This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements of the Company (and the related notes thereto) which preceded this report and the audited consolidated financial statements of the Company (and the related notes thereto) and Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Form 10-K for the fiscal year ended July 31, 2008.

Overview

We are a leading specialty retailer of fine jewelry in North America. At April 30, 2009, we operated 1,356 fine jewelry stores and 694 kiosk locations primarily in shopping malls throughout the United States of America, Canada and Puerto Rico. Our operations are divided into three business segments: Fine Jewelry, Kiosk Jewelry and All Other.

The Fine Jewelry segment focuses on diamond product, but differentiates its brands to the consumer through merchandise assortments and marketing. The Kiosk Jewelry segment reaches the opening price point of fine jewelry customers primarily through mall-based kiosks in the United States of America operating primarily under the name Piercing PagodaŽ. The All Other segment consists primarily of our insurance operations, which provide insurance and reinsurance facilities for various types of insurance coverage offered primarily to our private label credit card customers.

Our results for the third quarter were in-line with our expectations. The comparable store sales decline of 20.0 percent was the result of a continuing difficult retail environment and the impact of strong positive comparable store sales last year due to aggressive merchandise clearance. The merchandise clearance for the third quarter of fiscal 2009 was approximately 50 percent lower than last year. As a result of the decline in clearance activity, gross margins improved by 610 basis points compared to the second quarter of fiscal 2009 returning margins to over 50 percent without a significant decrease in comparable store sales trends compared to last quarter. We expect to maintain gross margins of approximately 50 percent, however, comparable store sales will continue to be negatively impacted as we anniversary last year's clearance initiatives through the first quarter of fiscal 2010. We estimate that the clearance activity accounted for approximately 10 percentage points of the 5.8 percent positive comparable store sales during the third quarter of fiscal 2008.

We believe the three initiatives we implemented over the last year remain critical to our long-term success. The initiatives include (1) focusing on our core customer by providing clarity and value through compelling merchandise assortments, cleaner in-store presentation and an improved marketing message,
(2) enhancing our operational effectiveness to ensure that our people and processes are aligned and focused on providing outstanding products and customer service, and (3) maintaining financial discipline with a continued focus on free cash flow generation and prudent use of capital. We believe the most important of these initiatives under the current economic environment is maintaining financial discipline. Accordingly, in February 2009 we announced inventory and cost savings initiatives expected to be realized through fiscal 2010 totaling approximately $75 million and $65 million, respectively. This is in addition to the $100 million in permanent inventory reductions and the $65 million plus in cost savings announced in February 2008. The $100 million of permanent inventory reductions associated with the February 2008 initiative was achieved in July 2008. The additional $75 million of inventory reductions is to be achieved through fiscal 2010 by reallocating inventory in closed stores and improved productivity through more efficient store level allocation at existing stores. As of April 30, 2009, the cost savings realized since inception of the February 2009 and 2008 initiatives totaled approximately $9 million and $59 million, respectively. The cost savings under both initiatives consist primarily of selling, general and administrative expenses. We continue to believe that we will achieve our goals under both initiatives.

Our continued focus on financial rigor also includes a review of our lease portfolio during the fourth quarter of fiscal 2009 to identify opportunities to renegotiate rents under existing leases and to accelerate the closure of underperforming locations. The initial review of our lease portfolio resulted in the closure of 42 fine jewelry and two kiosk stores in May 2009. As we continue our review, we may close additional stores beyond the 115 previously announced. As part of the review of our lease portfolio, we also intend to pursue our release from our position as the guarantor on the Bailey Banks & Biddle leases associated with the sale of the brand in November 2007.

During the nine month period ended April 30, 2009, the average Canadian currency rate decreased by approximately 18 percent relative to the U.S. dollar. Due to our Canadian operations being reported at the average U.S. dollar equivalent, the decline in the currency rate resulted in a $29.1 million decrease in reported revenues, substantially offset by a decrease in reported cost of sales and selling, general and administrative expenses of $14.4 million and $10.3 million, respectively. In addition, as a result of the decline in the Canadian currency rate we recorded losses associated with the settlement of Canadian accounts payable totaling $7.6 million during the nine months ended April 30, 2009 compared to $0.4 million during the same period in the prior year.

