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Bluefly, Inc. (NASDAQ:BFLY)

F1Q08 Earnings Call

March 26, 2008 5:00 pm ET

Executives

Melissa Payner – Chief Executive Officer

Barry Erdos – President, Chief Operating Officer & Director

Kara B. Jenny – Chief Financial Officer

Bradford Matson – Chief Marketing Officer

Analysts

Erin Moloney – Merriman Curhan Ford & Co.

Operator

Good afternoon and welcome to the Bluefly, Inc. fourth quarter 2007 earnings conference call. (Operator Instructions) As a reminder you can find a copy of our fourth quarter 2007 earnings release at our investor relations web site www.Investor.Bluefly.com. During the course of this call we’ll make suggestions 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 risk 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 risk and uncertainties are detailed from time-to-time in the reports we file with the Securities & Exchange Commission including Forms 8K, 10Q and 10K 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 publically 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 March 26, 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

Good afternoon everyone I want to welcome you to the Bluefly fourth quarter earnings call. With me today is Barry Erdos, our President and Chief Operating Officer, Kara Jenny our Chief Financial Officer and Brad Matson our Chief Marketing Officer. We will share some of the highlights from the fourth quarter and talk a little bit about 2008. Barry will take you through the financial results from the fourth quarter and at the conclusion of the call we will conduct a question and answer session.

As I mentioned on last quarter’s earnings call in order to improve our overall customer experience, we made a decision to move to a new fulfillment center. Unfortunately, the challenges associated with the move continued into the fourth quarter and had a negative impact on sales. In spite of this internal operational issue and a tough general retail environment, we were able to grow almost 10% in the quarter versus Q4 of 2006. We feel that the growth we did see in the quarter is a clear indication of continued strong consumer support for Bluefly’s unique value proposition. Based on the strong growth we experienced in the first six months of 2007 a 30% increase year-over-year, we expected our momentum to continue into the second half of the year. As I said the challenges of executing our warehouse move coupled with a difficult economic climate resulted in the 10% increase in sales, respectable versus many of our competitors but below our expectations and ultimately lead to a build-up of inventory. Remember inventory that is not immediately shippable at the warehouse does not appear on our site resulting in lost sales and a slower inventory turn, we do not take back orders.

As a result we were not able to sell through the amount of inventory that we had planned and determined we needed to write-off a portion of the inventory in order to liquidate the product to allow for spring receipt. We recorded a $1.5 million write-off of inventory which resulted in a 520 basis point hit to margin in the quarter. The overall margin was 600 basis points lower than last years. The reduction excluding the write-off was a result of mix and fx impact on the designer business.

As we told you last quarter, many of the issues surrounding the inventory would not be rectified until we completed our physical inventory in January. Fourth quarter delays in getting the product on the site as scheduled created loss of sales and margins. In addition, we were unable to completely fulfill many orders and in some cases we had to cancel the order completely resulting in both an immediate loss to sales and a negative customer experience. The re-buy rate from existing customers and number of orders per buyer in season were clearly impacted by the move. While it’s impossible to quantify sales that should have been, I am happy to report that the metrics we use to track customer loyalty improved steadily as the fall season progressed and have in 2008 returned to the high levels we had before the warehouse move. Since the physical inventory we have seen major improvements in the accuracy of the inventory at the warehouse and we continue to see improvements in the operational aspects of the business.

So let’s look at the growth of the business for a minute. Sales for the year grew by almost 19% and by almost 10% for the three months ended December 31st with very strong performances in certain product categories. We continue to see explosive growth in the designer accessory area which was up 31% over the fourth quarter versus last year and up 69% for the year. Designer handbags were up 95% in sales versus last year. Dresses grew by 15% in the quarter and almost 28% for the year but unit sales for dresses increased 52% in the quarter and 50% for the year. With the warm fall we saw our tops and tees business grow by 36% in the quarter and 41.5% for the full year. Units for tops and tees increased 32% for the quarter and 39% for the year, that was partially offset by the women’s collection business which was down 15% in the quarter and 11% for the year and this down turn is largely trend driven. I am sure you’ve all seen the comp store sales over the past few months for retail companies. Our growth rate is still pretty strong versus many of the more established companies. In fact, both specialty retail and department stores as a group have had a negative comp five out of the six past months.

