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Executives

Melissa Payner – Chief Executive Officer

Barry Erdos – President, Chief Operating Officer

Analysts

Bluefly Inc. (BFLY) Q3 2008 Earnings Call November 12, 2008 5:00 PM ET

Operator

Welcome to the Bluefly Incorporated third quarter 2008 earnings conference call. (Operator Instructions) During the course of this call the company will make statements that constitute forward-looking statements usually containing the words believe, project, expect or similar expressions. These statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements inherently involve risks and uncertainties that could cause actual results to differ materially from the forward looking statements.

These statements are only predictions based on assumptions that are believed to be reasonable at the time. The risks and uncertainties are detailed from time to time in the reports we file with the Securities and Exchange Commission including Forms 8-K, 10-Q and 10-K and you should consider them when making an investment decision regarding Bluefly. They may affect whether our forward-looking statements prove to be correct.

We undertake no obligation to publicly update or revise these forward-looking statements. In addition, our discussion today is being recorded and archived for at least 30 days for those who wish to listen at a later date. Those of you listening to the archived version should recognize that the statements that we make are current as of November 12, 2008 and will not have been updated to reflect any subsequent events or changes in the business.

I will now turn the call over to Melissa Payner, Chief Executive Officer for Bluefly.

Melissa Payner

I want to welcome you to the Bluefly third quarter earnings call. With me today are Barry Erdos, our President and Chief Operating Officer, Kara Jenny, our Chief Financial Officer and Brad Matson, our Chief Marketing Officer.

I will share some of the highlights from the third quarter. Barry will take you through the financial results from the third quarter and at the conclusion of the call, we will conduct a question and answer session.

Given the overall economic environment and the affect that it's had on other retailers, we believe that our third quarter results are quite encouraging. Year over year our net revenue for the quarter grew by approximately 10%. Operating loss including the non cash impact of the FAS 123 R expense, decreased by approximately $252,000.

Although the economic environment in the fourth quarter has become more challenging, we believe that the American consumer will continue their fascination with popular culture and shopping. They are just looking for permission to buy. Those retailers that are nimble enough to showcase the right product at the right price at the right time can gain market share.

Let's talk in a little more detail about our third quarter results. As I mentioned, sales were up by 10% in the quarter. Gross margin dollars grew by 28% and resulted in a gross margin percentage of 36.9%. We saw very strong performances in certain categories which have consistently driven our business season to season.

There was clear delineation between what was working and what wasn't working under the downward pressures of the current economic environment. Let's talk about what was working. Women's dresses have shown great resilience in light of a strong trend in the fall back towards sportswear with an 11% increase in overall dress volume. Day dresses drove the overall dress business with an increase in sales dollars of 27% and an increase in unit sales of 31% over last year.

Evening dresses continued to gain momentum in the fall season after a difficult first half. From a negative 26% in the first half of the year to negative 5% in Q3, as compared to last year, and by October to a positive 9% to last years sales.

After several seasons of the shift to our dresses, we are beginning to see a reversal of that trend for women's collections with an increase of 1% in sales for third quarter. Women's denim has also seen continued growth with a 12% increase compared to last year in sales and a 30% increase in unit sales in the third quarter. We were particularly challenged in these two areas throughout the spring half due to a lack of inventory.

We continue to see explosive growth in contemporary accessories with sales growth of 20% and margin growth of 23% over last year. Contemporary hand bags alone were up 56% for the quarter in sales and up 52% in margin dollars and up 23% in unit sales.

Now let's talk a little bit about what's not working. While designed accessories remains an important component to the total company sales, approximately 20% for the quarter, designer shoes and hand bags have dropped to last year in overall sales by 18%. Mix, late receipts and the current macro economic conditions all played a large role in the drop last year.

The total men's division continues to be challenged with a 14% sales drop in the quarter. The decrease in men's was driven by a decline in overall tailored clothing business which includes suits, dress shirts and designer shoes. We believe that this is a result of the macro economic conditions.

We see men's knits and denim as an opportunity as those businesses have suffered from a lack of new receipts.

Aside from the challenges in some of the larger categories, there are still come smaller categories that continue to see strong growth trends year over year for the quarter. Jewelry, we have 25% increase in sales, a 34% increase in margin dollars and a 36% increase in the unit sales over last year.

In swimwear we have an increase of 14% in sales, an increase of 12% in margin dollars and an increase of 8% in units over last year.

In women's belts we have a 24% increase in sales, 30% increase in margin dollars and a 52% increase in units.

In women's active wear, we have an 80% increase in sales, a 60% increase in margin dollars and a 72% increase in unit sales over last year.

So let's talk a little now about marketing. Marketing expenses including tax related costs for the quarter were $4.1 million, a 61% higher than they were for Q3 2007, but this increase is entirely due to a change in timing for our important and successful partnership with Project Runway.

Expenses for Project Runway's season four were in the fourth quarter of '07 versus Q3 of this year. This shift represents 100% of the increase of the marketing dollars in Q3 and we expect marketing spend for the year end 2008 to be below that of 2007.

We feel that the best way to gain both market share and improve productivity in this economy is with the smart allocation of marketing dollars and a relentless focus on messaging and conversion. Marketing plans for Q4 and beyond are built on three major platforms.

