U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2003
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 001-14498
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BLUEFLY, INC.
(Name of registrant as specified in its charter)
Delaware 13-3612110
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
42 West 39th Street, New York, NY 10018
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (212) 944-8000
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Securities registered under Section 12(b) of the Exchange Act: Common Stock, par
value $.01 per share
Securities registered under Section 12(g) of the Exchange Act: Common Stock, par
value $.01 per share
Indicate by check mark whether the registrant (1) filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ]
Indicate by check mark whether disclosure of delinquent filers in response to
Item 405 of Regulation S-K is not contained in this form, and will not be
contained, to the best of the registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
As of February 19, 2004, there were 14,471,375 shares of Common Stock, $.01 par
value, of the registrant outstanding. The aggregate market value of the voting
and non-voting common equity held by non-affiliates as of June 30, 2003, based
upon the last sale price of such equity reported on the National Associated of
Securities Dealers Automated Quotation SmallCap Market, was approximately
$5,621,000.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Bluefly, Inc. is a leading Internet retailer of designer fashion and home
accessories at discount prices. We sell over 350 brands of designer apparel,
accessories and home products at discounts up to 75% off retail value. During
2003, we offered over 80,000 different types of items for sale in categories
such as men's, women's and accessories as well as house and home accessories. We
launched the Bluefly.com Web site (the "Web site") in September 1998. Since its
inception, www.bluefly.com has served over 500,000 customers and shipped to over
20 countries.
Our common stock is listed on the Nasdaq SmallCap Market under the symbol "BFLY"
and on the Boston Stock Exchange under the symbol "BFL" and we are incorporated
in Delaware. Our executive offices are located at 42 West 39th Street, New York,
New York 10018, and our telephone number is (212) 944-8000. Our Internet address
is www.bluefly.com. We make available, free of charge, through our Web site, our
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the SEC.
In this report, the terms "we," "us," "Bluefly" and the "Company" refer to
Bluefly, Inc. and its predecessors and subsidiaries, unless the context
indicates otherwise.
RECENT DEVELOPMENTS
JANUARY 2004 FINANCING
On January 12, 2004, we completed a private placement (the "New Financing")
pursuant to which we raised $5,000,000. Under the terms of the deal, we issued
1,543,209 shares of common stock at $3.24 per share, which was 90% of the
trailing five-day average of the Company's volume-weighted stock price as of
December 29, 2003, the date that a preliminary agreement was reached as to the
pricing of the deal. We also issued the new investors warrants to purchase
385,801 shares of common stock at any time during the next five years at an
exercise price equal to $3.96 per share.
In January 2004, we also extended the maturity dates on the Convertible
Promissory Notes issued to affiliates of Soros Private Equity Partners, LLC that
collectively own a majority of our capital stock (collectively, "Soros") in July
and October 2003 (the "Notes"). The maturity dates of the Notes, which were
originally January and April 2004, respectively, were each extended to March 1,
2005. In February 2004, the maturity date of the Notes was further extended to
May 1, 2005.
PERSONNEL
In September 2003, we hired Melissa Payner-Gregor, former President and CEO of
Spiegel Catalog, Inc., as our President. Ms. Payner-Gregor reports directly to
our CEO and is responsible for our merchandising, marketing and e-commerce
groups. She also joined the Company's Board of Directors, which has been
expanded to eight members.
GENERAL
Based on current plans and assumptions relating to our operations, we believe
that our existing resources and working capital, are sufficient to satisfy our
cash requirements through the end of 2004. Of course, there can be no assurance
that such expectations will prove to be correct. Moreover, we may seek
additional debt and/or equity financing in order to grow our business. The
environment for raising investment capital has been difficult and there can be
no assurance that additional financing or other capital will be available upon
terms acceptable to us, or at all. If such financings are not available on terms
acceptable to us or we do not achieve our sales plan, future operations will
need to be modified, scaled back or discontinued. The inability to obtain
additional financing, if needed, would have a material adverse effect on our
business, prospects, financial condition and results of operations. See "Risk
Factors -We Are Making A Substantial Investment In Our Business And May Need To
Raise Additional Funds" and "Risk Factors -Certain Events Could Result in
Significant Dilution Of Your Ownership Of Our Common Stock."
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BUSINESS STRATEGY
Bluefly strives to be the "Store of First Resort for Fashion" by offering the
most compelling combination of selection, value, service and convenience. By
selectively acquiring end-of-season and excess inventory of high-end designer
fashion products and offering a friendly, convenient and upscale shopping
atmosphere, we believe that we are creating a hybrid retail environment that
combines the best of the three traditional retail channels: the selection of
full price department stores; the service and convenience of catalogs; and the
savings of traditional off-price stores.
Each of the three traditional retail channels offers something different to
consumers. Full price department stores typically offer a wide selection of top
designer products and make substantial efforts to provide good customer service.
Often missing from the full price department store experience are convenience
(of necessity, consumers must travel to and from the store, which in some
instances can take several hours) and discounts (while full price stores
generally have price mark-downs, the majority of their business is at full
price). While catalogs offer convenience and good customer service, they
generally do not offer discounts or a wide selection of designer products (many
catalogs, such as J.Crew, Lands' End, and Victoria Secret, are "vertical brands"
that sell only one brand of products). Off-price stores, such as T.J. Maxx and
Ross Stores, typically offer significant discounts to the customer but do not
offer the designer brand selection and customer service of full price department
stores or the convenience of catalogs.
Bluefly seeks to combine the best that these three traditional channels have to
offer with added benefits offered only by the Internet. At Bluefly.com, we aim
to offer the designer selection of a full price department store, the customer
service of a high-end retailer or catalog, the discounts of an off-price store,
the convenience of 24/7 shopping from home or the office, and sophisticated
search and sort functionality made possible by the Internet. We recognize that
we will not be able to satisfy all of our customers, all of the time, but then
no retailer can. Our proposition to the consumer is simply this: "Come to
Bluefly.com first for all of your fashion needs. We will do our best to exceed
your expectations and, if we have what you are looking for, you will receive top
designer merchandise at a discount and outstanding customer service in a
friendly, convenient, upscale environment. In those instances (which we hope to
be rare) where our designer selection does not meet your needs, the cost to you
will be the few minutes it took to browse or search our Web site. We, on the
other hand, will have the opportunity to complete many more sales with you if we
successfully build an experience that convinces you to visit us first to see if
we can fill your fashion needs." For these reasons, we hope to become the "Store
of First Resort for Fashion."
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. We recognize that liquidating excess inventory can be a
"necessary evil" and that brand dilution can occur when a brand's product is
offered in a traditional discount environment. We would like to make the
liquidation of excess inventory a positive experience for our vendors rather
than a distasteful one. We intend to do this by treating our suppliers with
honesty and respect and by creating a high-end retail environment that offers
only a premium matrix of brands. In doing so, we hope that Bluefly's younger,
affluent customer base will come to understand our suppliers' brands as the
designer intended, thereby reducing the potential for brand dilution.
We do not believe that we can become the "Store of First Resort for Fashion"
without using the Internet as a platform. The direct marketing of excess and
end-of-season apparel, fashion accessories and home products requires a
cost-effective medium that can display a large number of products, many of which
are in limited supply, and some of which are neither available in all sizes nor
easily replenished. We believe print catalogs are not well suited to this task.
The paper, printing, mailing and other production costs of a print catalog can
be significant and the lead times required to print a catalog make them
significantly inflexible in addressing inventory sell outs, price changes and
new styles. To work around these limitations, a traditional cataloger typically
requires products that are replenishable, available in a full range of sizes and
in substantial quantities. Similarly, retailing on television is costly and
requires substantial quantities of products that are available in all sizes in
order for it to be an economical medium. In addition, the number of items that
can be displayed on television is limited, and television does not allow viewers
to search for products that interest them. The availability of excess inventory
of high-end apparel and accessories is often at odds with these needs as such
merchandise is rarely replenishable and frequently offered in incomplete color
and size ranges.
The Internet, however, can be a far less expensive and far more effective
medium. By using the Internet as our platform, the number of items that we offer
is not limited by the high costs of printing and mailing catalogs. With the
Internet, we can automatically update product images as new products arrive and
other items sell out. By integrating real-time databases containing information
about both inventory and customers' size and brand preferences, we can create a
personalized shopping
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environment and allow our customers to search for the products that specifically
interest them, and more importantly, limit what they see to the items that are
available in their size. In addition, we believe that we are able to more
economically and consistently maintain an upscale environment through the design
of a single online storefront.
We believe that we have created a customer experience that is fundamentally
better than that offered by traditional off-price retailers. Similarly, we
believe that our upscale atmosphere, professional photography and premium brand
matrix 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.
E-COMMERCE AND THE ONLINE APPAREL MARKET
The dramatic growth of e-commerce has been widely reported and is expected to
continue. According to the United States Department of Commerce, online sales
grew by over 26% to $50 billion in 2003 compared to 2002. We believe that a
number of factors will contribute to the growth of e-commerce, including (i)
shoppers' growing familiarity and comfort with shopping online; (ii) the
proliferation of devices to access the Internet, and (iii) technological
advances that make navigating the Internet faster and easier.
We believe that the market for online sales of apparel is growing faster than
many other retail categories as a result of a confluence of trends, including
(i) the growth of the number of women online, who account for a larger share of
retail apparel purchases, (ii) the expansion of online traffic from technology
oriented users to users with mainstream demographic, (iii) the development of
sophisticated tools to search complex product categories such as apparel and
(iv) the growing adoption of high speed access of cable modems and DSL, which
makes viewing large numbers of photos much faster. Of course, there can be no
assurance that such expectations will prove to be correct or that they will have
a positive effect on our business.
CATALOG SALES AS A PREDICTOR OF FUTURE GROWTH
In many respects, shopping for apparel online is similar to purchasing apparel
through a print catalog. In both cases, the tactile experience is absent from
the transaction and shoppers must make purchase decisions on the basis of a
photograph and a textual description. While we believe that sophisticated
database technology, personalization technology, and the interactivity of the
Web will ultimately make the Internet a far more compelling medium than
catalogs, we also believe that the success of apparel sales via catalogs is a
good predictor of the future success of apparel sales via the Internet.
