UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF
              THE
      SECURITIES EXCHANGE ACT OF 1934





For the
quarterly period ended May 2,
2009





or





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF
              THE
      SECURITIES EXCHANGE ACT OF 1934





For the
transition period from _________ to __________





Commission
File Number: 0-25716





FINLAY
ENTERPRISES, INC.





(Exact
name of registrant as specified in its charter)





Delaware
                    
                    13-3492802(State or other jurisdiction of
                    
                    (I.R.S. Employerincorporation or organization)
                    
                    Identification No.)





529 Fifth Avenue, New York, NY
                      
                      10017(Address of principal executive offices)
                      
                      (Zip Code)





(212)
808-2800


(Registrant’s
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.





Yes x                                             No
 ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File
required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§
229.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such
files).





Yes  ̈                                No
 ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





Large
      accelerated filer  ̈
                Accelerated filer  ̈Non-accelerated filer  ̈ (Do not check if a smaller reporting company)
                Smaller reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).




Yes   ̈                                            No  x





As of
June 12, 2009, there were 9,438,835 shares of Common Stock, par value $0.01 per
share, of the registrant outstanding.










FINLAY
ENTERPRISES, INC.





FORM
10-Q





QUARTERLY
PERIOD ENDED MAY 2, 2009





INDEX





PAGE(S)PART
      I - FINANCIAL INFORMATIONItem
      1.
                              Consolidated
      Financial Statements (Unaudited)Consolidated
      Statements of Operations for the thirteen weeks ended May 2, 2009 and May
      3, 2008
                              
                              2Consolidated
      Balance Sheets as of May 2, 2009 and January 31, 2009
                              
                              3Consolidated
      Statements of Changes in Stockholders’ Equity (Deficit) and Comprehensive
      Loss for the thirteen weeks ended May 2, 2009
                              
                              4Consolidated
      Statements of Cash Flows for the thirteen weeks ended May 2, 2009 and May
      3, 2008
                              
                              5Notes
      to Consolidated Financial Statements
                              
                              6Item
      2.
                              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                              
                              18Item
      3.
                              Quantitative
      and Qualitative Disclosures About Market Risk
                              
                              31Item
      4.
                              Controls
      and Procedures
                              
                              31PART
      II - OTHER INFORMATIONItem
      1.
                              Legal
      Proceedings
                              
                              32Item
      1A.
                              Risk
      Factors
                              
                              32Item
      2.
                              Unregistered
      Sales of Equity Securities and Use of Proceeds
                              
                              33Item
      5.
                              Other
      Information
                              
                              33Item
      6.
                              Exhibits
                              
                              34SIGNATURES
                              
                              
                              36





PART
I – FINANCIAL INFORMATION




Item
1. Consolidated
Financial Statements





FINLAY
ENTERPRISES, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(in
thousands, except share and per share data)


(unaudited)





Thirteen Weeks EndedMay 2,
                  2009
                
                
                May 3,
                  2008Sales
                
                $
                159,321
                
                
                $
                142,072Cost
      of sales
                
                
                93,635
                
                
                
                80,148Gross
      margin
                
                
                65,686
                
                
                
                61,924Selling,
      general and administrative expenses
                
                
                76,653
                
                
                
                69,154Depreciation
      and amortization
                
                
                1,294
                
                
                
                3,650Loss
      from operations
                
                
                (12,261
                )
                
                
                (10,880
                )Interest
      expense, net
                
                
                13,056
                
                
                
                8,230Loss
      from operations before income taxes
                
                
                (25,317
                )
                
                
                (19,110
                )Benefit
      for income taxes
                
                
                -
                
                
                
                (7,211
                )Loss
      from continuing operations
                
                
                (25,317
                )
                
                
                (11,899
                )Discontinued
      operations, net of tax of $0.6 million in 2008
                
                
                (3,352
                )
                
                
                888Net
      loss
                
                $
                (28,669
                )
                
                $
                (11,011
                )Net
      income (loss) per share applicable to common shares:Basic
      and Diluted net income (loss) per share:Loss
      from continuing operations
                
                $
                (2.70
                )
                
                $
                (1.29
                )Discontinued
      operations, net of tax
                
                
                (0.36
                )
                
                
                0.10Net
      loss per share
                
                $
                (3.06
                )
                
                $
                (1.19
                )Weighted
      average shares outstanding - Basic and Diluted
                
                
                9,373,104
                
                
                
                9,223,784





The
accompanying notes are an integral part of these consolidated financial
statements.