Number one, an aggressive and flexible merchandizing promotional calendar that we revisit daily. Number two, a portfolio approach to on line marketing programs that maximizes sales while continuing to reduce ad to sales ratios. And three, smart 4D off line programs in partnership that include rich media components to build awareness and deepen customer engagement.

In the past month, Bluefly continued to build on its reputation as an innovator and leader in 4D marketing. Two key programs for the period were partnerships with Project Runway and Gossip Girls that included on air integration coupled with on site content that includes merchandise assortment directly tied to the television shows, videos, blogging and other interactive content.

We saw a 70% to new unique visitors year over year during the week in July that featured the premier of Runway Project season five and the exclusive launch of Christian Siriano's, the season four winners first designer collection.

Blog conversations about Bluefly's Q3 grew to more than 8,000 a 70% increase and since the beginning of the year, Bluefly videos have had more than 800,000 hits on You Tube. In the month of October, we also featured Fashion Decision 2008, a widget that appeared a Bluefly as well as all major social networking sites that allowed our community to weigh in on the election and see real time results reported by region.

The buzz about Bluefly is definitely building. A recent Wall Street Journal article celebrated Bluefly for being right for the times, citing 25% more buzz in October versus September according Zeta, an independent researcher.

Now, I will turn the call over to Barry who will run through some of the third quarter details.

Barry Erdos

Let me walk you through the major income statement and balance sheet line items. Net revenue in the third quarter grew by 10% to $19.8 million. Average order size increased 4.2% to $292.00 from $280.00 in the third quarter of 2007. We added over 39,000 new customers in the quarter, a 4.4% increase over last year.

Gross margin for the quarter was 36.9% versus 31.7% in Q3 2007. Gross margin dollars per order increased to $66.23 versus $54.31. As we mentioned on the last call, we were seeing positive benefits from certain initiatives put in place over the last several quarters, most notably in the form of a slight increase in the return rate for the year to date results compared to last year.

We have not a meaningful decrease in the return rate in the third quarter.

As a reminder, cost of goods sold include net product costs, cost of freight, third party carrier costs associated with getting the product to the consumer and the cost of packing materials.

Moving to the selling and fulfillment line; selling and fulfillment expenses increased 7.6% to $4.9 million for the third quarter versus the same period last year. The major components to selling and fulfillment are as follows; operating related costs which are credit card fees, pick and pack and warehousing and customer service. And this decreased 15% to $2.1 million from $2.5 million compared to the same period last year.

As a percentage of net revenues, operating related costs decreased from 13.7% to 10.6% in the quarter. This decrease was driven by efficiencies related to costs associated with fulfillment and customer service as well as the fact that the 2007 numbers included move related costs to our new fulfillment center of $462,000.

Technology spending increased to $1.8 million, an increase to 8.9% of revenue versus 6.3% in 2007. We capitalized approximately $509,000 of expenses in the quarter related to the APG upgrade. Our new web site was placed into service in August of 2008 at a total cost of $5.3 million and depreciation expenses relating to the new website was approximately $293,000 which is included in technology expenses.

E-commerce expenses remained relatively unchanged at approximately $1 million compared to the same period in the prior year. E-commerce expenses also remained relatively unchanged at 5.4% of net revenue compared to the same period last year.

Marketing expense; our total marketing expense including staff related costs for the quarter was $4.1 million versus $2.8 million for the third quarter of 2008. The third quarter included approximately $2.1 million in expenses related to our print and television advertising which was $1.4 million higher compared to the third quarter of 2007.

As Melissa mentioned, the increase is attributed to the timing of the Project Runway fifth season. It launched in July of 2008 during the third quarter whereas Project Runway's season four launched in the fourth quarter of 2007.

General and administrative expenses; G&A expenses decreased by $389,000 versus the third quarter of 2007. Included in the G&A expenses for the third quarter were $594,000 of expenses related to stock based compensation versus $1.5 million for the same period last year.

Turning to the balance sheet, our cash as of September 30, 2008 was $1.9 million, down from $6.7 million at the end of 2007. As we previously announced, in July we drew down on the $3 million commitment provided by two of our major shareholders. This amount is included on our balance sheet as long term notes and presented with accrued interest.

Inventory remained relatively unchanged at $28 million since December 31, 2007. Other current assets of $5.3 million includes $3.2 million in accounts receivable which is comprised of dollars due from credit card companies and $2.1 million of other pre-paid expenses which is mostly marketing related.

Fixed assets increased by $812,000 from year end. As previously mentioned at quarter end we have $5.3 million capitalized related to the cost associated with our APG implementation. At September 30, the company had approximately $3 million of debt on the balance sheet and we have $3.8 million available in our line of credit with Wells Fargo out of $7.5 million.

As of September 30, there were approximately 13.3 million shares of common stock outstanding before giving the effect of the conversions of the remaining series F preferred stock warrants, options or deferred stock units.

Now let me turn the call back to Melissa.

Melissa Payner

While we're continuing to operate in a difficult environment, our business continues to move in a positive direction. We continue to growth in sales and leverage our marketing expenses. We believe our value proposition will continue to be compelling to our customers.

I'd like to turn the call over now for any questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) There are no questions at this time.

Melissa Payner

Thank you very much.

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