  
                  $
                  386,0002012
                  
                  
                  535,0002013
                  
                  
                  554,0002014
                  
                  
                  573,0002015
                  
                  
                  594,0002016 &
      thereafter
                  
                  
                  3,293,000$
                  5,935,000
 Rent
expense (including amounts related to commercial rent tax) aggregated
approximately $613,000, $692,000 and $663,000 for the years ended
December 31, 2010, 2009 and 2008, respectively.
   Marketing
commitments
  As of
December 31, 2010, the Company’s future advertising and marketing
commitments, in connection with offline and online marketing programs, is as
follows:
 2011
                    
                    $
                    1,583,0002012
                    
                    
                    360,000$
                    1,943,000
 
   F-13
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 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.
  NOTE
8 – SUBORDINATED CONVERTIBLE NOTES
  In July 2008, the Company issued
Subordinated Notes in the aggregate principal amount of $3,000,000 that had a
term expiring three years from the date of issuance and bore interest at the
rate of 8% per annum, compounded annually, which is payable in cash upon
maturity or conversion (the “Subordinated Notes”).  In December 2009,
all outstanding Subordinated Notes were converted into shares of common stock,
as described below.
  The Subordinated Noteswereconvertible, at the holder’s option
into (a) equity securities that the Company might issue in any subsequent round
of financing at a price equal to the lowest price per share paid by any investor
in such subsequent round of financingin addition to(b) Common Stock at a price per share
equal to $3.65, which represented the 20-day trailing average stock price on the
date of issuance of the Subordinated Notes(collectively, the “Embedded Conversion
Feature”).
  In connection with the adoptionofauthoritative guidance relating to
determining whether an instrument (or embedded feature) is indexed to an
entity’s own stock,on
January 1, 2009, the Company determined that the embedded conversion feature in
the Subordinated Notes is not indexed to the Company’s own stock and, therefore,
is an embedded derivative financial liability (the “Embedded Derivative”), which
requires bifurcation andmustbe separately accountedfor as a separate
instrument.
  The Company measured the fair value of
the Embedded Derivative using a Black-Scholes valuation model as of January 1,
2009 to determine the cumulative effect of the change in accounting principle to
be recorded.  Expected volatility is based on the historical
volatility of the price of the Company’s Common Stock, measured over the same
period of time as the remaining maturity life of the Subordinated
Notes.  The risk free interest rate is based on the interest rate for
U.S. Treasury Notes having a maturity period equal to the remaining maturity
life of the Subordinated Notes.
  The Company recordedacumulative effect of the change in
accounting principle of approximately $779,000, which was recognized as a
decrease in accumulated deficit at January 1, 2009.  The amount
recognized in the Company’s Balance Sheet upon the initial adoption ofthe authoritative guidance
described abovewas
determined based on the amounts that would have been recognized ifthe authoritative guidancehad been applied from the issuance date
of the Subordinated Notes and the amount recognized in the Company’s Balance
Sheet upon the initial application ofthe authoritative guidance.  In addition, as a result of
the bifurcation, the Company recognized an Embedded Derivative of approximately
$98,000 and adiscount on
the Subordinated Notes of $877,000, which reduced the carrying value of the
Subordinated Notes at the date of adoption.  This discount represents
additional non-cash interest expense that is to be amortized over the remaining
life of the Subordinated Notes.
  The Company also re-measured the fair
value of the Embedded Derivative at each interim date.  Any change in
fair value is recorded as part of interest expense to related party
stockholders.
  In connection with, and as a condition
to, the December 2009 Private Placement, further described in Note 9 –
Stockholders’ Equity, both Soros and Maverick converted the $3,000,000 aggregate
principal balance outstanding into an aggregate of 1,764,706 shares of common
stock at a conversion rate of $1.70 per share.  Additionally, the
Company paid in cash approximately $347,000 of accrued interest at the Initial
Closing of the December 2009 Private Placement.
  As a result of the Company accounting
for the Subordinated Notes separate from the Embedded Conversion Feature, the
Company reclassified the net carrying amount of the Subordinated Notes of
approximately $2,466,000 on the date of conversion in equity with no gain or
loss recognized.
  The Company also remeasured the fair
value of the Embedded Derivative at the date of conversion using an intrinsic
valuation method as the price of the Company’s common stock was greater than the
conversion rate of $1.70.  The fair value of the Embedded Derivative
was approximately $882,000 at the date of conversion and the change in fair
value from the interim date was recorded as part of interest expense to related
party stockholders through the date of conversion.  The fair value of
the Embedded Derivative at the date of conversion of approximately $882,000 was
reclassified to equity.
   F-14
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 For the years ended December 31, 2009
and 2008, the Company recognized interest expense in connection with its
Subordinated Notes, including changes in fair value of the Embedded Derivative,
which were included in total interest expense to related party stockholders in
the Statements of Operations, as follows:
  2009
                  