2


FINLAY
ENTERPRISES, INC.


CONSOLIDATED
BALANCE SHEETS


(in
thousands, except share and per share data)





May 2,
                    2009
                    (unaudited)
                  
                  
                  January 31,
                    2009
                    (audited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                  
                  $
                  4,714
                  
                  
                  $
                  3,414Accounts
      receivable
                  
                  
                  28,664
                  
                  
                  
                  28,451Other
      receivables
                  
                  
                  769
                  
                  
                  
                  10,362Merchandise
      inventories
                  
                  
                  315,839
                  
                  
                  
                  442,738Prepaid
      expenses and other
                  
                  
                  2,844
                  
                  
                  
                  3,817Total
      current assets
                  
                  
                  352,830
                  
                  
                  
                  488,782Fixed
      assets:Building,
      equipment, fixtures and leasehold improvements
                  
                  
                  41,442
                  
                  
                  
                  50,882Less
      – accumulated depreciation and amortization
                  
                  
                  8,526
                  
                  
                  
                  8,212Fixed
      assets, net
                  
                  
                  32,916
                  
                  
                  
                  42,670Deferred
      charges and other assets, net
                  
                  
                  44,277
                  
                  
                  
                  36,177Total
      assets
                  
                  $
                  430,023
                  
                  
                  $
                  567,629LIABILITIES
      AND STOCKHOLDERS’ EQUITY (DEFICIT)Current
      liabilities:Short-term
      borrowings (in default)
                  
                  $
                  128,650
                  
                  
                  $
                  236,241Accounts
      payable – trade (including cash overdraft of $5,278 and $4,315 at May 2,
      2009 and January 31, 2009, respectively)
                  
                  
                  28,244
                  
                  
                  
                  34,116Accrued
      liabilities:Accrued
      salaries and benefits
                  
                  
                  11,898
                  
                  
                  
                  14,304Accrued
      miscellaneous taxes
                  
                  
                  7,458
                  
                  
                  
                  8,907Accrued
      interest
                  
                  
                  1,445
                  
                  
                  
                  1,417Deferred
      income
                  
                  
                  -
                  
                  
                  
                  155Deferred
      income taxes
                  
                  
                  18,330
                  
                  
                  
                  11,232Other
                  
                  
                  13,076
                  
                  
                  
                  16,183Total
      current liabilities
                  
                  
                  209,101
                  
                  
                  
                  322,555Senior
      Notes
                  
                  
                  40,582
                  
                  
                  
                  40,582Second
      Lien Notes
                  
                  
                  24,025
                  
                  
                  
                  23,334Third
      Lien Notes
                  
                  
                  172,755
                  
                  
                  
                  169,031Total
      long-term debt
                  
                  
                  237,362
                  
                  
                  
                  232,947Other
      non-current liabilities
                  
                  
                  5,216
                  
                  
                  
                  5,204Total
      liabilities
                  
                  
                  451,679
                  
                  
                  
                  560,706Commitments
      and contingencies (Note 12)Stockholders’
      equity (deficit):Common
      Stock, par value $0.01 per share; authorized 25,000,000
      shares;  issued 11,807,648 and 11,693,569 shares at May 2, 2009
      and January 31, 2009, respectively
                  
                  
                  117
                  
                  
                  
                  116Additional
      paid-in capital
                  
                  
                  96,459
                  
                  
                  
                  96,368Accumulated
      deficit
                  
                  
                  (90,367
                  )
                  
                  
                  (61,698
                  )Less
      treasury stock of 2,371,543 and 2,335,388 shares at May 2, 2009 and
      January 31, 2009, respectively, at cost
                  
                  
                  (27,865
                  )
                  
                  
                  (27,863
                  )Total
      stockholders’ equity (deficit)
                  
                  
                  (21,656
                  )
                  
                  
                  6,923Total
      liabilities and stockholders’ equity (deficit)
                  
                  $
                  430,023
                  
                  
                  $
                  567,629





The
accompanying notes are an integral part of these consolidated financial
statements.