Now, let’s turn to marketing and advertising related expenses. Marketing expenses for the quarter were $6.9 million 40% higher than Q4 2006. This is due to a shift in spending to support our integration with the Project Runway the full integration fee hit the fourth quarter while the benefits extend into the Q1 2008 and beyond and I will speak to the very positive results of that partnership in a few minutes. Q4 expenses for online marketing programs increased 21%, offline expenses increased from $2.6 million to $4.1 million due, as I state earlier, to a shift in spending to support our integration with Project Runway. Marketing expenses for the year came in as we discussed in the last call at $16 million. Net sales for the year increased 19% on a 13% increase in marketing spend improving the ad to growth sales ratio for the year by 100 basis points. Annual spending for online programs increased 26% and accounted for 46% of the marketing spend. Sales attributable to our search and affiliate program increased 63% in 07 and now account for 27% of our sales versus 20% in 2006. Annual spending for offline programs decreased from 59% of the marketing spend to 54% and this includes all integration fees for the 16 episodes of the Project Runway Season Four, starting in November of 07 and ending in March of 08.

Our sponsorship of Project Runway has been a very effective marketing tool. As the program airs we see a direct lift in traffic to our site. At 10:35 pm during the broadcast of Episode One on November 14, 2007 page views per second soared beating our previous all time peak by 40%. The finale aired on March 5, 2008 and we beat that record by another 20%. The initial spike in traffic was sustained throughout each week driving a 30% increase to weekly new unique visitors on our site for 18 consecutive weeks. The Project Runway Season Four television audience grew by 11% versus their prior season and the finale was over 3.5 million viewers. And was the largest audience in Bravo’s history. Project Runway’s viewers are the perfect fit for Bluefly among all cable programs Project Runway has the highest income and education for adult women an increased awareness in that group has laid a foundation for new customer growth in 2008. The association with Project Runway also had a positive impact on existing customers as well. In fact based on a recent independent survey 69% of existing Bluefly customers have watched Project Runway and 89% of those tell us they visited our site after watching the program. There’s no doubt in my mind that the combination of smart online marketing with awareness created by our association with Project Runway has helped Bluefly’s performance in a very difficult market and positions us well for the coming months. Now, I’ll turn the call over to Barry, who will run through some of the fourth quarter details.

Barry Erdos

Let me walk you through the major income statement and balance sheet line items. Net revenue in the fourth quarter grew by 9.7% to $29.7 million. Average order size was up slightly to $274 from $272 in the fourth quarter of 2006. We added nearly 67,000 new customers in the quarter, 3.5% increase over last year. Gross margin for the quarter was 34.3% versus 40.3% in the fourth quarter of 06. As Melissa mentioned the gross margin was negatively impacted by a $1.5 million inventory write-off. At the end of the year, we believe that the inventory on hand was more than needed to support the growth of the business and we made a decision to remove certain items from the site and to liquidate those styles. The main cause for this build-up in inventory related to the issue surrounding the warehouse move. Much of the inventory for the fall season was not available for sale during the entire period. This hindered our ability to merchandise the inventory according to our initial plans. In addition, the general retail environment became very promotional in the fourth quarter and that made it more difficult to move the product in a manner that was compelling to our customers. We believe that this write-off will help us achieve the proper inventory levels to support the business as planned in 2008.

Absent the $1.5 million write-off of inventory, gross margin dollars per order remain relatively flat in the fourth quarter of 07 at $68.82 versus $69.02 in 2006. The decline in gross margin percentage was mainly caused by the inventory write-off which accounted for 520 basis points for the gross margin percent decline, a shift in the merchandise mix and foreign exchange accounted for the balance of the decline. Fourth quarter sales in the designer accessories and shoe categories grew by over 31% year-over-year. Typically these categories have a lower product margin percent than those other categories that we sell. In addition, the weakness of the dollar against the Euro had a significant impact on the costs which negatively impacted the gross margin percentage. The product margin in the non-designer categories were basically flat to the same period last year. For the full year the designer categories were up over 69% versus the full year 2006. As a reminder costs of goods sold include for a net product cost fourth quarter results included the $1.5 million write-off, cost of freight in, fourth quarter carrier costs associated in getting the product to the consumer, again, these costs from the major party carriers have increased over the prior year, and the cost of packing materials.