                  2008Appreciation
      in fair value of embedded derivative financial liability to related partystockholders
                  
                  $
                  785,000
                  
                  
                  $
                  --Amortization
      of discount on notes payable to related party stockholders
                  
                  
                  343,000
                  
                  
                  
                  --Interest
      expense to related party stockholders
                  
                  
                  241,000
                  
                  
                  
                  106,000Amortization
      expense of warrants issued to related party stockholders
                  
                  
                  44,000
                  
                  
                  
                  129,000Total
      interest expense to related party stockholders
                  
                  $
                  1,413,000
                  
                  
                  $
                  235,000
  NOTE
9 – STOCKHOLDERS’ EQUITY
  Authorized
shares
  The
Company is incorporated in the State of Delaware.  In February 2010,
the Company amended its certificate of incorporation to decrease the number of
authorized shares of Common Stock, $.01 par value per share (the “Common
Stock”), from 200,000,000 shares to 50,000,000 shares and to decrease the number
of authorized shares of Preferred Stock, $.01 par value per share (the
“Preferred Stock”), from 25,000,000 shares to 1,000,000 shares.
  Warrants to purchase common
stock
  Warrants
to Soros and Maverick
  The
Company has issued warrants to Soros and Maverick in connection with past
financings. The following table represents warrants issued to purchase Common
Stock as of December 31, 2010:
 
 Number
      of
                  
                  Exercise
      PriceParty
                  
                  
                  Warrants
                  
                  Range
                  
                  Expiration
      DatesSoros
                  
                  
                  45,201
                  
                  $5.10
      – $8.80
                  
                  September
      2011 – March 2013Maverick
                  
                  
                  19,796
                  
                  $5.10
                  
                  March
      2013Consultant
                  
                  
                  10,000
                  
                  $10.00
                  
                  February
      201174,997
 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,
deferred stock unit awards, 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
February 2010, the Company amended its Amended and Restated 2005 Stock Incentive
Plan (the “2005 Plan”) to increase the aggregate number of shares of Common
Stock that may be the subject of stock-based compensation awards granted
pursuant to the 2005 Plan by 1,500,000 shares and, in June 2010, the Company
again amended the 2005 Plan to increase the aggregate number of shares of Common
Stock that may be the subject of stock-based compensation awards granted
pursuant to the 2005 Plan by an additional 1,586,392 shares.
 F-15
 Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 RestrictedStock 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, 2010:
 Weighted
      Average
                                    
                                    
                                    
                                    
                                    
                                    WeightedAverageGrant Date
                                    
                                    
                                    Deferred
                                    
                                    
                                    Grant DateRestricted
                                    
                                    
                                    Fair Value
                                    
                                    
                                    Stock
                                    
                                    
                                    Fair ValueStock
                                    
                                    
                                    (per share)
                                    
                                    
                                    Unit Awards
                                    
                                    
                                    (per share)Balance at December 31,
      2007
                                    
                                    
                                    39,651
                                    
                                    
                                    $
                                    12.60
                                    
                                    
                                    
                                    714,745
                                    
                                    
                                    $
                                    9.60Shares / Units
      Granted
                                    
                                    
                                    8,625
                                    
                                    
                                    
                                    3.71
                                    
                                    
                                    
                                    250,000
                                    
                                    
                                    
                                    4.99Shares / Units
      Forfeited
                                    
                                    
                                    (1,875
                                    )
                                    
                                    
                                    4.08
                                    
                                    
                                    
                                    (305,627
                                    )
                                    
                                    
                                    6.82Shares / Units Restriction
      Lapses
                                    
                                    
                                    (39,651
                                    )
                                    
                                    
                                    12.60
                                    
                                    
                                    
                                    (372,943
                                    )
                                    
                                    
                                    9.41Balance at December 31,
      2008
                                    
                                    
                                    6,750
                                    
                                    
                                    