3





FINLAY
ENTERPRISES, INC.


CONSOLIDATED
STATEMENTS OF CHANGES IN


STOCKHOLDERS’
EQUITY (DEFICIT)


AND
COMPREHENSIVE LOSS


(in
thousands, except share data)





TotalCommon Stock
                  
                  
                  Additional
                  
                  
                  
                  
                  
                  
                  
                  
                  Stockholders’Number
                  
                  
                  
                  
                  
                  Paid-in
                  
                  
                  Accumulated
                  
                  
                  Treasury
                  
                  
                  Equity/
                  
                  
                  Comprehensiveof Shares
                  
                  
                  Amount
                  
                  
                  Capital
                  
                  
                  Deficit
                  
                  
                  Stock
                  
                  
                  (Deficit)
                  
                  
                  LossBalance,
      January 31, 2009
                  
                  
                  9,358,181
                  
                  
                  $
                  116
                  
                  
                  $
                  96,368
                  
                  
                  $
                  (61,698
                  )
                  
                  $
                  (27,863
                  )
                  
                  $
                  6,923Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (28,669
                  )
                  
                  
                  -
                  
                  
                  
                  (28,669
                  )
                  
                  $
                  (28,669
                  )Comprehensive
      loss
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  (28,669
                  )Issuance
      of common stock
                  
                  
                  114,079
                  
                  
                  
                  1
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1Amortization
      of restricted stock compensation and restricted stock
units
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  91
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  91Purchase
      of treasury stock
                  
                  
                  (36,155
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (2
                  )
                  
                  
                  (2
                  )Balance,
      May 2, 2009 (unaudited)
                  
                  
                  9,436,105
                  
                  
                  $
                  117
                  
                  
                  $
                  96,459
                  
                  
                  $
                  (90,367
                  )
                  
                  $
                  (27,865
                  )
                  
                  $
                  (21,656
                  )





The
accompanying notes are an integral part of these consolidated financial
statements.


4


FINLAY
ENTERPRISES, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(in
thousands)


(unaudited)





Thirteen Weeks EndedMay 2,
                  2009
                
                
                May 3,
                  2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      loss
                
                $
                (28,669
                )
                
                $
                (11,011
                )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                
                
                1,388
                
                
                
                4,978Loss
      on disposal of fixed assets
                
                
                3,978
                
                
                
                -Write-off
      of deferred financing costs
                
                
                3,126
                
                
                
                -Amortization
      of deferred financing costs
                
                
                2,233
                
                
                
                508Amortization
      of restricted stock compensation, stock options and restricted stock
      units
                
                
                91
                
                
                
                269Payment-in-kind
      interest on Secured Notes
                
                
                4,415
                
                
                
                -Deferred
      income taxes
                
                
                -
                
                
                
                1,198Other,
      net
                
                
                (282
                )
                
                
                126Changes
      in operating assets and liabilities:(Increase)
      decrease in accounts and other receivables
                
                
                9,380
                
                
                
                (18,588
                )Decrease
      in merchandise inventories (a)
                
                
                98,406
                
                
                
                10,218(Increase)
      decrease in prepaid expenses and other
                
                
                973
                
                
                
                (451
                )Decrease
      in accounts payable and accrued liabilities
                
                
                (13,923
                )
                
                
                (59,137
                )NET
      CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
                
                
                81,116
                
                
                
                (71,890
                )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchases
      of equipment, fixtures and leasehold improvements
                
                
                (500
                )
                
                
                (6,153
                )Proceeds
      from sale of assets to Bloomingdale’s
                
                
                33,435
                
                
                
                -Acquisition
      of Bailey Banks & Biddle
                
                
                -
                
                
                
                (5,559
                )Deferred
      charges and other assets
                
                
                (121
                )
                
                
                (23
                )NET
      CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
                
                
                32,814
                
                
                
                (11,735
                )CASH
      FLOWS FROM FINANCING ACTIVITIESProceeds
      from revolving credit facility
                