The success of companies such as J.Crew and Lands' End is perhaps the best
evidence that people are prepared to purchase clothing and accessories remotely
despite the fact that no catalog can convey the tactile element of clothing or
provide a fitting room in which consumers can try on clothing.
MARKETING
We are seeking to position ourselves as the fashion consumer's store of first
resort, combining the service and selection found at high-end retailers with
savings typically available only at off-price stores or company-owned outlet
stores. We seek to incorporate this branding effort into all aspects of our
operations, including advertising, customer service, site experience, packaging
and delivery. We acquire new customers through multiple channels, including
traditional and online advertising, direct marketing and print advertising.
MERCHANDISING
Our merchandising efforts are led by our recently hired President and our buyers
who hail from such venerable retailers as Saks Fifth Avenue, Bergdorf Goodman
and Henri Bendel. We buy merchandise directly from designers as well as from
retailers and other third party, indirect resources. Currently, we offer
products from more than 350 name brand designers, which we believe to be the
widest selection of designers available from any online store. We have
established direct supply relationships with over 200 such designers. We believe
that we have been successful in opening up over 200 direct supply relationships,
in part because we have devoted substantial resources to establishing
Bluefly.com as a high-end retail environment. In this regard, 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 to liquidate their excess inventory.
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For a number of reasons, we believe that our inventory risk can be lower than
that of traditional retailers:
. By centralizing our inventory, we believe that we will be able
to optimize inventory turns because we will not be forced to
anticipate sales by region or allocate merchandise between
multiple locations;
. Our Web site captures a tremendous amount of customer data that
we can use to optimize our purchase of inventory;
. Unlike traditional brick-and-mortar retailers and catalogs, we
can change the pricing of our products almost instantaneously
and can price products based on supply and demand; and
. Unlike traditional brick-and-mortar retailers, which have a
limited amount of shelf space, significant rent payments and
attendant sales personnel costs, we hold inventory in a
warehouse with a lower per square foot rental charge, lower
personnel costs and more shelf space.
These factors can create lower inventory carrying costs. We believe that these
advantages have allowed us to continue to sell products at higher margin prices
for a longer period of time than traditional retailers, who are often forced to
mark down the price of a product to clear it from the floor if it does not sell
within the first few weeks. For example, we were able to increase our margin
from 30.5% in 2001 to 32.8% in 2002 despite the fact that our inventory grew
from approximately $6.4 million to approximately $10.9 million. While our margin
decreased to 29.9% in 2003, this decrease resulted from our decision to turn
more of our out-of-season merchandise into cash that could be used to purchase
new inventory, rather than holding it for the next season. Of course, there can
be no assurance that we will be able to continue to leverage these advantages
successfully and enhance their effects on our business.
WAREHOUSING AND FULFILLMENT
When we receive an order, the information is transmitted to our third party
warehouse and fulfillment center located in Virginia, where the items included
in the order are picked, packed and shipped directly to the customer. Our
inventory database is updated on a real-time basis, allowing us to display on
our Web site only those styles, sizes and colors of product available for sale.
We focus on customer satisfaction throughout our organization. In December 2003,
during our peak weeks of the holiday season, the vast majority of our orders
were shipped within one business day from receipt of the customer's order.
CUSTOMER SERVICE
We believe that a high level of customer service and support is critical to
differentiating ourselves from traditional off-price retailers and maximizing
customer acquisition and retention efforts. Our customer service effort starts
with our Web site, which is designed to provide an intuitive shopping
experience. An easy to use help center is available on the Web site and is
designed to answer many of our customers' most frequently asked questions. For
customers who prefer e-mail or telephone assistance, customer service
representatives are available seven days a week to provide assistance. To insure
that customers are satisfied with their shopping experience, we generally allow
returns for any reason within 90 days of the sale for a full refund.
TECHNOLOGY
We have implemented a broad array of state-of-the-art technologies that
facilitate Web site management, complex database search functionality, customer
interaction and personalization, transaction processing, fulfillment and
customer service functionality. Such technologies include a combination of
proprietary technology and commercially available, licensed technology. To
address the critical issues of privacy and security on the Internet, we
incorporate, for transmission of confidential personal information between
customers and our Web server, Secure Socket Layer Technology ("SSL") such that
all data is transmitted via a 128-bit encrypted session.
COMPETITION
Electronic commerce generally, and, in particular, the online retail apparel and
fashion accessories market, is a new, dynamic, high-growth market. Our
competition for online customers comes from a variety of sources, including
existing land-based retailers such as Neiman Marcus, Saks Fifth Avenue, The Gap,
Nordstrom, and Macy's, which are using the Internet to expand
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their channels of distribution, established Internet companies such as
Amazon.com and ebay.com and less established companies such as eLuxury, which
are building their brands online. In addition, our competition for customers
comes from traditional direct marketers such as L.L. Bean, Lands' End, and
J.Crew, television direct marketers such as QVC, and land-based off-price retail
stores, such as T.J. Maxx, Marshalls, Filene's Basement and Loehmanns, 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, site features, and content. Although we believe that we
compare favorably with our competitors, we recognize that this market is
relatively new and is evolving rapidly, and, accordingly, there can be no
assurance that this will continue to be the case.
INTELLECTUAL PROPERTY
We rely on various intellectual property laws and contractual restrictions to
protect our proprietary rights in services and technology, including
confidentiality, invention assignment and nondisclosure agreements with
employees and contractors. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use our intellectual property
without our authorization. In addition, we pursue the registration of our
trademarks and service marks in the U.S. and internationally and the
registration of our domain name and variations thereon. However, effective
intellectual property protection may not be available in every country in which
the services are made available online.
We rely on technologies that we license from third parties. These licenses may
not continue to be available to us on commercially reasonable terms in the
future. As a result, we may be required to obtain substitute technology of lower
quality or at greater cost, which could materially adversely effect our
business, financial condition, results of operations and cash flows.
We do not believe that our business, sales policies or technologies infringe the
proprietary rights of third parties. However, third parties have in the past and
may in the future claim that our business, sales policies or technologies
infringe their rights. We expect that participants in the e-commerce market will
be increasingly subject to infringement claims as the number of services and
competitors in the industry grows. Any such claim, with or without merit, could
be time consuming, result in costly litigation or require us to enter into
royalty or licensing agreements. Such royalty or licensing agreements might not
be available on terms acceptable to us, or at all. As a result, any such claim
of infringement against us could have a material adverse effect upon our
business, financial condition, results of operations and cash flows.
GOVERNMENTAL APPROVALS AND REGULATIONS
We are not currently subject to direct regulation by any domestic or foreign
governmental agency, other than regulations applicable to businesses generally,
and laws or regulations directly applicable to online commerce. We are not aware
of any permits or licenses that are required in order for us, generally, to sell
apparel and fashion accessories on the Internet, although licenses are sometimes
required to sell products made from specific materials. In addition, permits or
licenses may be required from international, federal, state or local
governmental authorities to operate or to sell certain other products on the
Internet in the future. No assurances can be given that we will be able to
obtain such permits or licenses. We may be required to comply with future
national and/or international legislation and statutes regarding conducting
commerce on the Internet in all or specific countries throughout the world. No
assurance can be made that we will be able to comply with such legislation or
statutes. Our Internet operations are not currently impacted by federal, state,
local and foreign environmental protection laws and regulations.
EMPLOYEES
As of February 19, 2004, we had 89 full-time employees and 3 part-time
employees, as compared to 77 full-time and 5 part-time employees as of February
19, 2003. None of our employees are represented by a labor union and we consider
our relations with our employees to be good.
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RISK FACTORS
We Have A History Of Losses And Expect That Losses Will Continue In The Future.
As of December 31, 2003, we had an accumulated deficit of $92,336,000. We
incurred net losses of $6,369,000, $6,479,000 and $25,006,000 for the years
ended December 31, 2003, 2002 and 2001, respectively. We have incurred
substantial costs to develop our Web site and infrastructure. In order to expand
our business, we intend to invest in sales, marketing, merchandising,
operations, information systems, site development and additional personnel to
support these activities. We therefore expect to continue to incur substantial
operating losses for the foreseeable future. Our ability to become profitable
depends on our ability to generate and sustain substantially higher net sales
while maintaining reasonable expense levels, both of which are uncertain. If we
do achieve profitability, we cannot be certain that we would be able to sustain
or increase profitability on a quarterly or annual basis in the future.
We Are Making A Substantial Investment In Our Business And May Need To Raise
Additional Funds. We may need additional financing to effect our business plan.
The environment for raising investment capital has been difficult and there can
be no assurance that additional financing or other capital will be available
upon terms acceptable to us, or at all. In the event that we are unable to
obtain additional financing, if needed, we could be forced to decrease expenses
that we believe are necessary for us to realize on our long-term prospects for
growth and profitability and/or liquidate inventory in order to generate cash.
Moreover, any additional equity financing that we may raise could result in
significant dilution of the existing holders of common stock. See "- Certain
Events Could Result In Significant Dilution Of Your Ownership Of Common Stock."
Our Lenders Have Liens On Substantially All Of Our Assets And Could Foreclose In
The Event That We Default Under Our Loan Facility. Under the terms of our loan
facility (the "Loan Facility"), Rosenthal & Rosenthal, Inc. ("Rosenthal"),
provides us with certain credit accommodations, including loans and advances,
factor-to-factor guarantees, letters of credit in favor of suppliers or factors
and purchases of payables owed to our suppliers. Pursuant to the Loan Facility,
we gave a first priority lien to Rosenthal on substantially all of our assets,
including our cash balances. In connection with the Loan Facility, we entered
into a reimbursement agreement with affiliates of Soros Private Equity Partners,
LLC that collectively own a majority of our capital stock (collectively,
"Soros"), pursuant to which Soros agreed to guarantee a portion of the Loan
Facility, (the "Soros Guarantee") we agreed to reimburse Soros for any amounts
it paid to our lender pursuant to such guarantee and we granted Soros a
subordinated lien on substantially all of our assets, including our cash
balances, in order to secure our reimbursement obligations. If we default under
the Loan Facility, Rosenthal and Soros would be entitled, among other things, to
foreclose on our assets in order to satisfy our obligations under the loan
facility and the reimbursement agreement. In addition, to the extent that Soros
is required to make any payments to Rosenthal under its guarantee of our
obligations under the Loan Facility, we would be required to issue an additional
warrant to Soros, which could result in a significant dilution of your ownership
of our Common Stock. See "- Certain Events Could Result In Significant Dilution
Of Your Ownership Of Our Common Stock."