Let’s move to the selling and fulfillment line. Selling and fulfillment expenses were $5.4 million for the fourth quarter versus $4.7 million in the same period last year. The major components in selling and fulfillment are as follows: operating related costs; credit card fees; pick-and–pack; warehousing; and customer service increased by 23% or $620, 000. As a percentage of net revenue operating related costs increased from 10% to 11.2% in the quarter. The increase was driven by an increase in orders and consulting expenses associated with the warehouse move.

Technology spending was flat versus last year and decreased as a percentage of revenue to 3.9% versus 4.2% in 2006. We capitalized approximately $934,000 of expenses in the quarter related to the ATG upgrade. To date, we have capitalized $3.6 million related to the ATG move. Ecommerce expenses increased by 10% in the fourth quarter versus the prior year. The increase in expenses was a result of salary and software related expenses.

Let’s turn to marketing expenses. Our total marketing expenses for the quarter was $6.9 million versus $4,950,000 for the fourth quarter of 06. The fourth quarter included approximately $4.1 million in expenses related to our print and television advertising versus $2.6 million in the fourth quarter of 2006. As Melissa noted, a portion of this increase is the integration fees for Project Runway, the balance is the result of timing related to the production costs. Marketing expenses for the year came in as we discussed in the last call at $16 million. General and Administrative; G&A expenses decreased by $1.6 million over the fourth quarter of 2006. Included in the general and administrative expenses for the fourth quarter were $1.5 million of expenses related to stock-based compensation versus $2.6 million to the similar period last year. The balance sheet; our cash as of December 31, 2007 was $6.7 million down from $7.2 million at the end of quarter three. As we have announced earlier today, two of our major shareholders agreed to provide a $3 million commitment should the company determine the need for additional funds. This commitment will allow us to continue to invest in the business. Inventory was $28.5 million the net inventory grew by 18% from December 31, 2006. Other current assets of $3.6 million includes $2.1 million in accounts receivable which is comprised of dollars due from credit card companies, and $770, 000 of other prepaid expenses which is mostly marketing related. Fixed assets increased by $2.4 million. At year end we had $3.6 million dollars capitalized related to the costs associated with our ATG implementation. The company has no debt on the balance sheet and we have $3.8 million available on our line with Wells Fargo out of the $7.5 million amount.

On March 26, 2008 subsequent to year end we extended our line with Wells Fargo until July, 2011. As of December 31st there were approximately 132.8 million shares of common stock outstanding before [inaudible] to conversions of the remaining Series F preferred stock, warrants options or deferred stock units. On March 13th the company announced that the board of directors approved a one per 10 reverse stock split. The effective date of the split will be April 3, 2008.

Before I turn the call back over to Melissa I wanted to give you a little insight into the first quarter of 2008. We are experiencing double digit growth in the quarter on top of a very quarter one of 2007 where we saw a 31% year-over-year growth rate relative to sales. Our gross margins will trend lower than last year as we spend the first part of the quarter which is our pre-spring launch, clearing out some of the inventory issues created by a weak retail environment and our own internal operational issues. The good news is that the operational warehouse and inventory issues are under control. We believe that we have the financial support of our major shareholders to make sure that we can continue to invest and grow the business in an intelligent manner. Now, let me turn the call back to Melissa.

Melissa Payner

I would just like to reiterate what Barry had said, with most of the internal distractions from 2007 behind us the health of our customer files appears to be returning to pre-warehouse move status and the interest driven from the Project Runway relationship should position us well for the balance of the spring season. We’re driving in to 2008 in a very difficult macroeconomic environment. Given the financial support from our largest shareholders we look forward to getting back on track and growing Bluefly into a much larger, profitable business. I’d like to turn the call over now to the Operator for question and answer.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Erin Moloney.

Erin Moloney – Merriman Curhan Ford & Co.

First of all just following up Barry on your last comments on the first quarter specifically on the gross margins, are there any reasons after you’re done kind of clearing through this excess inventory that you couldn’t see gross margins levels the rest of the year similar to historical levels?