Comparable store sales include internet sales and exclude revenue recognized from warranties and insurance premiums related to credit insurance policies sold to customers who purchase merchandise under our proprietary credit program. The sales results of new stores are included beginning their thirteenth full month of operation. The results of stores that have been relocated, renovated or refurbished are included in the calculation of comparable store sales on the same basis as other stores. However, stores closed for more than 90 days due to unforeseen events (hurricanes, etc.) are excluded from the calculation of comparable store sales.

From time to time, we include non-GAAP measurements of financial information in Management's Discussion and Analysis of Financial Condition and Results of Operations. We use these measurements as part of our evaluation of the performance of the Company. In addition, we believe these measures provide useful information to investors, particularly in evaluating the performance of the Company in the current fiscal year as compared to prior periods.

Results of Operations



The following table sets forth certain financial information from our unaudited
consolidated statements of operations expressed as a percentage of total
revenues.



                                      Three Months Ended        Nine Months Ended
                                           April 30,                April 30,
                                       2009         2008        2009         2008
Revenues                                100.0 %      100.0 %     100.0 %      100.0 %
Costs and expenses:
Cost of sales                            49.9         52.5        53.2         50.5
Selling, general and
administrative                           55.3         48.6        50.1         44.8
Cost of insurance operations              0.5          0.4         0.3          0.3
Depreciation and amortization             3.8          3.1         3.1          2.7
Impairment charges                          -            -         0.9          0.1
Operating (loss) earnings                (9.4 )       (4.6 )      (7.8 )        1.7
Interest expense                          0.5          0.4         0.6          0.6
(Loss) earnings before income
taxes                                    (9.9 )       (5.0 )      (8.4 )        1.1
Income tax (benefit) expense             (3.8 )       (1.3 )      (1.9 )        0.6
(Loss) earnings from continuing
operations                               (6.1 )       (3.6 )      (6.5 )        0.5
Earnings from discontinued
operations, net of taxes                    -          0.1           -          0.4
Net (loss) earnings                      (6.1 )%      (3.5 )%     (6.5 )%       0.9 %

Three Months Ended April 30, 2009 Compared to Three Months Ended April 30, 2008

Revenues. Revenues for the quarter ended April 30, 2009 were $379.1 million, a decrease of 20.5 percent compared to revenues of $476.7 million for the same period in the prior year. Comparable store sales decreased 20.0 percent as compared to the same period in the prior year. The decline in comparable store sales was driven by a 27.4 percent decrease in the number of customer transactions in our fine jewelry stores, partially offset by an increase in the average transaction price. We attribute the decline in customer transactions primarily to the general decline in the overall retail environment and a decrease in merchandise clearance compared to the same period in the prior year. The decline was also due to the $8.5 million impact associated with the decrease in the Canadian currency rate and a decrease in the number of open stores, partially offset by a $2.7 million increase in revenues recognized related to lifetime warranties.

The Fine Jewelry segment contributed $321.4 million of revenues in the quarter ended April 30, 2009, compared to $417.4 million for the same period in the prior year, representing a decrease of 23.0 percent.

Revenues include $54.4 million in the Kiosk Jewelry segment compared to $56.1 million in the prior year, representing a decrease of 3.0 percent. The decline in revenues is due primarily to a decrease in the number of open kiosks to 694 from 748 as of April 30, 2009 and 2008, respectively.

The All Other segment operations provided $3.3 million in revenues for the quarter ended April 30, 2009 as compared to $3.2 million for the same period in the prior year, representing an increase of 1.1 percent.

During the quarter ended April 30, 2009, we opened one store in the Fine Jewelry segment. In addition, we closed 31 stores in the Fine Jewelry segment and 7 locations in the Kiosk Jewelry segment.

Cost of Sales. Cost of sales includes cost of merchandise sold, as well as receiving and distribution costs. Cost of sales as a percentage of revenues was 49.9 percent for the quarter ended April 30, 2009, compared to 52.5 percent for the same period in the prior year. The decrease is primarily due to a decrease in store-wide discounts compared to the same period in the prior year.