Our Ability To Comply With Our Financial Covenants and Pay Our Indebtedness
Under Our Loan Facility Is Dependent Upon Meeting Our Business Plan. We are
required to pay interest under our Loan Facility on a monthly basis. In
addition, we are required, under the facility, to maintain working capital of at
least $4 million and net tangible worth of at least $5 million as of the end of
each fiscal year. Assuming we meet our business plan, we will satisfy these
covenants. To a certain extent, however, our ability to meet our business plan,
is subject to general economic, financial, competitive, legislative, regulatory
and other factors that are beyond our control and therefore we cannot assure you
that based on our business plan we will generate sufficient cash flow from
operations to enable us to pay our indebtedness under the Loan Facility and
maintain compliance with our net working capital covenant throughout the term of
the agreement or that we will be able to maintain compliance with the net worth
covenant. If we fall short of our business plan and are unable to raise
additional capital, we could default under our Loan Facility. In the event of a
default under the Loan Facility, Rosenthal and Soros would be entitled, among
other things, to foreclose on our assets (whether inside or outside a bankruptcy
proceeding) in order to satisfy our obligations under the Loan Facility and the
reimbursement agreement. In addition, a default under our Loan Facility could
require us to issue an additional warrant to Soros, which could result in a
significant dilution of your ownership of our common stock. See "Risk Factors -
Our Lenders Have Liens On Substantially All Of Our Assets And Could Foreclose In
The Event That We Default Under Our Loan Facility" and "- Certain Events Could
Result In Significant Dilution of Your Ownership of Our Common Stock."
Certain Events Could Result In Significant Dilution Of Your Ownership Of Our
Common Stock. Stockholders could be
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subject to significant dilution to the extent that we raise additional equity
financing, as a result of both the issuance of additional equity securities, the
potential conversion of the convertible promissory notes described below and the
anti-dilution provisions of our Series B, C, D and E preferred stock described
below, which provide for the issuance of additional securities to the holders
thereof, under certain circumstances, to the extent that the Preferred Stock is
converted at any time after a sale of Common Stock at less than $0.76 per share.
Moreover, as of February 19, 2004, there were outstanding options to purchase
9,102,557 shares of our Common Stock issued under our 1997 and 2000 Stock Option
Plans, warrants to purchase 981,644 shares of our Common Stock issued to Soros,
and additional warrants and options to purchase 723,301 shares of our Common
Stock. In addition, as of such date, our outstanding Preferred Stock was
convertible into an aggregate of 43,323,430 shares of our Common Stock (plus any
shares of our Common Stock issued upon conversion in payment of any accrued and
unpaid dividends). The exercise of our outstanding options and warrants and/or
the conversion of our outstanding Preferred Stock would dilute the then existing
stockholders' percentage ownership of our common stock, and any sales in the
public market of our Common Stock underlying such securities, could adversely
affect prevailing market price of our Common Stock. In the event that all of the
securities described above were converted to Common Stock, the holders of the
Common Stock immediately prior to such conversion would own approximately 21% of
the outstanding Common Stock immediately after such conversion, excluding the
effect of accrued dividends on Preferred Stock.
As described above, our Series B, C, D and E Preferred Stock contain
anti-dilution provisions pursuant to which, subject to certain exceptions, in
the event that we issue or sell our Common Stock or new securities convertible
into our Common Stock in the future for less than $0.76 per share, the number of
shares of our Common Stock to be issued upon the conversion of such Preferred
Stock would be increased to a number equal to the face amount of such Preferred
Stock divided by the price at which such Common Stock or other new securities
are sold.
In addition, Soros owns $4 million of convertible promissory notes issued by us
that bear interest at the rate of 12% per annum and are convertible, at Soros'
option, into our equity securities sold in any subsequent round of financing at
a price that is equal to the lowest price per share accepted by any investor
(including Soros or any of its affiliates) in such subsequent round of
financing.
Moreover, if Rosenthal draws on the Soros Guarantee during the continuance of a
default under the Loan Facility, or if at any time the total amount outstanding
under the Loan Facility exceeds 90% of the undrawn amount of the Soros
Guarantee, we will be required to issue to Soros another warrant (each a
"Contingent Warrant") to purchase a number of shares of Common Stock equal to
the quotient of (a) any amounts drawn under the Soros Guarantee and (b) 75% of
the average closing price of our Common Stock on the ten days preceding the date
of issuance of such warrant. Each Contingent Warrant will be exercisable for ten
years from the date of issuance at an exercise price equal to 75% of the average
closing price of our Common Stock on the ten days after the date of issuance.
Soros Owns A Majority Of Our Stock And Therefore Effectively Controls Our
Management And Policies. As of February 19, 2004, through its holdings of our
common stock, as well as our preferred stock, and warrants convertible into our
common stock, Soros beneficially owned, in the aggregate, approximately 84% of
our common stock. The holders of our preferred stock vote on an "as converted"
basis with the holders of our common stock. By virtue of its ownership of our
preferred stock, Soros has the right to appoint two designees to our Board of
Directors, each of whom has seven votes on any matter voted upon by our Board of
Directors. Collectively, these two designees have 14 out of 20 possible votes on
each matter voted upon by our Board of Directors. In addition, we are required
to obtain the approval of holders of our preferred stock prior to taking certain
actions. The holders of our preferred stock have certain pre-emptive rights to
participate in future equity financings and certain anti-dilution rights that
could result in the issuance of additional securities to such holders. In view
of their large percentage of ownership and rights as the holders of our
preferred stock, Soros effectively controls 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. In addition, Soros has demand
registration rights with respect to the shares of our common stock that it
beneficially owns. Any decision by Soros to exercise such registration rights
and to sell a significant amount of our shares in the public market could have
an adverse effect on the price of our common stock. See "- Certain Events Could
Result In Significant Dilution of Your Ownership Of Common Stock."
If We Are Not Accurate In Forecasting Our Revenues, We May Be Unable To Adjust
Our Operating Plans In A Timely
8
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 "- We
Are Making A Substantial Investment In Our Business And May Need To Raise
Additional Funds" and "- Our Ability To Comply With Our Financial Covenants and
Pay Our Indebtedness Under Our Loan Facility Is Dependent Upon Meeting Our
Business Plan."
Unexpected Changes In Fashion Trends Could Cause Us To Have Either Excess or
Insufficient Inventory. Fashion trends can change rapidly, and our business is
sensitive to such changes. There can be no assurance that we will accurately
anticipate shifts in fashion trends and adjust our merchandise mix to appeal to
changing consumer tastes in a timely manner. If we misjudge the market for our
products or are unsuccessful in responding to changes in fashion trends or in
market demand, we could experience insufficient or excess inventory levels or
higher markdowns, either of which would have a material adverse effect on our
business, financial condition and results of operations.
We Will Be Subject To Cyclical Variations In The Apparel And E-Commerce Markets.
The apparel industry historically has been subject to substantial cyclical
variations. Furthermore Internet usage slows down in the summer months. We and
other apparel vendors rely on the expenditure of discretionary income for most,
if not all, sales. In the first three quarters of 2003, the retail apparel
market experienced sluggish growth, requiring many retailers to significantly
reduce prices and discount merchandise. We lowered our prices during the first
quarter of 2003, in part, as the result of this sluggish growth, and maintained
lower pricing levels in the second and third quarters of 2003 in order to
generate cash from excess out-of-season inventory. While the fourth quarter of
2003 saw a slight improvement in the retail apparel market, any future decrease
in growth rates or downturn, whether real or perceived, in economic conditions
or prospects could adversely affect consumer spending habits and, therefore,
have a material adverse effect on our revenue, cash flow and results of
operations. Alternatively, any improvement, whether real or perceived, in
economic conditions or prospects could adversely impact our ability to acquire
merchandise and, therefore, have a 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 "- We Do Not Have Long Term
Contracts With The Majority Of Our Vendors And Therefore The Availability of
Merchandise Is At Risk."
We Purchase Product From Some Indirect Supply Sources, Which Increases Our Risk
of Litigation Involving The Sale Of Non-Authentic Or Damaged Goods. We purchase
merchandise both directly from brand owners and indirectly from retailers and
third party distributors. The purchase of merchandise from parties other than
the brand owners increases the risk that we will mistakenly purchase and sell
non-authentic or damaged goods which could result in potential liability under
applicable laws, regulations, agreements and orders. Moreover, any claims by a
brand owner, with or without merit, could be time consuming, result in costly
litigation, generate bad publicity for us, and have a material adverse impact on
our business, prospects, financial condition and results of operations.
If Our Co-Location Facility Or Our Third Party Distribution Center Fails, Our
Business Could be Interrupted For A Significant Period Of Time. Our ability to
receive and fulfill orders successfully and provide high-quality customer
service, largely depends on the efficient and uninterrupted operation of our
computer and communications hardware systems and fulfillment center.
Substantially all of our computer and communications hardware is located at a
single co-location facility in New Jersey. Our inventory is held, and our
customer orders are filled, at a third party distribution center located in
Virginia. These operations are vulnerable to damage or interruption from fire,
flood, power loss, telecommunications failure, terrorist attacks, acts of war,
break-ins, earthquake and similar events. We do not presently have redundant
systems in multiple locations or a formal disaster recovery plan. Accordingly, a
failure at one of these facilities could interrupt our business for a
significant period of time, and our business interruption insurance may be
insufficient to compensate us for losses that may occur. Any such interruption
would negatively impact our sales, results of operations and cash flows for the
period in which it occurred, and could have a long-term adverse effect on our
relationships with our customers and suppliers.
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
9
requirement for online commerce and communications is the secure transmission of
confidential information over public networks. There can be no assurance that
advances in computer capabilities, new discoveries in the field of cryptography,
or other events or developments will not result in a compromise or breach of the
algorithms we use to protect customer transaction and personal data contained in
our customer database. A party who is able to circumvent our security measures
could misappropriate proprietary information or cause interruptions in our
operations. If any such compromise of our security were to occur, it could have
a material adverse effect on our reputation with customers, thereby affecting
our long-term growth prospects. In addition, we may be required to expend
significant capital and other resources to protect against such security
breaches or to alleviate problems caused by such breaches.