                
                96,816
                
                
                
                240,816Principal
      payments on revolving credit facility
                
                
                (204,407
                )
                
                
                (167,434
                )Capitalized
      financing costs
                
                
                (6,000
                )
                
                
                -Bank
      overdraft
                
                
                963
                
                
                
                10,287Purchase
      of treasury stock
                
                
                (2
                )
                
                
                (12
                )NET
      CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
                
                
                (112,630
                )
                
                
                83,657INCREASE
      IN CASH AND CASH EQUIVALENTS
                
                
                1,300
                
                
                
                32CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                
                
                3,414
                
                
                
                5,358CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                
                $
                4,714
                
                
                $
                5,390SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid
                
                $
                6,433
                
                
                $
                4,010Income
      taxes paid (refunded)
                
                $
                (8,624
                )
                
                $
                211SUPPLEMENTAL
      DISCLOSURE OF NON-CASH ACTIVITIES:Award
      of vested participant restricted stock units
                
                $
                -
                
                
                $
                30Accrual
      for purchases of fixed assets
                
                $
                -
                
                
                $
                1,060





(a)
Excludes $28,943 of inventory sold to Bloomingdale’s reflected in investing
activities.





The
accompanying notes are an integral part of these consolidated financial
statements.


5





FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
1 – MANAGEMENT’S STRATEGIC PLAN AND LIQUIDITY ISSUES





General





The
accompanying unaudited consolidated financial statements of Finlay Enterprises,
Inc. (the “Company,” the “Registrant,” “we,” “us” and “our”), and our
wholly-owned subsidiary, Finlay Fine Jewelry Corporation and its wholly-owned
subsidiaries (“Finlay Jewelry”), have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information.  References to “Finlay” mean
collectively, the Company and Finlay Jewelry.  In the opinion of
management, the accompanying unaudited consolidated financial statements contain
all adjustments necessary to present fairly our financial position as of May 2,
2009, and our results of operations and cash flows for the thirteen weeks ended
May 2, 2009 and May 3, 2008. Due to the seasonal nature of our business, results
for interim periods are not indicative of annual results.  The
unaudited consolidated financial statements have been prepared on a basis
consistent with that of the audited consolidated financial statements as of
January 31, 2009 referred to below. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted pursuant to the rules and regulations of the Securities and
Exchange Commission (the “Commission”).





These consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K for the fiscal year
ended January 31, 2009 (“Form 10-K”) previously filed with the
Commission.





As a
result of the decline in our licensed department store based business over the
past several years coupled with challenging economic conditions in 2008 and
2009, we announced in February 2009, our plan to exit the licensed department
store based business. In addition, we anticipate closing approximately half of
our specialty jewelry stores in 2009.  The implementation of this
strategic plan will result in a significant reduction in our sales. The plan
includes the liquidation of inventory and the termination of license agreements
or leases in the affected department store based fine jewelry departments and
specialty jewelry stores.





We view
the execution of this strategic plan as crucial to strengthening the financial
condition of our specialty jewelry store business. We are in the process of
reducing our cost structure to levels appropriate to support the specialty
jewelry store business, which includes significantly reducing headcount in our
administrative and distribution center functions as well as eliminating sales
associate positions in the affected department stores and specialty store
locations. By the end of May 2009, approximately 2,100 employees either left or
were severed from the Company. We expect to complete our strategic plan by the
end of 2009.





In
conjunction with the adoption of this strategic plan, Finlay Jewelry amended its
revolving credit agreement (the “Revolving Credit Agreement”) in February 2009,
as adjusted in March 2009, to reduce the senior secured revolving line of credit
from $550.0 million to $266.6 million (the “Revolving Credit Facility”) and to
increase the interest rates thereunder. The amendment also requires us to comply
with various milestones in connection with the strategic plan, to provide
additional financial reporting to the lenders and to maintain compliance with a
variance covenant from the approved restructuring
budget.   Additionally, the Revolving Credit Agreement now
matures in February 2010 instead of the previous maturity date of November 2012.
The net sales proceeds from the liquidation of inventory are being used to repay
our outstanding balance under Finlay Jewelry’s Revolving Credit Facility in
2009.