Selling, General and Administrative. Included in selling, general and administrative expenses ("SG&A") are store operating, advertising, buying and general corporate overhead expenses. SG&A was 55.3 percent of revenues for the quarter ended April 30, 2009 compared to 48.6 percent for the same period last year. On a dollar basis, SG&A decreased by $22.2 million to $209.5 million for the quarter ended April 30, 2009. The percentage increase is due to lower total revenues during the quarter compared to the same period in the prior year. The dollar decrease is primarily the result of our expense reduction initiatives totaling $18.6 million for the quarter ended April 30, 2009.

Depreciation and Amortization. Depreciation and amortization as a percentage of revenues for the quarters ended April 30, 2009 and 2008 was 3.8 percent and 3.1 percent, respectively. The increase is due to lower total revenues during the quarter compared to the same period in the prior year.

Interest Expense. Interest expense as a percentage of revenues for the quarters ended April 30, 2009 and 2008 was 0.5 percent and 0.4 percent, respectively. The increase in interest expense was a result of an increase in borrowings and lower total revenues compared to the same period in the prior year, substantially offset by a decrease in the weighted average effective interest rate from 4.1 percent last year to 1.8 percent this year.

Income Tax Benefit. The effective tax rate for the quarters ended April 30, 2009 and 2008 was 38.4 percent and 26.4 percent, respectively. The effective tax rate for the quarter ended April 30, 2009 includes a benefit of $6.9 million related to a decrease in the estimated valuation allowance recorded during the second quarter of fiscal 2009, partially offset by a charge totaling $2.7 million related to the expiration of certain net operating loss carryforwards. The effective tax rate for the quarter ended April 30, 2008 includes a charge related to the cumulative impact of an increase in the estimated annual tax rate on earnings related to the six months ended January 31, 2008.

Nine Months Ended April 30, 2009 Compared to Nine Months Ended April 30, 2008

Revenues. Revenues for the nine months ended April 30, 2009 were $1,422.6 million, a decrease of 15.4 percent compared to revenues of $1,681.8 million for the same period in the prior year. Comparable store sales decreased 15.4 percent as compared to the same period in the prior year. The decline in comparable store sales was driven by a 17.9 percent decrease in the number of customer transactions in our fine jewelry stores, partially offset by an increase in the average transaction price. We attribute the decline in customer transactions primarily to the general decline in the overall retail environment, partially offset by an increase in merchandise clearance compared to the same period in the prior year. The decline was also due to the $29.1 million impact associated with the decrease in the Canadian currency rate and a decrease in the number of open stores, partially offset by a $7.0 million increase in revenues recognized related to lifetime warranties.

The Fine Jewelry segment contributed $1,228.5 million of revenues in the nine months ended April 30, 2009, compared to $1,478.1 million for the same period in the prior year, representing a decrease of 16.9 percent.

Revenues include $184.5 million in the Kiosk Jewelry segment compared to $194.4 million in the prior year, representing a decrease of 5.1 percent. The decline in revenues is due primarily to a decrease in the number of open kiosks to 694 from 748 as of April 30, 2009 and 2008, respectively.

The All Other segment operations provided $9.6 million in revenues for the nine months ended April 30, 2009 as compared to $9.3 million for the same period in the prior year, representing an increase of 3.5 percent.

During the nine months ended April 30, 2009, we opened 14 stores in the Fine Jewelry segment. In addition, we closed 54 stores in the Fine Jewelry segment and 49 locations in the Kiosk Jewelry segment.

Cost of Sales. Cost of sales includes cost of merchandise sold, as well as receiving and distribution costs. Cost of sales as a percentage of revenues was 53.2 percent for the nine months ended April 30, 2009, compared to 50.5 percent for the same period in the prior year. The increase is primarily due to an increase in store-wide discounts compared to the same period in the prior year.

Selling, General and Administrative. Included in SG&A are store operating, advertising, buying and general corporate overhead expenses. SG&A was 50.1 percent of revenues for the nine months ended April 30, 2009 compared to 44.8 percent for the same period last year. On a dollar basis, SG&A decreased by $39.8 million to $713.0 million for the nine months ended April 30, 2009. The percentage increase is due to lower total revenues during the nine months compared to the same period in the prior year. The dollar decrease is the result of our expense reduction initiatives totaling $47.2 million for the nine months ended April 30, 2009, partially offset by a $5.0 million increase in legal and severance costs and a $7.2 million increase in foreign currency losses.