                                    3.60
                                    
                                    
                                    
                                    286,175
                                    
                                    
                                    
                                    8.80Shares / Units
      Granted
                                    
                                    
                                    10,312
                                    
                                    
                                    
                                    1.04
                                    
                                    
                                    
                                    --
                                    
                                    
                                    
                                    --Shares / Units
      Forfeited
                                    
                                    
                                    (750
                                    )
                                    
                                    
                                    0.73
                                    
                                    
                                    
                                    (10,464
                                    )
                                    
                                    
                                    7.05Shares / Units Restriction
      Lapses
                                    
                                    
                                    (7,875
                                    )
                                    
                                    
                                    4.12
                                    
                                    
                                    
                                    (263,397
                                    )
                                    
                                    
                                    7.26Balance at December 31,
      2009
                                    
                                    
                                    8,437
                                    
                                    
                                    
                                    0.92
                                    
                                    
                                    
                                    12,314
                                    
                                    
                                    
                                    12.70Shares / Units
      Granted
                                    
                                    
                                    8,062
                                    
                                    
                                    
                                    2.25
                                    
                                    
                                    
                                    --
                                    
                                    
                                    
                                    --Shares / Units
      Forfeited
                                    
                                    
                                    (1,500
                                    )
                                    
                                    
                                    1.49
                                    
                                    
                                    
                                    (51
                                    )
                                    
                                    
                                    12.70Shares / Units Restriction
      Lapses
                                    
                                    
                                    (7,687
                                    )
                                    
                                    
                                    0.94
                                    
                                    
                                    
                                    (12,263
                                    )
                                    
                                    
                                    12.70Balance at December 31,
      2010
                                    
                                    
                                    7,312
                                    
                                    
                                    
                                    2.25
                                    
                                    
                                    
                                    --
                                    
                                    
                                    
                                    --Aggregate Grant Date Fair
      Value
                                    
                                    $
                                    16,000
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    --Vesting Service Period of Shares
      Granted
                                    
                                    1 year
                                    
                                    
                                    
                                    
                                    
                                    
                                    12 – 36
    monthsNumber of Shares / Units Vested
      DuringDecember 31,
      2008
                                    
                                    
                                    39,651
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    372,943Number of Shares / Units
      Non-vested atDecember 31,
      2008
                                    
                                    
                                    6,750
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    56,327Number of Shares / Units Vested
      DuringDecember 31,
      2009
                                    
                                    
                                    6,750
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    11,925Number of Shares / Units
      Non-vested atDecember 31,
      2009
                                    
                                    
                                    8,437
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    389Number of Shares / Units Vested
      DuringDecember 31,
      2010
                                    
                                    
                                    7,687
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    12,263Number of Shares / Units
      Non-vested atDecember 31,
      2010
                                    
                                    
                                    7,312
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    --
 For the
years ended December 31, 2010, 2009 and 2008 the Company recognized expense of
approximately $23,000, $534,000 and $2,274,000, respectively, in connection with
these awards.
  As of
December 31, 2010, the total compensation cost related to non-vested restricted
stock not yet recognized was $2,000. Total compensation cost is expected to be
recognized within one year on a weighted average basis.  F-16
 Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 Stock
Options
  The following table summarizes the
Company’s stock option activity:
  Number of
                  
                  
                  WeightedAverageShares
                  
                  
                  ExercisePriceBalance atDecember 31, 2007
                  
                  
                  342,878
                  
                  
                  $
                  10.60Options
    granted
                  
                  
                  38,000
                  
                  
                  
                  4.40Options
      cancelled
                  
                  
                  (26,022
                  )
                  
                  
                  10.87Options
      exercised
                  
                  
                  --
                  
                  
                  
                  --Balance atDecember 31, 2008
                  
                  
                  354,856
                  
                  
                  
                  9.83Options
    granted
                  
                  
                  11,000
                  
                  
                  
                  1.49Options
      cancelled
                  
                  
                  (158,096
                  )
                  
                  
                  10.18Options
      exercised
                  
                  
                  --
                  
                  
                  
                  --Balance atDecember 31, 2009
                  
                  
                  207,760
                  
                  
                  
                  9.09Options
    granted
                  
                  
                  1,904,348
                  
                  
                  
                  2.40Options
      cancelled
                  
                  
                  (21,000
                  )
                  
                  
                  3.92Options
      exercised
                  
                  
                  --
                  
                  
                  