Brand Owners Could Establish Procedures To Limit Our Ability To Purchase
Products Indirectly. Brand owners have implemented, and are likely to continue
to implement, procedures to limit or control off-price retailers' ability to
purchase products indirectly. In addition, several brand owners in the U.S. have
distinctive legal rights rendering them the only legal importer of their
respective brands into the U.S. If we acquire such product indirectly from
distributors and other third parties who may not have complied with applicable
customs laws and regulations, such goods could be subject to seizure from our
inventory by U.S. Customs Service, and the importer may have a civil action for
damages against us. See "Risk Factors - We Do Not Have Long Term Contracts With
The Majority of Our Vendors And Therefore The Availability Of Merchandise Is At
Risk."
Our Growth May Place A Significant Strain On Our Management And Administrative
Resources And Cause Disruptions In Our Business. Our historical growth has
placed, and any further growth is likely to continue to place, a significant
strain on our management and administrative resources. To be successful, we must
continue to implement information management systems and improve our operating,
administrative, financial and accounting systems and controls. We will also need
to train new employees and maintain close coordination among our executive,
accounting, finance, marketing, merchandising, operations and technology
functions. Any failure to implement such systems and training, and to maintain
such coordination, could affect our ability to plan for, and react quickly to,
changes in our business and, accordingly, could cause an adverse impact on our
cash flow and results of operations in the periods during which such changes
occur. In addition, as our workforce grows, our exposure to potential employment
liability issues increases, and we will need to continue to improve our human
resources functions in order to protect against such increased exposure.
Moreover, our business is dependent upon our ability to expand our third-party
fulfillment operations, customer service operations, technology infrastructure,
and inventory levels to accommodate increases in demand, particularly during the
peak holiday selling season. Our planned expansion efforts in these areas could
cause disruptions in our business. Any failure to expand our third-party
fulfillment operations, customer service operations, technology infrastructure
or inventory levels at the pace needed to support customer demand could have a
material adverse effect on our cash flow and results of operations during the
period in which such failures occur and could have a long-term effect on our
reputation with our customers.
We Are Heavily Dependent On Third-Party Relationships, And Failures By A Third
Party Could Cause Interruptions To Our Business. We are heavily dependent upon
our relationships with our fulfillment operations provider and Web hosting
provider, delivery companies like UPS and the United States Postal Service, and
credit card processing companies such as Paymentech and Cybersource to service
our customers' needs. To the extent that there is a slowdown in mail service or
package delivery services, whether as a result of labor difficulties, terrorist
activity or otherwise, our cash flow and results of operations would be
negatively impacted during such slowdown, and the results of such slowdown could
have a long-term negative effect on our reputation with our customers. The
failure of our fulfillment operations provider, credit card processors or Web
hosting provider to properly perform their services for us could cause similar
effects. Our business is also generally dependent upon our ability to obtain the
services of other persons and entities necessary for the development and
maintenance of our business. If we fail to obtain the services of any such
person or entities upon which we are dependent on satisfactory terms, or we are
unable to replace such relationship, we would have to expend additional
resources to develop such capabilities ourselves, which could have a material
adverse impact on our short-term cash flow and results of operations and our
long-term prospects.
We Are In Competition With Companies Much Larger Than Ourselves. Electronic
commerce generally and, in particular, the online retail apparel and fashion
accessories market, is a new, dynamic, high-growth market and is rapidly
changing and intensely competitive. Our competition for customers comes from a
variety of sources including:
. existing land-based, full price retailers, such as Neiman
Marcus, Saks Fifth Avenue, Nordstrom, The Gap, and Macy's, which
are using the Internet to expand their channels of distribution;
10
. less established companies, such as eLuxury, which are building
their brands online;
. internet sites such as Amazon.com and ebay.com
. traditional direct marketers, such as L.L. Bean, Lands' End and
J. Crew;
. television direct marketers such as QVC; and
. traditional off-price retail stores such as T.J. Maxx,
Marshalls, Ross, Filene's Basement and Loehmanns, which may or
may not use the Internet to grow their customer base.
We expect competition in our industry to intensify and believe that the list of
our competitors will grow. 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;
. site features; and
. content.
There can be no assurance that we will be able to compete successfully against
competitors and future competitors, and competitive pressures faced by us could
force us to increase expenses and/or decrease our prices at some point in the
future.
We Do Not Have Long Term Contracts With The Majority of Our Vendors And
Therefore The Availability Of Merchandise Is At Risk. We have few 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. 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 customer's 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."
We Need To Further Establish Brand Name Recognition. We believe that further
establishing, maintaining and enhancing our brand is a critical aspect of our
efforts to attract and expand our online traffic. The number of Internet sites
that offer competing services, many of which already have well established
brands in online services or the retail apparel industry generally, increases
the importance of establishing and maintaining brand name recognition. Promotion
of Bluefly.com will depend largely on our success in providing a high quality
online experience supported by a high level of customer service, which cannot be
assured. In addition, to attract and retain online users, and to promote and
maintain Bluefly.com in response to competitive pressures, we may find it
necessary to increase substantially our advertising and marketing expenditures.
If we are unable to provide high quality online services or customer support, or
otherwise fail to promote and maintain Bluefly.com, or if we incur excessive
expenses in an attempt to promote and maintain Bluefly.com, our long-term growth
prospects, would be materially adversely affected.
There Can Be No Assurance That Our Technology Systems Will Be Able To Handle
Increased Traffic; Implementation of Changes to Web Site. A key element of our
strategy is to generate a high volume of traffic on, and use of, Bluefly.com.
Accordingly, the satisfactory performance, reliability and availability of
Bluefly.com, transaction processing systems and
11
network infrastructure are critical to our reputation and our ability to attract
and retain customers, as well as maintain adequate customer service levels. Our
revenues will depend on the number of visitors who shop on Bluefly.com and the
volume of orders we can handle. Unavailability of our Web site or reduced order
fulfillment performance would reduce the volume of goods sold and could also
adversely affect consumer perception of our brand name. We may experience
periodic system interruptions from time to time. If there is a substantial
increase in the volume of traffic on Bluefly.com or the number of orders placed
by customers, we will be required to expand and upgrade further our technology,
transaction processing systems and network infrastructure. There can be no
assurance that we will be able to accurately project the rate or timing of
increases, if any, in the use of Bluefly.com or expand and upgrade our systems
and infrastructure to accommodate such increases on a timely basis. In addition,
in order to remain competitive, we must continue to enhance and improve the
responsiveness, functionality and features of Bluefly.com, which is particularly
challenging given the rapid rate at which new technologies, customer preferences
and expectations and industry standards and practices are evolving in the online
commerce industry. Accordingly, we redesign and enhance various functions on our
Web site on a regular basis, and we may experience instability and performance
issues as a result of these changes.
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. 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. We have entered into employment
agreements with each of our executive officers. The employment agreements with
our CEO and CFO/COO expire on June 30, 2005. The employment agreement with our
President expires on March 1, 2007. However, none of these employment agreements
prohibit the executive officer from terminating his or her employment with us in
order to pursue a more attractive opportunity and, to the extent that we do not
successfully implement our plans, other opportunities may appear more
attractive. The loss of the services of any of our executive officers could have
a material adverse effect on our credibility in the vendor communities and our
ability to recruit new key operating personnel.
Our Success Is Dependent Upon Our Ability To Attract New Key Personnel. Our
operations will also depend to a great extent on our ability to attract new key
personnel with relevant experience and retain existing key personnel in the
future. The market for qualified personnel is extremely competitive. Our failure
to attract additional qualified employees could have a material adverse effect
on our prospects for long-term growth.
There Are Inherent Risks Involved In Expanding Our Operations. We may choose to
expand our operations by developing new Web sites, promoting new or
complementary products or sales formats, expanding the breadth and depth of
products and services offered, expanding our market presence through
relationships with third parties, adopting non-Internet based channels for
distributing our products, or consummating acquisitions or investments.
Expansion of our operations in this manner would require significant additional
expenses and development, operations and editorial resources and would strain
our management, financial and operational resources. For example, we have
historically expended significant internal resources in connection with the
redesign of our Web site and the implementation of our online strategic
alliances, and we expect to devote significant manpower to the launch of our
storefront on Amazon.com. Moreover, in the event that we expand upon our efforts
to open brick-and-mortar outlet stores, we will be required to devote
significant internal resources and capital to such efforts. There can be no
assurance that we would be able to expand our efforts and operations in a
cost-effective or timely manner or that any such efforts would increase overall
market acceptance. Furthermore, any new business or Web site that is not
favorably received by consumer or trade customers could damage our reputation.
We May Be Liable For Infringing The Intellectual Property Rights Of Others.
Third parties may assert infringement claims against us. From time to time in
the ordinary course of business we have been, and we expect to continue to be,
subject to claims alleging infringement of the trademarks and other intellectual
property rights of third parties. These claims and any resulting litigation, if
it occurs, could subject us to significant liability for damages. In addition,
even if we prevail, litigation could be time-consuming and expensive and could
result in the diversion of our time and attention. Any claims from third parties
may also result in limitations on our ability to use the intellectual property
subject to these claims unless we are able to enter into agreements with the
third parties making these claims.
12
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 the Company in excess of our insurance
coverage, it could have a material adverse effect on our cash flow and on our
reputation with customers. Unsuccessful claims could result in the expenditure
of funds and management time and could have a negative impact on our business.
We Cannot Guarantee The Protection Of Our Intellectual Property. Our
intellectual property is critical to our success, and we rely on trademark,
copyright, domain names and trade secret protection to protect our proprietary
rights. Third parties may infringe or misappropriate our trademarks or other
proprietary rights, which could have a material adverse effect on our business,
prospects, results of operations or financial condition. While we enter into
confidentiality agreements with our employees, consultants and strategic
partners and generally control access to and distribution of our proprietary
information, the steps we have taken to protect our proprietary rights may not
prevent misappropriation. We are pursuing registration of various trademarks,
service marks and domain names in the United States and abroad. Effective
trademark, copyright and trade secret protection may not be available in every
country, and there can be no assurance that the United States or foreign
jurisdictions will afford us any protection for our intellectual property. There
also can be no assurance that any of our intellectual property rights will not
be challenged, invalidated or circumvented. In addition, we do not know whether
we will be able to defend our proprietary rights since the validity,
enforceability and scope of protection of proprietary rights in Internet-related
industries is uncertain and still evolving. Moreover, even to the extent that we
are successful in defending our rights, we could incur substantial costs in
doing so.