Depreciation and Amortization. Depreciation and amortization as a percentage of revenues for the nine months ended April 30, 2009 and 2008 was 3.1 percent and 2.7 percent, respectively. The increase is due to lower total revenues during the nine months compared to the same period in the prior year.

Impairment Charges. Impairment charges for the nine months ended April 30, 2009 and 2008 includes $8.2 million and $1.6 million, respectively, related to long-lived assets associated with underperforming stores. In addition, during the nine months ended April 30, 2009, a $5.0 million goodwill impairment charge was recorded related to a reporting unit in the Fine Jewelry segment.

Interest Expense. Interest expense as a percentage of revenues for the nine months ended April 30, 2009 and 2008 was flat at 0.6 percent. The weighted average effective interest rate decreased from 5.7 percent last year to 2.9 percent this year. The decrease in the weighted average effective interest rate was offset by an increase in borrowings and lower total revenues during the nine months compared to the same period in the prior year.

Income Tax (Benefit) Expense. The effective tax rate for the nine months ended April 30, 2009 and 2008 was 22.5 percent and 53.6 percent, respectively. The effective tax rate for the nine months ended April 30, 2009 includes a net charge totaling $11.7 million associated with our decision during the second quarter of fiscal 2009 to revoke our election under APB 23 to indefinitely reinvest certain foreign earnings outside the U.S. and a $2.7 million charge related to the expiration of certain net operating loss carryforwards. The effective tax rate for the nine months ended April 30, 2008 includes certain tax benefits that were larger in proportion to estimated earnings in fiscal 2008.

Liquidity and Capital Resources

Our cash requirements consist primarily of funding ongoing operations, including inventory requirements, capital expenditures for new stores, renovation of existing stores, upgrades to our information technology systems and distribution facilities and debt service. In addition, from time to time we have repurchased shares of our common stock.

Net cash from operating activities decreased from $86.5 million for the nine months ended April 30, 2008 to a deficit of $28.1 million for the nine months ended April 30, 2009. The decrease is primarily the result of operating losses generated during the nine months ended April 30, 2009 compared to operating earnings in the same period in the prior year. The operating losses in the current year were primarily due to the general decline in the overall retail environment and our highly promotional pricing during the Holiday season. The decrease is also the result of a decrease in net cash received related to deferred revenues for lifetime warranties of approximately $29 million. The decrease was partially offset by an approximately $18 million decrease in amounts due from vendors for returned merchandise and vendor deposits.

Our business is highly seasonal, with a disproportionate amount of sales (approximately 40 percent) occurring in November and December of each year, the Holiday season. Other important periods include Valentine's Day and Mother's Day. We purchase inventory in anticipation of these periods and, as a result, have higher inventory and inventory financing needs immediately prior to these periods. Owned inventory at April 30, 2009 was $759.0 million, a decrease of $108.0 million compared to inventory levels at April 30, 2008. The decrease in inventory was primarily the result of aggressive merchandise clearance programs during the last half of fiscal 2008, partially offset by lower than expected sales during fiscal 2009.

Our cash requirements are funded through cash flows from operations, funds available under our U.S. revolving credit facility and vendor payment terms. As of April 30, 2009, our U.S. revolving credit facility provided for borrowings up to $500 million. The borrowings under the U.S. facility are capped at the lesser of (1) 73 percent of the cost of eligible inventory during October through December and 69 percent for the remainder of the year (minus certain reserves that may be established under the credit facility), plus 85 percent of credit card receivables or (2) 90 percent of the appraised liquidation value of eligible inventory (minus certain reserves that may be established under the credit facility), plus 85 percent of credit card receivables. The U.S. facility also provides for increased seasonal borrowing capabilities of up to $100 million and contains an accordion feature that allows us to permanently increase the facility size in $25 million increments up to another $100 million. Under the terms of the U.S. credit facility, we are required to maintain $50 million of borrowing availability or satisfy a minimum fixed charge coverage ratio of 1.1:1.0 for an applicable 12 month reference period. We do not currently meet the minimum fixed charge coverage ratio. Vendor purchase order terms typically require payment within 60 days.