                  --Balance atDecember 31, 2010
                  
                  
                  2,091,108
                  
                  
                  
                  3.05Vested atDecember 31,
      2008
                  
                  
                  317,064
                  
                  
                  
                  10.32Vested at December 31,
      2009
                  
                  
                  180,787
                  
                  
                  
                  9.94Vested atDecember 31,
      2010
                  
                  
                  520,908
                  
                  
                  
                  5.00
 The stock
options are exercisable in different periods through 2020.  Additional
information with respect to the outstanding options as of December 31,
2010, is as follows:
 Options
      Outstanding
                    
                    
                    Options
      ExercisableWeighted
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    WeightedAverage
                    
                    Weighted
                    
                    
                    
                    
                    
                    
                    Weighted
                    
                    AverageRemaining
                    
                    Average
                    
                    
                    
                    
                    
                    
                    Average
                    
                    RemainingOptions
                    
                    Contractual
                    
                    Exercise
                    
                    
                    Options
                    
                    Exercise
                    
                    ContractualRange of Exercise
      Prices
                    
                    Outstanding
                    
                    Life
                    
                    Price
                    
                    
                    Exercisable
                    
                    Price
                    
                    Life$0.51 –
    $2.50
                    
                    
                    1,848,000
                    
                    
                    9.2 Years
                    
                    
                    $
                    2.39
                    
                    
                    
                    
                    334,056
                    
                    
                    $
                    2.39
                    
                    
                    9.2 Years$2.51 –
    $5.00
                    
                    
                    87,348
                    
                    
                    4.5 Years
                    
                    
                    
                    3.36
                    
                    
                    
                    
                    31,092
                    
                    
                    
                    4.49
                    
                    .3
                    7.0 Years$5.01 –
    $7.50
                    
                    
                    --
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    --$7.51 –
    $10.00
                    
                    
                    81,235
                    
                    
                    2.5 Years
                    
                    
                    
                    9.05
                    
                    
                    
                    
                    81,235
                    
                    
                    
                    9.05
                    
                    
                    2.5 Years$10.01 –
    $12.50
                    
                    
                    31,250
                    
                    
                    5.0 Years
                    
                    
                    
                    11.87
                    
                    
                    
                    
                    31,250
                    
                    
                    
                    11.87
                    
                    
                    5.0 Years$12.51 –
    $15.50
                    
                    
                    42,900
                    
                    
                    4.0 Years
                    
                    
                    
                    12.96
                    
                    
                    
                    
                    42,900
                    
                    
                    
                    12.96
                    
                    
                    4.0 Years$15.51 –
    $17.50
                    
                    
                    --
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    --$17.51 –
    $20.00
                    
                    
                    --
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    
                    
                    --
                    
                    
                    
                    --
                    
                    
                    --$20.51 –
    $25.00
                    
                    
                    375
                    
                    
                    1 Year
                    
                    
                    
                    21.60
                    
                    
                    
                    
                    375
                    
                    
                    
                    21.60
                    
                    
                    1 Year$0.51 –
    $25.00
                    
                    
                    2,091,108
                    
                    
                    8.6 Years
                    
                    
                    
                    3.05
                    
                    
                    
                    
                    520,908
                    
                    
                    
                    5.00
                    
                    
                    7.3 Years
 The total
fair value of the 345,642 options that vested during the year was approximately
$590,000.  At December 31, 2010, the aggregate intrinsic value of the
fully vested options was $169,000 and the weighted average remaining contractual
life of the options was approximately 7 years. The Company has not capitalized
any compensation cost, or modified any of its stock option grants for the years
ended December 31, 2010, 2009 and 2008. Other selected information is as
follows:  F-17
 Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
 
 2010
                  
                  2009
                  
                  2008Aggregate
      intrinsic value of outstanding options
                  
                  $
                  935,000
                  
                  
                  $
                  11,000
                  
                  
                  $
                  --Aggregate
      intrinsic value of options exercised
                  
                  
                  --
                  
                  
                  
                  --
                  
                  
                  
                  --Weighted
      average fair value of options granted
                  
                  
                  2.28
                  
                  
                  
                  1.08
                  
                  
                  
                  2.86
 As of
December 31, 2010, the total compensation cost related to non-vested stock
option awards not yet recognized was $1,948,000. Total compensation cost is
expected to be recognized over three 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 the U.S. Treasury note in effect on the date of
the grant.
  The table
below presents the weighted average assumptions used to calculate the fair value
of options granted for the year ended December 31, 2010, 2009 and 2008,
respectively:
 2010
                      