Barry Erdos

It’s still early to tell, the macro environment as you know does not seem to be getting any better but we feel good about the quality of our inventory flow and we will market and price the inventory according to those external factors.

Melissa Payner

The only thing I would add to that is what would cause a shift is the mix. For example the more designer merchandise that we sell, the designer accessories that are impacted by the Euros that will have an impact on the margin percent, but the margin dollars are higher because they’re such high ticket items. It’s hard to say today what the year will look like.

Erin Moloney – Merriman Curhan Ford & Co.

And assuming, I guess sales trends stay as you have planned going forward the excess inventory you have now coming out of the last year should be all cleaned up by the end of the current quarter, here?

Barry Erdos

Yes.

Erin Moloney – Merriman Curhan Ford & Co.

Great, okay. And then, looking at your marketing, where is your marketing expense plan for 2008? Usually you guys talk about that a little bit and I didn’t hear that on the call this time.

Barry Erdos

Sure, in 08 we see a major shift to online spend versus offline so, where as we ended 07 with 54% of our spend offline and 46% online we will be at 44% offline in 08 and 56% online. The focus is really to spend where we get proven payback in search and affiliate programs and we’ve narrowed the focus of our offline advertising. Really Runway has been a tremendous success for us and we are looking to repeat those types of relationships versus a broader advertising approach.

Erin Moloney – Merriman Curhan Ford & Co.

Should it end up a kind of similar rate? So kind of switching offline versus online percentages it sounds like. And then, should it be a similar dollar amount to what you saw in 07?

Barry Erdos

Slightly increase with a one to two or more percent improvement in ad to sales ratio. If we continue the trend we are on now we will see an improvement in the rate.

Erin Moloney – Merriman Curhan Ford & Co.

Melissa, I was hoping you could talk about too some of the trends, fashion trends that you’re seeing for this spring?

Melissa Payner

First of all color is the most important thing and it’s generally - we’re seeing it everywhere but I think it’s important in accessories because I think people feel more comfortable adding a bright handbag to what they’re wearing but we are seeing bright colors in tops. And for us, bright blue, sort of an electric blue, is turning out to be one of the most important colors although we did hear a lot about yellow. It’s not as strong for us, but it is a strong color and the bright blue is really taking off. I think that’s going to be strong and denim, denim is very strong. That’s kind of surprising, because the market was saturated with denim and it appears to be, with all of the new silhouettes out there that seems to be important again. And then there’s been somewhat of a shift away from the whole “it” bag, which was the last year and half and really towards shoes and so people are - shoes and heels on shoes are really wild, I don’t know if you’ve noticed but they are really architectural and interesting so that’s been a big focus. And then I think we are going to see a shift back towards sportswear starting into the fall season and a little bit away from dresses, although I think dresses will remain important, I think we are going to get some blazers back.

Erin Moloney – Merriman Curhan Ford & Co.

Last question, I was wondering just looking back on your fourth quarter sales how much do you think was kind of your own issues with the warehouse move, how much is the economy? And then, if you can talk just a little bit how you’ve seen your customers react historically with the weak economic environment?

Barry Erdos

As we indicated during the call the two issues you alluded to, if I had to weigh them, for the quarter purposes I’s say certainly the operational issues had a greater impact than the environment and you can really see how well we were doing leading into the fall season and suddenly with the warehouse move, we began to see the fall in the top line as well. As we go forward paces in 2008 I really don’t see any operational issues I think it’s strictly our customer, how she reacts to our inventory relative to a disposable income and thus far, it’s been good.

Bradford Matson

A perspective of customer re-buy rates is how we track someone’s loyalty or interest in Bluefly. And we saw as the operational issues decreases, those rates around 10%, that as we said in the call improved over the season and now for 08 those numbers are back to the levels that we had before the move. So even in this environment the rebound rates are there and she’s interested in Bluefly’s values proposition.

Operator

(Operator Instructions)

Melissa Payner

If there are no further questions I just want to thank everyone for coming and we will see you next quarter.

Operator

This does conclude today’s conference call. You may now disconnect.

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Source: Bluefly, Inc F1Q08 (Quarter End 1/27/2008) Earnings Call Transcript

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