Edgar Filing: BLUEFLY INC

Unassociated Document

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 1934

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

Commission File Number 001-14498

BLUEFLY, INC.

(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

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

Signatures		29

Financial Statements		F – 1

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.

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.

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

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

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

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

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

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

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.

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				2009
Quarter	High		Low		High		Low

First	$	3.14	$	2.00	$	0.99	$	0.32
Second	$	3.03	$	1.79	$	1.79	$	0.98
Third	$	2.50	$	1.52	$	2.24	$	1.00
Fourth	$	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:


Statements of Operations Data:	Year Ended December 31,
	2010			2009			2008			2007			2006

Net sales	$	88,563		$	81,222		$	95,774		$	91,493		$	77,062
Cost of sales		55,360			49,665			60,288			58,754			46,153
Gross profit		33,203			31,557			35,486			32,739			30,909

Selling and fulfillment expenses		16,881			16,675			19,620			18,898			15,808
Marketing expenses		12,576			8,661			15,359			16,063			14,196
General and administrative expenses		7,592			8,882			11,355			13,848			13,001
Total operating expenses		37,049			34,218			46,334			48,809			43,005

Operating 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			502

Net loss(3)	$	(4,033	)	$	(4,369	)	$	(11,340	)	$	(15,829	)	$	(12,193	)

Basic and diluted net loss per
common share(4)	$	(0.17	)	$	(0.31	)	$	(0.90	)	$	(1.21	)	$	(2.28	)

Basic and diluted weighted
average common shares
outstanding(4)(5)		23,685,338			14,003,534			13,369,257			13,091,130			8,017,053

Balance Sheet Data:	As of December 31,
	2010			2009			2008			2007			2006

Cash and cash equivalents	$	10,429		$	10,049		$	4,004		$	6,730		$	20,188

Inventories, net		25,128			17,668			23,157			28,492			24,189

Other current assets		3,304			4,278			4,347			3,589			4,229

Total assets		42,144			35,646			37,750			45,019			52,430

Current liabilities		12,320			12,611			16,250			17,922			14,603

Long-term liabilities(6)		183			--			3,106			60			--

Total liabilities		12,503			12,611			19,356			17,982			14,603

Stockholders’ 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

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.

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 customer credits 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 to are 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

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					2008
				As a % of					As a % of					As a % of
				Net Sales					Net Sales					Net Sales

Net 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		62.9
Gross profit		33,203		37.5			31,557		38.9			35,486		37.1


Selling and fulfillment
expenses		16,881		19.0			16,675		20.5			19,620		20.5
Marketing expenses		12,576		14.2			8,661		10.7			15,359		16.0
General and administrative
expenses		7,592		8.6			8,882		10.9			11,355		11.9
Total operating expenses		37,049		41.8			34,218		42.1			46,334		48.4


Operating 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		2008

Average order size (including shipping & handling)	$	299.98	$	266.66	$	279.72
New customers added during the year*		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.

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				Difference
			As a % of				As a % of		Increase
			Net 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		8.2
Total 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-Commerce expenses 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

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

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				Difference
			As a % of				As a % of		Increase
			Net 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.

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

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 Than
	Total(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		3,293,000
Marketing 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.

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. We adopted 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 not have an impact upon our financial position or operating results other 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 Disagreements With Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

Disclosure Controls and Procedures

As of the end of the period covered by this Form 10-K (the “Evaluation Date”), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act were recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

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 report from our registered public accounting firm regarding internal control over financial reporting. Management’s report was not

subject to attestation by the independent registered public accounting firm pursuant to rules of the SEC that permit us to 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 during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information.

None.

PART III.

Item 10. Directors, Executive Officers and Corporate Governance.