                      2009
                      
                      2008Risk-free
      interest rate
                      
                      
                      2.39
                      %
                      
                      2.66
                      %
                      
                      2.65
                      %Expected
      life (in years)
                      
                      
                      5.5
                      
                      
                      5.8
                      
                      
                      5.0Dividend
      yield
                      
                      
                      0.00
                      %
                      
                      0.00
                      %
                      
                      0.00
                      %Expected
      volatility
                      
                      
                      84.07
                      %
                      
                      86.25
                      %
                      
                      79.47
                      %
 For the
years ended December 31, 2010, 2009 and 2008 the Company recognized expense of
approximately $611,000, $77,000 and $433,000, respectively, in connection with
these awards.
  December
2009 Private Placement
  On
December 21, 2009, the Company entered into a Securities Purchase Agreement with
Rho Ventures VI, L.P. (“Rho”) pursuant to which the Company agreed to issue and
sell to Rho up to 8,823,529 newly issued shares (the “Private Placement Shares”)
of its common stock, par value $.01 per share (the “Common Stock”), for an
aggregate purchase price of $15,000,000, or $1.70 per share, in a private
placement transaction (the “Private Placement”).  The Company issued
and sold 2,786,337 of the Private Placement Shares to Rho at an initial closing
(the “Initial Closing”) held on December 21, 2009 for an aggregate purchase
price of approximately $4,737,000. The Company received proceeds from the
Initial Closing of approximately $4,468,000, net of $269,000 of issuance
costs.
  At the
Initial Closing, and as a condition thereto, Soros and Maverick converted into
an aggregate of 1,764,706 shares of Common Stock the $3,000,000 aggregate
principal amount outstanding pursuant to the terms of the Subordinated Notes,
each dated as of July 23, 2008, issued by the Company to Soros and Maverick for
shares of Common Stock at a conversion rate of $1.70 per share.  All
accrued and unpaid interest of approximately $347,000 was paid by the Company in
cash at the Initial Closing.
  On
February 25, 2010, the Company completed the second closing (the “Second
Closing”) of the Private Placement. At the Second Closing, the Company issued
and sold the remaining 6,037,192 Private Placement Shares to Rho for an
aggregate purchase price of approximately $10,263,000. The Company received
proceeds from the Second Closing of approximately $10,020,000, net of $243,000
of issuance costs.
  Registration
Rights and Warrants Issuance
  In
connection with the Private Placement, the Company entered into a Registration
Rights Agreement pursuant to which it agreed to file a registration statement
with respect to the Private Placement Shares within 30 days following the date
of the Second Closing (the “Filing Deadline”) and to cause such registration
statement to be declared effective by the Securities and
   F-18
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 
  Exchange
Commission within 180 days following the date of the Second Closing (the
“Effectiveness Deadline”). The Registration Rights Agreement provided that the
Company would be obligated to issue warrants to Rho in certain circumstances if
the registration statement was not filed by the Filing Deadline or declared
effective by the Effectiveness Deadline. The Company filed a registration
statement with the Securities and Exchange Commission covering the Private
Placement Shares on March 10, 2010 and the registration statement was declared
effective on May 25, 2010.  As the registration statement was filed
within the Filing Deadline and was declared effective within the Effectiveness
Deadline, the Company did not record any amounts in the financial statements
with regards to warrants.
  NOTE
10 – FINANCING AGREEMENT
  In
February 2009 and in March 2008, the Company agreed to amendments to its credit
facility (the credit facility as amended is hereafter referred to as the “Credit
Facility”) with Wells Fargo Retail Finance, LLC (“Wells Fargo”) to (i) extend
the term until July 26, 2011 from July 26, 2008; (ii) increase the rate at which
interest accrues on the average daily amount under the Credit Facility during
the preceding month to a per annum rate equal to the prime rate plus 0.75% or
LIBOR plus 3.25%; (iii) increase the monthly commitment fee on the unused
portion of the Credit Facility to 0.50% from 0.35%, which has since been amended
in December 2009 as a condition to the December 2009 Private Placement to
increase the monthly commitment fee on the unused portion of the Credit Facility
from 0.50% to 0.75%; (iv) include a servicing fee of $3,333 per month; (v)
increase the early termination fee to 1% of the revolving credit ceiling, from
0.50% through maturity; and (vi) amend the standby and documentary letter of
credit fees to 3.25% and 2.75%, respectively.
  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 substantially
all of the Company’s assets. Availability under the Credit Facility is
determined by a formula that takes into account a certain percentage of the
amount of the Company’s inventory and a certain percentage of the Company’s
accounts receivable. 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, 2010, total availability under the
Credit Facility was approximately $6,353,000, of which $2,825,000 was committed
for letters of credit in favor of suppliers, leaving approximately $3,528,000
available for further borrowings. The terms of the Credit Facility contain a
material adverse condition clause.  In the event of a material adverse
change in the Company’s financial condition, the Company would not be able to
obtain additional borrowings under the Credit Facility and existing borrowings
would become due and payable.
  For the years ended December 31,
2010, 2009and 2008, the Company incurred approximately
$219,000, $239,000 and $264,000 of interest expense and fees,
respectively, under the Credit Facility.
  NOTE
11 – QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
  Amounts
in thousands, except per share data:
 