Effective
with the February 2009 amendment to the Revolving Credit Agreement, we are
required to achieve certain weekly targeted percentages of our sales and cash
receipts and maintain cash disbursements below certain targeted percentages as
set forth in our operating plan, and we are currently in default of this
covenant. Although the lenders reserve all rights and remedies under the
Revolving Credit Agreement and can accelerate repayment of the outstanding
balance at any time, they have not exercised such rights at this time other than
to impose the default interest rate under the Revolving Credit Agreement
effective June 1, 2009.  Refer to Note 13 for a further discussion of
the default interest rate.  As a result of cross-default provisions,
an acceleration would enable the holders of our long-term debt to declare a
default and demand repayment as well.  As the long-term debt is not
callable by its holders as of May 2, 2009, it is not classified as a current
liability at such date.


6


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
1 – MANAGEMENT’S STRATEGIC PLAN AND LIQUIDITY ISSUES (continued)





There can
be no assurances that we will be able to obtain alternate financing on terms
acceptable to us. In the event that we are unable to secure adequate borrowing
under the Revolving Credit Agreement or an alternate financing source, our cash
flows from operations may be inadequate to meet our obligations, which may
prevent us from operating.





Our
ability to continue as a going concern is dependent on the successful
implementation of our strategic plan, the repayment of the amounts due under the
Revolving Credit Facility and our ability to obtain a new line of credit on or
before the maturity date of the Revolving Credit Agreement.  In
addition, we experienced a significant operating loss in 2008, we have incurred
an operating loss in the first quarter of 2009, and we are expected to incur
operating losses for the remainder of 2009. As discussed above, we are in
default of certain covenants under the Revolving Credit Agreement. These
uncertainties raise substantial doubt about our ability to continue as a going
concern. The accompanying consolidated financial statements do not include any
adjustments to reflect possible future effects on the recoverability and
classification of assets or the amounts and the classifications of liabilities
that may result should we be unable to continue as a going concern.





On March
22, 2009, we completed the sale of certain assets to Bloomingdale’s. The assets
included inventory and fixed assets for the 34 departments that we operated in
Bloomingdale’s for a purchase price of approximately $33.4
million.  The proceeds from this transaction were used to pay-down a
portion of the outstanding balance under Finlay Jewelry’s Revolving Credit
Facility.





Results
of continuing operations for the period ended May 2, 2009 exclude the results
from our licensed department stores that closed in the first quarter of 2009
and, for the period ended May 3, 2008, exclude the results from our licensed
department stores that closed in the first quarter of 2009 and stores which
closed in 2008, which have been classified as discontinued operations in
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets.” Refer to Note
4 for a further discussion of locations that closed.





NOTE
2 - SIGNIFICANT ACCOUNTING POLICIES





Consolidation:
The accompanying consolidated financial statements include the accounts of the
Company and our wholly-owned subsidiary, Finlay Jewelry. Intercompany accounts
and transactions have been eliminated in consolidation.





Use of
Estimates: The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates include
merchandise inventories, vendor allowances, useful lives of finite-lived assets,
accounting for acquisitions, the valuation of self-insurance reserves, income
taxes and other accruals. Actual results may differ from those
estimates.





Merchandise
Inventories:Consolidated inventories are stated at the lower of cost or
market determined by the last-in, first-out (“LIFO”) method using internally
developed indices.  Inventory is reduced for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
the estimated market value based upon assumptions about future demand and market
conditions.


7





FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 - SIGNIFICANT ACCOUNTING POLICIES (continued)





Vendor
Allowances: We receive allowances from our vendors through a variety of
programs and arrangements, including cooperative advertising. Vendor allowances
are recognized as a reduction ofcost of sales upon the
sale of merchandise or SG&A when the purpose for which the vendor funds were
intended to be used has been fulfilled. Accordingly, a reduction in vendor
allowances received would increase our cost of sales and/or
SG&A.