Based on an inventory appraisal performed in January 2009, the available borrowings under the U.S. credit facility are currently determined under item
(2) described above and are capped at approximately 63 percent of the cost of eligible inventory during January through September. The amount of available borrowings will continue to be calculated under item (1) described above during October through December. In February 2009, we terminated our $30 million Canadian credit facility and entered into certain Joinder Agreements under which we will utilize our Canadian and Puerto Rican subsidiaries' inventory, credit card receivables and certain other assets as collateral under the U.S. facility. The increase in collateral under the U.S. facility offset the decline in available borrowings that would have occurred as a result of the decrease in the appraised liquidation value. There were no borrowings outstanding under the Canadian facility at the time of termination.

As of April 30, 2009, we had cash and cash equivalents totaling $24.0 million. We also had approximately $147 million available in borrowing capacity under our U.S. revolving credit facility. We believe that we have sufficient capacity under our U.S revolving credit facility to meet our foreseeable financing needs.

Under an arrangement with Citibank, N.A ("CITI"), CITI provides financing for our customers to purchase merchandise through private label credit cards. The arrangement also enables us to write credit insurance. Customers use our CITI arrangements to pay for approximately 40 percent of purchases in the U.S. and approximately 25 percent of purchases in Canada. Under the agreements governing our arrangement, our Canadian and U.S. subsidiaries must satisfy various financial and other covenants. As of April 30, 2009, our Canadian subsidiary did not satisfy a fixed charge coverage covenant which could allow CITI to terminate the agreement upon 30 days written notice and our U.S. subsidiary did not satisfy a minimum sales threshold which could allow CITI to terminate the agreement upon 180 days written notice if certain cure provisions are not met by us. In June 2009, we amended the agreements with CITI as follows: (1) CITI waived its right to terminate both agreements for the covenant violations described above prior to March 2010, (2) we will provide CITI a $5 million letter of credit and, for the period November 15 through February 14 of each year, an additional $10 million seasonal letter of credit in connection with our U.S. agreement, (3) the minimum sales threshold was lowered related to our U.S. subsidiary and (4) CITI released its right to require us to purchase the U.S. receivable portfolio upon termination of the agreement as a result of our failure to meet the minimum sales threshold.

During fiscal 2008, the Board of Directors authorized share repurchases of $350 million. As part of the stock repurchase program, we repurchased a total of 17.6 million shares of our common stock, or $326.7 million, in fiscal 2008. As of April 30, 2009, we have approximately $23.3 million in remaining authorization under our repurchase program.

Capital Growth

During the nine months ended April 30, 2009, we invested approximately $6.7 million in capital expenditures to open 14 new stores in the Fine Jewelry segment. We invested approximately $16.1 million to remodel, relocate and refurbish 29 stores in our Fine Jewelry segment, 7 stores in our Kiosk Jewelry segment and to complete store enhancement projects. We also invested $2.3 million in infrastructure, primarily related to our information technology and distribution centers. We anticipate investing approximately $4.9 million in capital expenditures for the remainder of fiscal year 2009, including $2.4 million in existing store refurbishments and approximately $2.5 million in capital investments related to information technology infrastructure and support operations.

Off-Balance Sheet Arrangements

In connection with the sale of the Bailey Banks & Biddle brand on November 9, 2007, the buyer, Finlay Fine Jewelry Corporation ("Finlay"), assumed the obligations for the store operating leases. As a condition of this assignment, we remained contingently liable for the leases for the remainder of the respective current lease terms, which generally ranged from fiscal 2009 through fiscal 2017. The maximum potential liability for base rent payments under the leases totaled approximately $67 million as of April 30, 2009. We may also be obligated for common area charges and other payments. In May 2009, we began negotiations with the landlords to release us as the guarantor of the leases for specified payments. These payments would eliminate any future contingent liability associated with the Bailey Banks & Biddle leases. It is uncertain at this time if these negotiations will be successful and, if not, whether any payments would be required in the future as a result of default by Finlay. The possible loss or range of loss related to the leases cannot be reasonably estimated at this time. As a result, we have not recorded a liability as of April 30, 2009.

Inflation

In management's opinion, changes in revenues, net earnings, and inventory valuation that have resulted from inflation and changing prices have not been material during the periods presented. The trends in inflation rates pertaining to merchandise inventories, especially as they relate to gold and diamond costs, are primary components in determining our last-in, first-out inventory. There is no assurance that inflation will not materially affect us in the future.