 Quarter
      Ended(1)2010
                          
                          March 31,
                          
                          June 30,
                          
                          September
    30,
                          
                          December
  31,Net sales
                          
                          $
                          20,240
                          
                          
                          $
                          20,545
                          
                          
                          $
                          19,202
                          
                          
                          $
                          28,576Gross
profit
                          
                          $
                          8,337
                          
                          
                          $
                          7,978
                          
                          
                          $
                          6,924
                          
                          
                          $
                          9,964Net (loss)
      income
                          
                          $
                          (1,501
                          )
                          
                          $
                          (724
                          )
                          
                          $
                          (2,077
                          )
                          
                          $
                          269Net (loss) income per common share
      – basic and diluted
                          
                          $
                          (0.07
                          )
                          
                          $
                          (0.03
                          )
                          
                          $
                          (0.08
                          )
                          
                          $
                          0.01Weighted average common shares
      outstanding – basic(2)
                          
                          
                          20,896,437
                          
                          
                          
                          24,597,254
                          
                          
                          
                          24,598,151
                          
                          
                          
                          24,598,811Weighted average common shares
      outstanding – diluted(2)
                          
                          
                          20,896,437
                          
                          
                          
                          24,597,254
                          
                          
                          
                          24,598,151
                          
                          
                          
                          24,724,658   F-19
  Bluefly,
Inc.
 Notes
to Financial Statements
 December
31, 2010
 Quarter
      Ended(1)2009
                                                      
                                                      March 31,
                                                      
                                                      June 30,
                                                      
                                                      September
    30,
                                                      
                                                      December
  31,Net sales
                                                      
                                                      $
                                                      19,902
                                                      
                                                      
                                                      $
                                                      19,858
                                                      
                                                      
                                                      $
                                                      17,108
                                                      
                                                      
                                                      $
                                                      24,354Gross
profit
                                                      
                                                      $
                                                      6,775
                                                      
                                                      
                                                      $
                                                      7,884
                                                      
                                                      
                                                      $
                                                      6,839
                                                      
                                                      
                                                      $
                                                      10,059Net loss
                                                      
                                                      $
                                                      (3,120
                                                      )
                                                      
                                                      $
                                                      (186
                                                      )
                                                      
                                                      $
                                                      (915
                                                      )
                                                      
                                                      $
                                                      (148
                                                      )Net loss per common share – basic
      and diluted
                                                      
                                                      $
                                                      (0.23
                                                      )
                                                      
                                                      $
                                                      (0.01
                                                      )
                                                      
                                                      $
                                                      (0.07
                                                      )
                                                      
                                                      $
                                                      (0.01
                                                      )Weighted average common shares
      outstanding – basic(2)
                                                      
                                                      
                                                      13,832,679
                                                      
                                                      
                                                      
                                                      13,843,985
                                                      
                                                      
                                                      
                                                      13,844,637
                                                      
                                                      
                                                      
                                                      14,517,313Weighted average common shares
      outstanding – diluted(2)
                                                      
                                                      
                                                      13,832,679
                                                      
                                                      
                                                      
                                                      13,843,985
                                                      
                                                      
                                                      
                                                      13,844,637
                                                      
                                                      
                                                      