Vendor
allowances have been accounted for in accordance with Emerging Issues Task Force
(“EITF”) Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for
Cash Consideration Received from a Vendor” (“EITF No. 02-16”). EITF No. 02-16
addresses the accounting treatment for vendor allowances and provides that cash
consideration received from a vendor should be presumed to be a reduction of the
prices of the vendors’ product and should therefore be shown as a reduction in
the purchase price of the merchandise. Further, these allowances should be
recognized as a reduction in cost of sales when the related product is sold. To
the extent that the cash consideration represents a reimbursement of a specific,
incremental and identifiable cost, then those vendor allowances should be used
to offset such costs.





At May 2, 2009 and January 31, 2009,
deferred vendor allowances totaled $3.3 million and $5.4 million, respectively,
for owned merchandise, which allowances are included as an offset to merchandise
inventories on the Consolidated Balance Sheets.





Net Income (Loss)
Per Share: Net income (loss) per share has been computed in accordance
with SFAS No. 128, “Earnings per Share”.  Basic and diluted net income
(loss) per share were calculated using the weighted average number of shares
outstanding during each period, with options to purchase common stock, par value
$0.01 per share (“Common Stock”), restricted stock and restricted stock units,
included in diluted net income (loss) per share, using the treasury stock
method, to the extent that such stock options, restrictedstock and restricted
stock units were dilutive. As we had a loss from continuing operations for the
thirteen weeks ended May 2, 2009 and May 3, 2008, the stock options, restricted
stock and restricted stock units are not considered in the calculation of
diluted net income (loss) per share due to their anti-dilutive effect. As a
result, the weighted average number of shares outstanding used for both the
basic and diluted net income (loss) per share calculations was the same. Total
stock options, restricted stock and restricted stock units outstanding were
1,190,189 and 1,347,016 at May 2, 2009 and May 3, 2008, respectively, at prices
ranging from $2.71 to $24.31 per share in each period.





Deferred
Financing Costs: Deferred financing costs are amortized over the term of
the related debt agreements using the straight line method, which approximates
the effective interest method. Net deferred financing costs totaled $12.6
million at May 2, 2009 and $18.6 million at January 31, 2009, net of accumulated
amortization of $12.0 million and $6.6 million, respectively. The deferred
financing costs are
reflected  as  a  component  of  Deferred  charges  and  other
assets,  net in the accompanying Consolidated Balance Sheets.
Amortization of deferred financing costs for the thirteen weeks ended May 2,
2009 and May 3, 2008 totaled $2.2 million and $0.5 million, respectively, and
have been recorded as a component of Interest expense, net in the accompanying
Consolidated Statements of Operations. During the thirteen weeks ended May 2,
2009, as a result of the February 2009 amendment to reduce the Revolving Credit
Agreement from $550.0 million to $266.6 million, we recorded a $3.1 million
write-off of deferred financing costs, which is included in Interest expense,
net.





Discontinued
Operations:We account for closing stores as discontinued operations when
the operations and cash flows of a store being disposed of are eliminated from
on-going operations and we do not have any significant continuing involvement in
its operations. In reaching the determination as to whether the cash flows of a
store will be eliminated from on-going operations, we consider whether it is
likely that customers will migrate to similar stores in the same geographic
market, and our analysis includes an evaluation of the proximity to the disposed
store.


8


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
2 - SIGNIFICANT ACCOUNTING POLICIES (continued)





Intangible
Assets:As a result of our acquisitions in recent years, tradenames and
other intangible assets were recorded and are included in deferred charges and
other assets, net in the accompanying Consolidated Balance Sheets. Indefinite
lived intangible assets, consisting of tradenames, are tested for impairment
each year or as impairment indicators arise in accordance with SFAS No. 142,
“Goodwill and Other Intangible Assets”.





Accounting
Standards Adopted in 2009: On February 3, 2008, we adopted certain
provisions of SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which
establishes a single authoritative definition of fair value, sets a framework
for measuring fair value and expands on required disclosures about fair value
measurement. The provisions of SFAS No. 157 related to financial assets and
liabilities as well as other assets and liabilitiescarried
at fair value on a recurring basis did not have any effect on our consolidated
financial statements. The provisions of SFAS No. 157 related to other
nonfinancial assets and liabilities carried at fair value on a nonrecurring
basis, were effective for the Company on February 1, 2009 and did not have any
effect on our consolidated financial statements.