Our Business Could Be Harmed By Consumers' Concerns About The Security of
Transactions Over the Internet. Concerns over the security of transactions
conducted on the Internet and commercial online services, the increase in
identity theft and the privacy of users may also inhibit the growth of the
Internet and commercial online services, especially as a means of conducting
commercial transactions. Moreover, although we have developed systems and
processes that are designed to protect consumer information and prevent
fraudulent credit card transactions and other security breaches, failure to
mitigate such fraud or breaches could have a material adverse effect on our
business, prospects, financial condition and results of operations.
We Face Legal Uncertainties Relating To The Internet In General and To Our
Industry In Particular And May Become Subject To Costly Government Regulation.
We are not currently subject to direct regulation by any domestic or foreign
governmental agency, other than regulations applicable to businesses generally,
and laws or regulations directly applicable to online commerce. However, it is
possible that laws and regulations may be adopted that would apply to the
Internet and other online services. Furthermore, the growth and development of
the market for online commerce may prompt calls for more stringent consumer
protection laws that may impose additional burdens on those companies conducting
business online. The adoption of any additional laws or regulations may increase
our cost of doing business and/or decrease the demand for our products and
services and increase our cost of doing business.
The applicability to the Internet of existing laws in various jurisdictions
governing issues such as property ownership, sales and other taxes, libel and
personal privacy is uncertain and may take years to resolve. Any such new
legislation or regulation, the application of laws and regulations from
jurisdictions whose laws do not currently apply to our business, or the
application of existing laws and regulations to the Internet and online commerce
could also increase our cost of doing business. In addition, if we were alleged
to have violated federal, state or foreign, civil or criminal law, we could face
material liability and damage to our reputation and, even if we successfully
defend any such claim, we incur significant costs in connection with such
defense.
We Face Uncertainties Relating To Sales And Other Taxes. We are not currently
required to pay sales or other similar taxes in respect of shipments of goods
into states other than Virginia, New Jersey and New York. However, one or more
states may seek to impose sales tax collection obligations on out-of-state
companies such as our company that engage in online commerce. In addition, any
new operation in states outside Virginia, New Jersey and New York could subject
shipments into such states to state sales taxes under current or future laws. A
successful assertion by one or more states or any foreign country that the sale
of merchandise by us is subject to sales or other taxes, could subject us to
material liabilities and, to the extent that we pass such costs on to our
customers, could decrease our sales.
Change Of Control Covenant And Liquidation Preference of Preferred Stock. We
have agreed with Soros, that for so long as any shares of their Preferred Stock
are outstanding, we will not take any action to approve or otherwise facilitate
any merger,
13
consolidation or change of control, unless provisions have been made for the
holders of such Preferred Stock to receive from the acquirer an amount in cash
equal to the respective aggregate liquidation preferences of such Preferred
Stock. The aggregate liquidation preference of the Preferred Stock is equal to
the greater of (i) approximately $48,300,000 (plus any accrued and unpaid
dividends) and (ii) the amount that the holders of shares of Preferred Stock
would receive if they were to convert such shares of Common Stock immediately
prior to liquidation.
The Holders Of Our Common Stock May Be Adversely Affected By The Rights Of
Holders Of Preferred Stock That May Be Issued In The Future. Our certificate of
incorporation and by-laws, as amended, contain certain provisions that may
delay, defer or prevent a takeover. Our Board of Directors has the authority to
issue up to 15,486,250 additional shares of preferred stock, and to determine
the price, rights, preferences and restrictions, including voting rights, of
those shares, without any further vote or action by the stockholders.
Accordingly, our Board of Directors is empowered, without approval of the
holders of Common Stock, to issue preferred stock, for any reason and at any
time, with such rates of dividends, redemption provisions, liquidation
preferences, voting rights, conversion privileges and other characteristics as
they may deem necessary. 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.
Forward-Looking Statements and Associated Risks. This Annual Report contains
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Forward-looking statements include, without limitation, any statement that may
predict, forecast, indicate, or imply future results, performance, or
achievements, and may contain the words "believe," "anticipate," "expect,"
"estimate," "project," "will be," "will continue," "will likely result," or
words or phrases of similar meaning. Forward-looking statements involve risks
and uncertainties that may cause actual results to differ materially from the
forward-looking statements ("Cautionary Statements"). The risks and
uncertainties include, but are not limited to those matters addressed herein
under "Risk Factors." All subsequent written and oral forward-looking statements
attributable to the Company or persons acting on the Company's 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. The Company undertakes no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
ITEM 2. PROPERTIES
We lease approximately 26,000 square feet of office space in New York City. The
property is in good operating condition. The lease expires in 2010. Our total
lease expense for the current office space during 2003 were approximately
$427,000.
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.
In October 2002, the Company commenced an action against Breider Moore & Co.,
LLC ("Breider Moore") and Joseph Breider in the Supreme Court of the State of
New York, County of New York, as a result of Breider Moore's failure to
consummate an agreed upon investment in the Company in connection with a June
2002 Soros investment. Breider Moore had committed to invest approximately $7
million on the same terms and conditions as those that applied to Soros'
investment. However, this investment was not consummated. In the action, we
asserted breach of contract claim against Breider Moore, fraud claims against
Breider Moore and Mr. Breider and a piercing the corporate veil claim against
Mr. Breider. In February 2003, we obtained summary judgment on our breach of
contract claim, and our piercing the corporate veil claim was dismissed. One of
our fraud claims is still pending and one has been dismissed. Given that we had
been granted summary judgment on the breach of contract claim, an evidentiary
hearing on our damages was held before a special referee in May 2003. In July
2003, the special referee recommended that we be awarded damages in the amount
of approximately $3.3 million for our breach of contract claim against Breider
Moore. On December 2, 2003, the court entered judgment in our favor against
Breider Moore in the amount of $3,793,688. We do not know what assets, if any,
Breider Moore has and whether we will be able to collect on the judgment. We are
currently trying to ascertain the location of assets owned by Breider Moore and
it may be necessary for us to commence collection proceedings in connection with
our efforts to collect on any such judgment, and, given the substantial costs
involved with such litigation, there can be no assurance that the amount that we
would be able to collect with respect to any such judgment would exceed the
costs associated with obtaining and executing on such judgment.
14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's common stock, par value $.01 per share ("Common Stock"), is quoted
on The Nasdaq SmallCap Market and the Boston Stock Exchange. The following table
sets forth the high and low bid prices for the Common Stock for the periods
indicated, as reported by the Nasdaq SmallCap Market:
Fiscal 2003 High Low
-------------- ------ ------
First Quarter $ 1.69 $ 0.67
Second Quarter $ 1.60 $ 0.72
Third Quarter $ 1.80 $ 0.76
Fourth Quarter $ 5.96 $ 1.20
Fiscal 2002 High Low
-------------- ------ ------
First Quarter $ 2.24 $ 1.27
Second Quarter $ 1.93 $ 1.07
Third Quarter $ 1.30 $ 0.55
Fourth Quarter $ 1.74 $ 0.62
HOLDERS
As of February 19, 2004, there were approximately 114 holders of record of the
Common Stock. We believe that there were more than 5,000 beneficial holders of
the Common Stock as of such date.
DIVIDENDS
We have never declared or paid cash dividends on our Common Stock. 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.
15
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
EQUITY COMPENSATION PLAN INFORMATION (as of December 31, 2003)
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
FUTURE ISSUANCE UNDER
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING (excluding securities
OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND reflected in column (a))
PLAN CATEGORY WARRANTS AND RIGHTS(a) RIGHTS (b) (b)
- ------------------------------- ---------------------------- ---------------------------- -------------------------
Equity compensation plans
approved by security holders 7,184,468 $ 2.17 3,270,508
Equity compensation plans not
approved by security holders 1,323,902 $ 1.34 65,110
Total 8,508,370 $ 2.04 3,335,618
The following is a summary of the material provisions of the Bluefly, Inc. 2000
Plan Stock Option Plan (the "2000 Plan"), our only equity compensation plan that
has not been approved by our stockholders.
Eligibility. Key employees of the Company who are not officers or directors of
the Company and its affiliates and consultants to the Company are eligible to be
granted options.
Administration of the 2000 Plan. The Option Plan/Compensation Committee
administers the 2000 Plan. The Option Plan/Compensation Committee has the full
power and authority, subject to the provisions of the 2000 Plan, to designate
participants, grant options and determine the terms of all options. The 2000
Plan provides that no participant may be granted options to purchase more than
1,000,000 shares of Common Stock in a fiscal year. The Option Plan/Compensation
Committee is required to make adjustments with respect to options granted under
the 2000 Plan in order to prevent dilution or expansion of the rights of any
holder. The 2000 Plan requires that the Option Plan/Compensation Committee be
composed of at least two directors.
Amendment. The 2000 Plan may be wholly or partially amended or otherwise
modified, suspended or terminated at any time or from time to time by the Board
of Directors, but no amendment without the approval of our stockholders shall be
made if stockholder approval would be required under any law or rule of any
governmental authority, stock exchange or other self-regulatory organization to
which we are subject. Neither the amendment, suspension or termination of the
2000 Plan shall, without the consent of the holder of an option under the 2000
Plan, alter or impair any rights or obligations under any option theretofore
granted.
Options Issued Under 2000 Plan. The Option Plan/Compensation Committee
determines the term and exercise price of each option under the 2000 Plan and
the time or times at which such option may be exercised in whole or in part, and
the method or methods by which, and the form or forms in which, payment of the
exercise price may be paid.
Upon the exercise of an option under the 2000 Plan, the option holder shall pay
us the exercise price plus the amount of the required federal and state
withholding taxes, if any. The 2000 Plan also allows participants to elect to
have shares withheld upon exercise for the payment of withholding taxes.