                                                      14,517,313Quarter
      Ended(1)2008
                                                      
                                                      March 31,
                                                      
                                                      June 30,
                                                      
                                                      September
    30,
                                                      
                                                      December
  31,Net sales
                                                      
                                                      $
                                                      25,245
                                                      
                                                      
                                                      $
                                                      23,334
                                                      
                                                      
                                                      $
                                                      19,802
                                                      
                                                      
                                                      $
                                                      27,393Gross
profit
                                                      
                                                      $
                                                      8,936
                                                      
                                                      
                                                      $
                                                      9,098
                                                      
                                                      
                                                      $
                                                      7,307
                                                      
                                                      
                                                      $
                                                      10,145Net loss
                                                      
                                                      $
                                                      (2,938
                                                      )
                                                      
                                                      $
                                                      (2,036
                                                      )
                                                      
                                                      $
                                                      (4,993
                                                      )
                                                      
                                                      $
                                                      (1,373
                                                      )Preferred stock
      dividends(3)
                                                      
                                                      $
                                                      (11
                                                      )
                                                      
                                                      $
                                                      (11
                                                      )
                                                      
                                                      $
                                                      (12
                                                      )
                                                      
                                                      $
                                                      (3
                                                      )Net loss available to common
      stockholders(4)
                                                      
                                                      $
                                                      (2,949
                                                      )
                                                      
                                                      $
                                                      (2,047
                                                      )
                                                      
                                                      $
                                                      (5,717
                                                      )
                                                      
                                                      $
                                                      (1,376
                                                      )Net loss per common share – basic
      and diluted
                                                      
                                                      $
                                                      (0.22
                                                      )
                                                      
                                                      $
                                                      (0.15
                                                      )
                                                      
                                                      $
                                                      (0.43
                                                      )
                                                      
                                                      $
                                                      (0.10
                                                      )Weighted average common shares
      outstanding – basic(2)
                                                      
                                                      
                                                      13,251,101
                                                      
                                                      
                                                      
                                                      13,269,123
                                                      
                                                      
                                                      
                                                      13,309,383
                                                      
                                                      
                                                      
                                                      13,647,132Weighted average common shares
      outstanding – diluted(2)
                                                      
                                                      
                                                      13,251,101
                                                      
                                                      
                                                      
                                                      13,269,123
                                                      
                                                      
                                                      
                                                      13,309,383
                                                      
                                                      
                                                      
                                                      13,647,132
 
 (1)
              Quarterly
      amounts may not sum to the annual amounts due to
  rounding.(2)
              As
      a result of losses incurred by the Company, all potentially dilutive
      securities are anti-dilutive and accordingly, basic and diluted weighted
      average common shares outstanding are equal for the periods
      presented.(3)
              As
      of December 31, 2008, all Series F Preferred Stock have been converted
      into common stock.(4)
              Includes
      a beneficial conversion feature charge of approximately $712,000 in the
      third quarter.
  NOTE
12 – SUBSEQUENT EVENT
 
 On
January 4, 2011, the Company and A + D Labs LLC (“A + D Labs” and, collectively
with the Company, the “Members”) entered into a Limited Liability Company
Operating Agreement (the “Operating Agreement”) in connection with the formation
of Eyefly LLC (“Eyefly”), a newly formed Delaware limited liability company,
which is initially owned 52% by the Company and 48% by A + D
Labs.  Eyefly was formed for the purposes of developing and operating
an e-commerce Web site and related online and mobile applications focused on
selling fashionable prescription eyewear directly to consumers.
 
 Pursuant
to the Operating Agreement, the Members made an aggregate $700,000 of initial
capital contribution ($364,000 from the Company and $336,000 from A + D Labs)
and agreed to make an additional $600,000 of capital contributions ($312,000
from the Company and $288,000 from A + D Labs) as necessary.
 
 For
financial reporting purposes, Eyefly’s assets, liabilities and the results of
operations will be consolidated with those of the Company and A + D Lab’s 48%
membership interest in Eyefly will be included in the Company’s consolidated
financial statements as a noncontrolling interest in 2011.
 
 In
connection with the formation of Eyefly, the Company agreed to amendments to its
Credit Facility with Wells Fargo pursuant to which (i) Wells Fargo agreed to the
Company’s investment in Eyefly and (ii) the Company granted Wells Fargo a
security interest in the Company’s equity interest in Eyefly.
 