In April
2008, the Financial Accounting Standards Board (“FASB”) issued Staff Position
No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No.
142-3”). FSP No. 142-3 amends the factors that should be considered in
developing renewal or extension assumptions used to determine the useful life of
a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible
Assets”. We will apply the provisions of this statement prospectively to
business combinations for which the acquisition date is on or after February 1,
2009, although we can only assess the impact of the standard once an acquisition
is consummated.





NOTE
3 - DESCRIPTION OF BUSINESS





We
conduct business through our wholly-owned subsidiary, Finlay
Jewelry.  We operate luxury stand-alone jewelry stores on a national
basis and we are in the process of liquidating the licensed fine jewelry
departments which we currently operate in major department stores throughout the
United States. As discussed in Note 1, we announced in February 2009 our plan to
exit the licensed department store based business. In addition, we anticipate
closing approximately half of our specialty jewelry stores by the end of 2009.
All references herein to “departments” refer to fine jewelry departments
operated pursuant to license agreements with host stores and all references
herein to “stand-alone jewelry stores” refer to our specialty jewelry stores,
consisting of Bailey Banks & Biddle, Carlyle & Co. Jewelers LLC
(“Carlyle”) and L. Congress, Inc. (“Congress”).





Finlay
Jewelry currently operates 68 Bailey Banks & Biddle specialty jewelry stores
(including one Zell Bros. store) in 24 states with a focus on the luxury market
offering jewelry and watches under high-end brand names. Finlay Jewelry also
currently operates 34 Carlyle specialty jewelry stores which sell luxury priced
jewelry in nine states under the Carlyle & Co., J.E. Caldwell & Co. and
Park Promenade tradenames and five Congress specialty jewelry stores in
Southwest Florida.





NOTE
4 – DISCONTINUED OPERATIONS AND OTHER





In
February 2008, Macy’s announced its integration plans including a divisional
realignment. As a result of Macy’s corporate restructuring initiatives, 93
departments were closed at the end of 2008. Total sales generated from these
departments in 2008 were $108.5 million.





Additionally,
in February 2008, we received notification that Finlay Jewelry’s license
agreement with Lord & Taylor would not be renewed and Finlay Jewelry closed
a total of 36 Lord & Taylor departments in April 2009.  In March
2009, we completed the sale of certain assets to Bloomingdale’s and we ceased to
operate their departments. Furthermore, we closed a significant portion of the
Dillard’s and Bon-Ton departments that we operated. During the thirteen weeks
ended May 2, 2009, the departments we closed were as follows:


9





FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
4 – DISCONTINUED OPERATIONS AND OTHER (continued)




Store Group
                  
                  Number of
                    LocationsBon-Ton
                  
                  
                  72Dillard’s
                  
                  
                  52Lord
      & Taylor
                  
                  
                  36Bloomingdale’s
                  
                  
                  34194





The
results for these departments are included in discontinued operations in the
accompanying Consolidated Statements of Operations for the thirteen weeks ended
May 2, 2009 and May 3, 2008, respectively.




Thirteen Weeks EndedMay 2,
                          2009
                        
                        May 3,
                          2008(in thousands)Sales
                        
                        $
                        21,534
                        
                        
                        $
                        63,040Income
      (loss) before income taxes (1) (2)
                        
                        
                        (3,352
                        )
                        
                        
                        1,464Discontinued
      operations, net of tax of $0.6 million in 2008
                        
                        
                        (3,352
                        )
                        
                        
                        888







(1)
            Includes
      an allocation of $0.1 million and $0.5 million of interest expense related
      to the Revolving Credit Agreement for 2009 and 2008,
      respectively.


(2)
            The
      results of operations of the closed departments excludes allocations of
      general and administrative expenses and interest expense related to the
      Senior Notes and the Secured Notes.