16
The unexercised portion of any option granted to a key employee under the 2000
Plan generally will be terminated (i) 30 days after the date on which the
optionee's employment is terminated for any reason other than (a) Cause (as
defined in the 2000 Plan), (b) retirement or mental or physical disability, or
(c) death; (ii) immediately upon the termination of the optionee's employment
for Cause; (iii) three months after the date on which the optionee's employment
is terminated by reason of retirement or mental or physical disability; or (iv)
(A) 12 months after the date on which the optionee's employment is terminated by
reason of his death or (B) three months after the date on which the optionee
shall die if such death occurs during the three-month period following the
termination of the optionee's employment by reason of retirement or mental or
physical disability. The Option Plan/Compensation Committee has in the past, and
may in the future, extend the period of time during which an optionee may
exercise options following the termination of his or her employment.
Under the 2000 Plan, an option generally may not be transferred by the optionee
other than by will or by the laws of descent and distribution. During the
lifetime of an optionee, an option under the 2000 Plan may be exercised only by
the optionee or, in certain instances, by the optionee's guardian or legal
representative, if any.
RECENT SALE OF UNREGISTERED SECURITIES
JANUARY 2004
On January 12, 2004, we completed the New Financing pursuant to which we raised
$5,000,000 from a group of investors led by Redwood Grove Capital Management,
LLC, a California-based private equity firm. Under the terms of the deal, we
issued 1,543,209 shares of common stock at $3.24 per share, which was 90% of the
trailing five-day average of the Company's volume-weighted stock price as of
December 29, 2003, the date that a preliminary agreement was reached as to the
pricing of the deal. We also issued the new investors warrants to purchase
385,801 shares of common stock at any time during the next five years at an
exercise price equal to $3.96 per share. We agreed to file a registration
statement with the Securities and Exchange Commission on behalf of these new
investors within 30 days of the closing, in order to register the common stock
issued as well as the common stock underlying the warrants, and to use
commercially reasonable efforts to have such registration statement declared
effective within 90 days of the closing. We also agreed to certain liquidated
damages provisions to the extent that we do not meet these deadlines. A
registration statement was filed on January 16, 2004, but has not yet been
declared effective. We paid Enable Capital, LLC and Broadband Capital Management
finders fees of $194,000 and $100,000, respectively, in consideration for their
roles in introducing us to the participants in the New Financing.
The above-described sales were deemed to be exempt from registration under the
Securities Act of 1933, as amended (the "Securities Act"), pursuant to Section
4(2) of the Securities Act.
17
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with the consolidated financial statements and the notes thereto and the
information contained in Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Historical results are not
necessarily indicative of future results. All data is in thousands, except share
data:
Year Ended December 31,
----------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Statement of Operations Data:
Net sales $ 37,928 $ 30,606 $ 22,950 $ 17,512 $ 5,109
Cost of sales 26,603 20,571 15,954 14,018 4,554
------------ ------------ ------------ ------------ ------------
Gross profit 11,325 10,035 6,996 3,494 555
Selling, marketing and fulfillment expenses 12,197 11,547 13,765 18,797 10,794
General and administrative expenses 5,103 4,686 5,098 5,296 3,450
------------ ------------ ------------ ------------ ------------
Total operating expenses 17,300 16,233 18,863 24,093 14,244
Operating loss (5,975) (6,198) (11,867) (20,599) (13,689)
Interest (expense)/other income (394) (281) (13,139) (510) 430
Loss from continuing operations (6,369) (6,479) (25,006) (21,109) (13,257)
Net loss (6,369) (6,479) (25,006) (21,109) (13,194)
Basic and diluted loss from continuing operations
per share $ (0.88) $ (2.44) $ (3.41) $ (4.45) $ (2.83)
Basic and diluted loss per share: $ (0.88) $ (2.44) $ (3.41) $ (4.45) $ (2.82)
Basic and diluted weighted average number of
common shares outstanding available to common
stockholders 11,171,018 9,927,027 8,185,065 4,924,906 4,802,249
Balance Sheet Data:
As of December 31,
----------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Cash $ 7,721 $ 1,749 $ 5,419 $ 5,350 $ 7,934
Inventories, net 11,340 10,868 6,388 7,294 7,020
Other current assets 1,863 1,159 1,417 1,510 739
Total assets 22,998 16,595 14,572 15,674 16,768
Current liabilities 8,459 7,072 5,988 5,937 6,182
Short-term convertible notes payable, net - - - 19,698 -
Long term liabilities 4,260 2,439 182 - -
Redeemable preferred stock - - - 11,088 10,286
Shareholders' equity (deficit) 10,279 7,084 8,402 (21,049) 300
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis of our financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties. We have based these forward-looking statements on our current
expectations and projections of future events. However, our actual results could
differ materially from those discussed herein as a result of the risks that we
face, including but not limited to those risks stated in "Risk Factors," or
faulty assumptions on our part. In addition, the following discussion should be
read in conjunction with the audited consolidated financial statements and the
related notes thereto included elsewhere in this report.
OVERVIEW
Bluefly, Inc., a Delaware corporation, is a leading Internet retailer of
designer fashions and home accessories at outlet store prices. We sell over 350
brands of designer apparel, accessories and home products at discounts up to 75%
off retail value. Bluefly.com, a Web site that sells end-of-season and excess
inventory of apparel and accessories, was launched in September 1998.
We have grown significantly since launching our Web site in September 1998. Our
net sales increased approximately 24% to $37,928,000 for the year ended December
31, 2003 from $30,606,000 for the year ended December 31, 2002. In the fourth
quarter of 2003, our net sales increased by approximately 42% to $13,993,000
from $9,856,000 in the fourth quarter of 2002. Net sales attributable to the
Company's Manhattan holiday clearance store, which opened in late November, were
approximately $465,000.
In the fourth quarter of 2003, we achieved our first ever quarterly net profit.
For the fourth quarter of 2003, we had net income of $111,000 as compared to a
net loss of $1,660,000 in the fourth quarter of 2002. The Manhattan holiday
clearance store, in part, contributed to our profitability in the fourth quarter
of 2003. Our net loss for the year ended December 31, 2003 decreased by
approximately 2% to $6,369,000 from $6,479,000 for the year ended 2002. Despite
our net profit during the fourth quarter of 2003, we expect to operate at a net
loss in 2004.
Our gross margin decreased to 29.9% in 2003 from 32.8% in 2002 and 30.5% in
2001. The decrease in 2003 was driven by our decision to turn more of our
out-of-season merchandise, as well as inventory items that we were particular
deep in, into cash that could be used to purchase new inventory, rather than
holding the inventory for the next season. Given our stronger balance sheet, we
believe that we can improve upon our 2003 margin levels in 2004, although there
is no assurance that we will be successful in doing so.
Our customer acquisition costs decreased to $10.22 per customer in 2003, from
$17.04 per customer in 2002 and $39.32 per customer in 2001. We believe that it
may be prudent to increase our customer acquisition costs in 2004 and beyond in
order to acquire larger numbers of customers with profitable ordering patterns.
Our reserve for returns and credit card chargebacks increased to 37% in 2003
from 36% in 2002 and 32% in 2001. The increase in return rates has primarily
been driven by shifts in our merchandise mix towards products that generate
higher return rates, but also higher gross margins and average order sizes.
While we are testing initiatives to reduce our return rates, we believe that the
overall shift in merchandise mix has been beneficial to the overall gross profit
realized per order. Accordingly, we do not expect return rates to decrease to
2001 levels in the near term.
Our inventory levels increased to approximately $11.3 million as of December 31,
2003, from approximately $10.9 million as of December 31, 2002 and approximately
$6.4 million as of December 31, 2001. We believe that we were underinvested in
inventory as of December 31, 2001 as a result of the limitations on our working
capital at that time, and that the heavier investment that we made in inventory
during 2002 was a key factor in our sales growth during both 2002 and 2003.
Historically, due to our limited working capital, a number of our suppliers
limited our payment terms and, in some cases, required us to pay for merchandise
in advance of delivery. The effect of this has been to further limit our working
capital and to increase our usage of the factoring agreement included in the
Loan Facility. Given our stronger balance sheet, we have recently been able to
improve our payment terms with many suppliers, and we intend to continue to seek
to improve these terms during 2004. Of course, there can be no assurance that we
will be successful in these efforts.
19
At December 31, 2003, we had an accumulated deficit of $92,336,000. The net
losses and accumulated deficit resulted primarily from the costs associated with
developing and marketing our Web site and building our infrastructure. In order
to expand our business, we intend to invest in sales, marketing, merchandising,
operations, information systems, site development and additional personnel to
support these activities. We therefore expect to continue to incur substantial
operating losses for the foreseeable future. Although we have experienced
revenue growth in recent years, this growth may not be sustainable and therefore
should not be considered indicative of future performance.
CRITICAL ACCOUNTING POLICIES
Management Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods. The
most significant estimates and assumptions relate to the adequacy of the
allowances for sales returns and recoverability of inventories. Actual amounts
could differ significantly from these estimates.
Revenue Recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin
("SAB") No. 101 "Revenue Recognition in the Financial Statements", as amended.
Gross sales consists primarily of revenue from product sales and shipping and
handling charges and is net of promotional discounts. Net sales represent gross
sales, less provisions for returns, credit card chargebacks, and adjustments for
uncollected sales taxes. Revenue is recognized when all the following criteria
are met:
. A customer executes an order via our website.
. 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.
Shipping and handling billed to customers are classified as revenue in
accordance with Financial Accounting Standards Board ("FASB") Task Force's
Emerging Issues Task Force ("EITF") No. 00-10, "Accounting for Shipping and
Handling Fees and Costs" ("EITF No. 00-10").
Provision for Returns and Doubtful Accounts
We generally permit returns for any reason within 90 days of the sale.
Accordingly, we establish a reserve for estimated future returns and bad debt at
the time of shipment based primarily on historical data. We perform credit card
authorizations and check the verification of our customers prior to shipment of
merchandise. However, our future return and bad debt rates could differ from
historical patterns, and, to the extent that these rates increase significantly,
it could have a material adverse effect on our business, prospects, cash flows,
financial condition and results of operations.
Inventory Valuation
Inventories, which consist of finished goods, are stated at the lower of cost or
market value. Cost is determined by the first-in, first-out ("FIFO") method. We
review our inventory levels in order to identify slow-moving merchandise and in
some instances use markdowns below cost to clear merchandise. Markdowns below
cost may be used if inventory exceeds customer demand for reasons of style,
changes in customer preference or lack of consumer acceptance of certain items,
or if it is determined that the inventory in stock will not sell at its
currently marked price. Such markdowns may have an adverse impact on earnings,
depending on the extent of the markdowns and amount of inventory affected.