 The
Company’s credit facility expires in July 2011.  However, the Company
has reached an agreement in principle regarding a renewal of the credit
facility.  Notwithstanding this agreement, there is no assurance that
the Company will be able to renew its credit facility on favorable terms, or at
all.
 
 
  F-20
  Schedule
II – Valuation and Qualifying Accounts For
the Three Years Ended December 31, 2010
  Column A
                                  Column B
                                  
                                  Column C
                                  
                                  Column D
                                  
                                  Column ECharged to
                                  
                                  Charged toEnding Balance
      at
                                  
                                  Costs and
    Other
                                  
                                  Other
                                  
                                  
                                  
                                  
                                  
                                  Ending Balance
      atDescription
                                  December 31,
      2009
                                  
                                  Expenses
                                  
                                  Accounts
                                  
                                  Deductions
                                  
                                  December 31,
      2010Allowance for sales
      returns
                                  $
                                  (2,627,000
                                  )
                                  
                                  $
                                  (55,570,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  55,055,000
                                  
                                  
                                  $
                                  (3,142,000
                                  )Allowance for doubtful
      accounts
                                  $
                                  (91,000
                                  )
                                  
                                  $
                                  (324,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  342,000
                                  
                                  
                                  $
                                  (73,000
                                  )Inventory
      reserves
                                  $
                                  (1,286,000
                                  )
                                  
                                  $
                                  (359,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  552,000
                                  
                                  
                                  $
                                  (1,093,000
                                  )Deferred tax valuation
      allowance
                                  $
                                  (47,388,000
                                  )
                                  
                                  $
                                  (3,322,000
                                  )
                                  
                                  $
                                  2,993,000
                                  
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  (47,717,000
                                  )Column A
                                  Column B
                                  
                                  Column C
                                  
                                  Column D
                                  
                                  Column ECharged to
                                  
                                  Charged toEnding Balance
      at
                                  
                                  Costs and
    Other
                                  
                                  Other
                                  
                                  
                                  
                                  
                                  
                                  Ending Balance
      atDescription
                                  December 31,
      2008
                                  
                                  Expenses
                                  
                                  Accounts
                                  
                                  Deductions
                                  
                                  December 31,
      2009Allowance for sales
      returns
                                  $
                                  (3,707,000
                                  )
                                  
                                  $
                                  (48,934,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  50,014,000
                                  
                                  
                                  $
                                  (2,627,000
                                  )Allowance for doubtful
      accounts
                                  $
                                  (80,000
                                  )
                                  
                                  $
                                  (350,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  339,000
                                  
                                  
                                  $
                                  (91,000
                                  )Inventory
      reserves
                                  $
                                  (1,689,000
                                  )
                                  
                                  $
                                  534,000
                                  
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  (131,000
                                  )
                                  
                                  $
                                  (1,286,000
                                  )Deferred tax valuation
      allowance
                                  $
                                  (42,093,000
                                  )
                                  
                                  $
                                  (6,660,000
                                  )
                                  
                                  $
                                  1,365,000
                                  
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  (47,388,000
                                  )Column A
                                  Column B
                                  
                                  Column C
                                  
                                  Column D
                                  
                                  Column ECharged to
                                  
                                  Charged toEnding Balance
      at
                                  
                                  Costs and
    Other
                                  
                                  Other
                                  
                                  
                                  
                                  
                                  
                                  Ending Balance
      atDescription
                                  December 31,
      2007
                                  
                                  Expenses
                                  
                                  Accounts
                                  
                                  Deductions
                                  
                                  December 31,
      2008Allowance for sales
      returns
                                  $
                                  (4,204,000
                                  )
                                  
                                  $
                                  (59,665,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  60,162,000
                                  
                                  
                                  $
                                  (3,707,000
                                  )Allowance for doubtful
      accounts
                                  $
                                  (106,000
                                  )
                                  
                                  $
                                  (553,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  579,000
                                  
                                  
                                  $
                                  (80,000
                                  )Inventory
      reserves
                                  $
                                  (3,686,000
                                  )
                                  
                                  $
                                  (290,000
                                  )
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  2,287,000
                                  
                                  
                                  $
                                  (1,689,000
                                  )Deferred tax valuation
      allowance
                                  $
                                  (39,443,000
                                  )
                                  
                                  $
                                  (3,257,000
                                  )
                                  
                                  $
                                  607,000
                                  
                                  
                                  $
                                  --
                                  
                                  
                                  $
                                  (42,093,000
                                  )
 
  S-1