20
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 in the period that included the enactment date. We have
assessed the future taxable income and determined that a 100% deferred tax
valuation allowance is deemed necessary. In the event that we were to determine
that we would be able to realize our deferred tax assets, an adjustment to the
deferred tax valuation allowance would increase income in the period such
determination is made.
RESULTS OF OPERATIONS
The following table sets forth our statement of operations data for the years
ended December 31st. All data is in thousands except as indicated below:
2003 2002 2001
-------------------- -------------------- --------------------
As a % of As a % of As a % of
Net Sales Net Sales Net Sales
Net sales $ 37,928 100.0% $ 30,606 100.0% $ 22,950 100.0%
Cost of sales 26,603 70.1% 20,571 67.2% 15,954 69.5%
-------- -------- --------
Gross profit 11,325 29.9% 10,035 32.8% 6,996 30.5%
Selling, marketing and fulfillment expenses 12,197 32.2% 11,547 37.7% 13,765 59.9%
General and administrative expenses 5,103 13.5% 4,686 15.3% 5,098 22.2%
-------- -------- --------
Total operating expenses 17,300 45.7% 16,233 53.0% 18,863 82.1%
Operating loss (5,975) (15.8)% (6,198) (20.2)% (11,867) (51.6)%
Interest (expense) other income (394) (1.0)% (281) (0.9)% (13,139) (57.3)%
-------- -------- --------
Net loss $ (6,369) (16.8)% $ (6,479) (21.1)% $(25,006) (108.9)%
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:
2003 2002 2001
---------- ---------- ----------
Average Order Size (including shipping & handling) $ 174.99 $ 167.20 $ 143.71
Average Order Size Per New Customer (including shipping & handling) $ 158.38 $ 149.74 $ 127.41
Average Order Size Per Repeat Customer (including shipping & handling) $ 184.95 $ 177.31 $ 156.85
Total Customers 512,948 388,700 287,637
Customers Added during the Year 124,248 101,063 102,397
Revenue from Repeat Customers as a % of total Revenue 66% 67% 60%
Customer Acquisition Costs $ 10.22 $ 17.04 $ 39.32
We define a "repeat customer" as a person who has bought more than once from us
during their lifetime. We calculate customer acquisition cost by dividing total
advertising expenditures (excluding staff related costs) during a given time
period by total new customers added during that period. All measures of the
number of customers are based on unique email addresses.
21
FOR THE YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED DECEMBER 31,
2002
Net sales: Gross sales for the year ended December 31, 2003 increased by
approximately 27% to $60,279,000, from $47,491,000 for the year ended December
31, 2002. For the year ended December 31, 2003, we recorded a provision for
returns and credit card chargebacks and other discounts of $22,351,000, or
approximately 37% of gross sales. For the year ended December 31, 2002, the
provision for returns and credit card chargebacks and other discounts was
$16,885,000, or approximately 36% of gross sales. The increase in this provision
as a percentage of gross sales was related primarily to an increase in the
return rate. We believe that the increase in return rate was partly the result
of a shift in our merchandise mix towards certain product categories that
historically have generated higher return rates, but also higher gross margins
and average order size.
After the necessary provisions for returns, credit card chargebacks and
adjustments for uncollected sales taxes, our net sales for the year ended
December 31, 2003 were $37,928,000. This represents an increase of approximately
24% compared to the year ended December 31, 2002, in which net sales totaled
$30,606,000. The growth in net sales was largely driven by the increase in the
numbers of new customers acquired (approximately 23% higher than the full year
2002) and the increase in gross average order size (approximately 5% higher than
the full year 2002). In addition, our shipping and handling revenue increased as
we raised our standard shipping rate from $5.95 per order to $7.95 per order in
the first quarter of 2003. For the year ended December 31, 2003 revenue from
shipping and handling (which is included in net sales) increased by 44% to
$2,939,000 from $2,048,000 for the year ended December 31, 2002.
Cost of sales: Cost of sales consists of the cost of product sold to customers,
in-bound and out-bound shipping costs, inventory reserves, commissions and
packing materials. Cost of sales for the year ended December 31, 2003 totaled
$26,603,000, resulting in gross margin of approximately 30%. Cost of sales for
the year ended December 30, 2002 totaled $20,571,000, resulting in gross margin
of 33%. Gross profit increased by 13%, to $11,325,000 for the year ended
December 31, 2003, compared to $10,035,000 for the year ended December 31, 2002.
The decrease in gross margin resulted primarily from our decision to reduce our
product margin during the first three quarters of 2003 on certain merchandise in
an effort to reduce prior season inventory levels. The increase in gross profit
is related to the increase in net sales on an absolute basis.
Selling, marketing and fulfillment expenses: Selling, marketing and fulfillment
expenses increased by approximately 6% for the year 2003 compared to the year
ended 2002. As a percentage of net sales, our selling, marketing and fulfillment
expenses decreased to 32% in 2003 from approximately 37.7% in 2002. The decrease
resulted primarily from refinements to our marketing strategy that allowed us to
better target potential new customers and convert repeat customers, as well as
the cost savings we derived from our move to a new web hosting facility.
Selling, marketing and fulfillment expenses were comprised of the following:
Year Ended Year Ended Percentage Difference
December 31, 2003 December 31, 2002 increase (decrease)
----------------- ----------------- ---------------------
Marketing $ 1,898,000 $ 2,274,000 (16.5)%
Operating 5,349,000 4,534,000 18.0%
Technology 3,430,000 3,552,000 (3.4)%
E-Commerce 1,520,000 1,187,000 28.1%
----------------- -----------------
$ 12,197,000 $ 11,547,000 5.6%
Marketing expenses include expenses related to online and print advertising,
direct mail campaigns as well as staff related costs. The decrease in marketing
expenses of approximately 17% was largely related to a shift in our customer
acquisition strategy. We reduced our advertising expenditures and focused more
on email, affiliate programs and other performance based programs. Primarily as
a result of this shift, we were able to decrease our customer acquisition costs
for the year ended December 31, 2003 by approximately 40% to $10.22 per new
customer from $17.04 per new customer for the year ended December 31, 2002.
However, in the event that we attempt to accelerate revenue growth, it may be
necessary to utilize less cost efficient methods of customer acquisition, and
accordingly there can be no assurance that customer acquisition costs will not
increase in the future.
Operating expenses include all costs related to inventory management,
fulfillment, customer service, credit card processing and during the fourth
quarter of 2003, the costs associated with the Company's Manhattan holiday
clearance store. Operating expenses increased in 2003 by approximately 18%
compared to 2002 as a result of variable costs associated with the increased
sales volume (e.g., picking and packing orders, processing returns and credit
card fees).
22
Technology expenses consist primarily of Web site hosting and staff related
costs. For the year ended December 31, 2003, technology expenses decreased by
approximately 3% compared to the year ended December 31, 2002. This decrease was
related to a decrease in overall web hosting costs offset by accelerated
depreciation of equipment acquired under a capital lease due to a change in the
estimated useful life, along with increased amortization expense incurred as a
result of capitalized costs incurred in connection with the upgraded version of
the Web Site. Depreciation and amortization for the year ended December 31, 2003
represented approximately 40% of the total technology expense, while
depreciation and amortization for the year ended December 31, 2002 represented
approximately 17% of the total technology expense. These amounts were partially
offset by a reduction of approximately 61% in our Web Site hosting costs in
connection with our move to a new web hosting facility.
E-Commerce expenses include expenses related to our photo studio, image
processing, and Web Site design. For the year ended December 31, 2003, this
amount increased by approximately 28% as compared to the year ended December 31,
2002, primarily due to the creation of an Online Retail Group within the
E-Commerce department. The department employed an average of 17 employees per
month in 2003, compared to an average of 13 per month in 2002. The Online Retail
Group is, among other things, responsible for leveraging the Web Site technology
to improve the on-site customer experience. In September 2003, we launched a
redesigned Web Site. The redesigned Web Site provides a new look and, we
believe, more intuitive navigation. The costs of the new site were primarily
included in E-Commerce and expensed as incurred.
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, 2003 increased by approximately 9% to $5,103,000 as compared to
$4,686,000 for the year ended December 31, 2002. As a percentage of net sales,
general and administrative expenses decreased to 13.5% in 2003 from 15.3% in
2002. The increase in general and administrative expenses was the result of
increased salary and benefit expenses of approximately 7% as well as an increase
in professional fees of 50%.
Loss from operations: Operating loss decreased by approximately 4% in 2003, to
$5,975,000 from $6,198,000 in 2002 as a result of the increase in sales and
gross margin dollars and decreases in selling, marketing and fulfillment
expenses and general and administrative expenses as a percentage of net sales.
Interest expense and other income, net: Interest expense for the year ended
December 31, 2003 totaled $432,000, and related to fees paid in connection with
our Loan Facility, amortization of warrants issued in connection with the
January 2003 Financing, and interest on the notes issued in connection with the
July 2003 Financing. For the year ended December 31, 2002, interest expense
totaled $349,000, and related primarily to fees paid in connection with the Loan
Facility.
Interest income for the year ended December 31, 2003 decreased to $38,000 from
$68,000 for the year ended December 31, 2002. The decrease is related to the
decrease in our cash balance as interest income primarily represents interest
earned on our cash balance.
FOR THE YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31,
2001
Net sales: Gross sales for the year ended December 31, 2002 increased by
approximately 40% to $47,491,000, from $33,833,000 for the year ended December
31, 2001. For the year ended December 31, 2002, we recorded a provision for
returns and credit card chargebacks and other discounts of $16,885,000, or
approximately 36% of gross sales. For the year ended December 31, 2001, the
provision for returns and credit card chargebacks and other discounts was
$10,883,000, or approximately 32% of gross sales. The increase in this provision
as a percentage of gross sales was related primarily to an increase in the
return rate. We believe that the increase in return rate was partly the result
of a shift in our merchandise mix towards certain product categories that
historically have generated higher return rates, but also higher gross margins
and average order size. Accordingly, we believe that this shift had a positive
impact on our per order economics. For the year ended December 31, 2002, revenue
from shipping and handling (which is included in net sales) increased by
approximately 19% to $2,048,000 from $1,724,000 for the year ended December 31,
2001.
After the necessary provisions for returns, credit card chargebacks and
adjustments for uncollected sales taxes, our net sales for the year ended
December 31, 2002 were $30,606,000. This represents an increase of approximately
33% compared to the year ended December 31, 2001, in which net sales totaled
$22,950,000. The growth in net sales was largely driven by the increases in
average order size and sales to repeat customers. We believe that the decrease
in the amount of advertising directed at potential customers
23
(as opposed to existing customers) contributed to the fact that the number of
new customers acquired in 2002 decreased by 1% from that of 2001. We believe
that the increase in sales to repeat customers (67% of total sales in 2002,
compared to 60% of total sales in 2001) was the result of increased marketing
efforts to repeat customers.
Cost of sales: Cost of sales for the year ended December 31, 2002 totaled
$20,571,000, resulting in gross margin of approximately 33%. Cost of sales for
year ended December 30, 2001 totaled $15,954,000, resulting in gross margin of
30.5%. Gross profit increased by 43%, to $10,035,000 for the year ended December
31, 2002 compared to $6,996,000 for the year ended December 31, 2001. The
increase in gross margin resulted primarily from improved product margins.
Selling, marketing and fulfillment expenses: Selling, marketing and fulfillment
expenses decreased by approximately 16.1% for the year 2002 compared to the year
ended 2001. As a percentage of net sales, our selling, marketing and fulfillment
expenses decreased to 37.7% in 2002 from approximately 60% in 2001. The decrease
resulted primarily from a more targeted marketing strategy aimed at our existing
customer base and the cost savings we derived from our move to a new web hosting
facility. Selling, marketing and fulfillment expenses were comprised of the
following:
Year Ended Year Ended Percentage Difference
December 31, 2002 December 31, 2001 increase (decrease)
----------------- ----------------- ---------------------
Marketing $ 2,274,000 $ 4,858,000 (53.2)%
Operating 4,534,000 3,939,000 15.1%
Technology 3,552,000 3,733,000 (4.8)%
E-Commerce 1,187,000 1,235,000 (3.9)%
----------------- -----------------
$ 11,547,000 $ 13,765,000 (16.1)%
The decrease in marketing expenses of approximately 53% was largely related to a
shift in our customer acquisition strategy. Consistent with our streamlined
operating plan announced in June 2001, we significantly reduced our advertising
expenditures and focused more on email and direct mail programs. Primarily as a
result of this shift, we were able to decrease our customer acquisition costs
for the year ended December 31, 2002 by approximately 57% to $17.04 per new
customer from $39.32 per new customer for the year ended December 31, 2001.
Operating expenses increased in 2002 by approximately 15% compared to 2001 as a
result of variable costs associated with the increased sales volume (e.g.,
picking and packing orders, processing returns and credit card fees).
For the year ended December 31, 2002, technology expenses decreased by
approximately 5% compared to the year ended December 31, 2001. This reduction
was primarily related to a reduction in our Web site hosting costs in connection
with our move to a new web hosting facility. These cost savings were offset by
increased amortization expense resulting from the launch of the new Web site.
Effective September 15, 2002 (the launch date of the new Web site) we began
amortizing costs related to the launch of the new Web site over the estimated
useful life of the new site. Previously, these costs were capitalized.
E-Commerce expenses for the year ended December 31, 2002, decreased by
approximately 4% as compared to the year ended December 31, 2001, primarily due
to a headcount reduction in the creative services department in June 2001.
General and administrative expenses: General and administrative expenses for the
year ended December 31, 2002 decreased by approximately 8% to $4,686,000 as
compared to $5,098,000 for the year ended December 31, 2001. As a percentage of
net sales, general and administrative expenses decreased to 15.3% in 2002 from
22.2% in 2001.
The decrease in general and administrative expenses was the result of decreased
salary and benefit expenses related to the headcount reduction that was put into
place in connection with the Company's June 2001 streamlined operating plan, in
which the Company eliminated approximately 32 jobs or, approximately 34% of the
Company's workforce.
Loss from operations: Operating loss decreased by approximately 48% in 2002, to
$6,198,000 from $11,867,000 in 2001 as a result of the increase in sales and
gross margin and decreases in selling, marketing and fulfillment expenses and
general and administrative expenses.
24
Interest expense and other income, net: Interest expense for the year ended
December 31, 2002 totaled $349,000, and consisted primarily of fees paid in
connection with our Loan Facility. For the year ended December 31, 2001,
interest expense totaled $13,379,000. This amount consisted principally of
approximately $13,007,000 of non-cash, one-time charges that were incurred in
connection with the conversion of certain notes payable and redeemable equity
into permanent equity. This amount also included interest expense of $175,000,
related to the interest on the notes payable that were issued during fiscal 2000
and converted to permanent equity in fiscal 2001.
Interest income for the year ended December 31, 2002 decreased to $68,000 from
$240,000 for the year ended December 31, 2001. The decrease resulted from the
decrease in our cash balance as interest income primarily represents interest
earned on our cash balance.
LIQUIDITY AND CAPITAL RESOURCES
General
At December 31, 2003, we had approximately $7.7 million of liquid assets,
entirely in the form of cash and cash equivalents, and working capital of
approximately $12.5 million. In addition, as of December 31, 2003, we had
approximately $2.3 million of borrowings committed under the Loan Facility,
leaving approximately $2.1 million of availability. Subsequent to year end, in
January of 2004 we raised $5,000,000 through the sale of 1,543,209 shares of our
common stock and warrants to purchase an additional 385,801 shares of our common
stock at an exercise price of $3.96 per share. See "Recent Developments."
In January 2004, we also extended the maturity dates on the Convertible
Promissory Notes issued to affiliates of Soros that collectively own a majority
of our capital stock in July and October 2003. The Notes originally matured in
January and April 2004, respectively, and the maturity date was extended to
March 1, 2005. In February 2004, the maturity date on the on the Convertible
Promissory Notes issued to affiliates of Soros were again extended to May 1,
2005. See "Recent Developments."
We fund our operations through cash on hand, operating cash flow, as well as the
proceeds of any equity or debt financing. Operating cash flow is affected by
revenue and gross margin levels, as well as return rates, and any deterioration
in our performance on these financial measures would have a negative impact on
our liquidity. Total availability under the Loan Facility is based upon our
inventory levels and is dependent, among other things, on the Company having at
least $5.0 million of tangible net worth and $4.0 million of working capital. In
addition, both availability under the Loan Facility and our operating cash flows
are affected by the payment terms that we receive from suppliers and service
providers, and the extent to which suppliers require us to request Rosenthal to
provide credit support under the Loan Facility. We believe that our suppliers'
decision-making with respect to payment terms and/or the type of credit support
requested is largely driven by their perception of our credit rating, which is
affected by information reported in the industry and financial press and
elsewhere as to our financial strength. Accordingly, negative perceptions as to
our financial strength could have a negative impact on our liquidity.
Historically, due to our limited working capital, a number of our suppliers
limited our payment terms and, in some cases, required us to pay for merchandise
in advance of delivery. The effect of this has been to further limit our working
capital and to increase our usage of the factoring agreement included in the
Loan Facility. Given our stronger balance sheet, we have recently been able to
improve our payment terms with many suppliers, and we intend to continue to seek
to improve these terms during 2004. Of course, there can be no assurance that we
will be successful in these efforts.
We anticipate that our existing resources and working capital should be
sufficient to satisfy our cash requirements through the end of fiscal 2004. Of
course, there can be no assurance that such expectations will prove to be
correct. Moreover, we currently plan to seek additional debt and/or equity
financing in order to maximize the growth of our business. If such financing is
not available on terms acceptable to us and or we do not achieve our sales plan,
future operations will need to be modified, scaled back or discontinued. There
can be no assurance that any additional financing or other sources of capital
will be available to us upon acceptable terms, or at all. The inability to
obtain additional financing, when needed, would have a material adverse effect
on our business, financial condition and results of operations.
Loan Facility
Pursuant to the Loan Facility, Rosenthal provides us with certain credit
accommodations, including loans and advances, factor-to-factor guarantees,
letters of credit in favor of suppliers or factors and purchases of payables
owed to our suppliers. The Rosenthal Financing Agreement was amended in March
2003 to: (i) extend the term until June 30, 2004; (ii) increase the
25
maximum amount available under the Loan Facility (subject to an existing $10
million cap) to an amount equal to the Soros Guarantee plus the lower of (x)
$2.0 million (instead of the prior $1.0 million), (y) 20% of the book value of
our inventory or (z) the full liquidation value of our inventory; (iii) increase
the tangible net worth requirement to $5.0 million from $1.5 million; (iv)
redefine the working capital definition to exclude short-term debt held by
affiliates (effective as of December 19, 2002), (v) increase the working capital
requirement to $4.0 million from $3.5 million; (vi) increase the annual fee we
pay Rosenthal for the Loan Facility to $30,000 from $10,000, (vii) require us to
maintain a cash balance of at least $250,000 and; (viii) require Soros to
increase from $1.5 million to $2.0 million the amount of the Soros Guarantee and
extend its term to November 15, 2004 from November 15, 2003. In consideration
for Soros' agreement to increase the amount of and to maintain the Soros
Guarantee until November 15, 2004, we issued to Soros a warrant to purchase
25,000 shares of our Common Stock at an exercise price equal to $0.78 per share
(the 10 day trailing average of the closing sale price of our Common Stock on
the date of issuance), exercisable at any time prior to March 17, 2013. The
Financing Agreement was further amended in the fourth quarter of 2003 to allow
Rosenthal in its sole discretion to increase the amount available under the Loan
Facility (subject to the existing $10 million cap) by $500,000.
Interest accrues monthly on the average daily amount outstanding under the Loan
Facility during the preceding month at a per annum rate equal to the prime rate
plus 1%. In addition to the annual facility fee of $30,000, we also pay
Rosenthal certain fees to open letters of credit and guarantees in an amount
equal to a certain percentage of the face amount of the letter of credit for
each thirty (30) days such letter of credit, or a portion thereof, remains open.
In consideration for the Loan Facility, among other things, we granted to
Rosenthal a