In
conjunction with the licensed department store closings, as of May 2, 2009, we
reduced headcount by approximately 190 positions in our administrative and
distribution center functions and have eliminated approximately 1,900 sales
associate positions in our field operations. The following is a summary of the
activity in the accrual established for severance charges for our field
operations, corporate office and distribution center functions (in
thousands):




Severance and
                    Termination
                    BenefitsBalance
      at February 2, 2008
                  
                  $
                  117Charges
                  
                  
                  1,776Payments
                  
                  
                  (612
                  )Balance
      at January 31, 2009
                  
                  
                  1,281Charges
                  
                  
                  1,571Payments
                  
                  
                  (911
                  )Balance
      at May 2, 2009
                  
                  $
                  1,941





NOTE
5 - MERCHANDISE INVENTORIES





Merchandise
inventories consisted of the following:




May
      2,
                      2009
                    
                    
                    January
      31,
                      2009(in
      thousands)Jewelry
      goods – rings, watches and other fine jewelry(first-in, first-out
      (“FIFO”)  basis) (a)
                    
                    $
                    348,072
                    
                    
                    $
                    491,616Less:  Excess
      of FIFO cost over LIFO inventory value
                    
                    
                    32,233
                    
                    
                    
                    48,878$
                    315,839
                    
                    
                    $
                    442,738







(a)
            Merchandise
      inventories, on a FIFO basis, include $240.3 million and $277.5 million,
      respectively, at May 2, 2009 and January 31, 2009 related to our
      stand-alone jewelry stores.





We
determine our LIFO inventory value by utilizing internally developed
indices.  In the current year, the LIFO method had the effect of
decreasing cost of sales and net loss for the thirteen weeks ended May 2, 2009
by $16.6 million as a result of the liquidation of inventory carried at lower
costs prevailing in prior years in the licensed departments. In the prior
comparable period, the LIFO method amounted to a $2.2 million increase in cost
of sales.


10


FINLAY
ENTERPRISES, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS





NOTE
5 - MERCHANDISE INVENTORIES (continued)





Approximately
$21.0 million and $126.4 million at May 2, 2009 and January 31, 2009,
respectively, of merchandise received on consignment is not included in
merchandise inventories and accounts payable-trade in the accompanying
Consolidated Balance Sheets.





NOTE
6 – SHORT AND LONG TERM DEBT





In
November 2007, Finlay Jewelry replaced its existing revolver with a new
five-year Revolving Credit Agreement with certain banks to provide financing in
the form of a senior secured revolving line of credit up to $550.0
million.  Finlay Jewelry amended its Revolving Credit Agreement in
February 2009, as adjusted in March 2009, to reduce the revolving line of credit
from $550.0 million to $266.6 million and to increase the  interest
rates thereunder. The Revolving Credit Agreement provides us with a $229.1
million (“Tranche A”) and $37.5 million (“Tranche B”) Revolving Credit Facility.
The amendment also requires us to comply with various milestones in connection
with the strategic plan, to provide additional financial reporting to the
lenders and to maintain compliance with a variance covenant from the approved
restructuring budget. Additionally, the Revolving Credit Agreement now matures
in February 2010.





As stated
in the February 2009 amendment to the Revolving Credit Agreement, we are in
default of the weekly financial covenants.  In addition, our
management has determined that there is substantial doubt about our ability to
continue as a going concern, and as a result, the independent auditor’s report
accompanying our Form 10-K contains a going concern explanatory paragraph, which
also constitutes a default under our Revolving Credit Agreement.





As a
result of these defaults, the lenders under the Revolving Credit Agreement are
no longer obligated to permit us to borrow under the facility or issue letters
of credit for our account.  We received a letter dated as of March 12,
2009, from General Electric Capital Corporation (as agent under the Revolving
Credit Agreement) (“GE”), pursuant to which GE, on behalf of all the lenders,
reserved all rights and remedies under the Revolving Credit Agreement. GE and
the lenders may, but are not obligated to, continue to issue letters of credit
and permit us to borrow under the Revolving Credit Facility and GE and the
lenders may terminate the Revolving Credit Agreement and/or demand immediate
repayment at any time.





Effective
February 25, 2009, the loans under Tranche A bore interest at a floating rate
equal to a margin of 3.00% over the Index Rate or 4.75% over LIBOR (London
Interbank Offer Rate).  Additionally, the loans under Tranche B bore
interest at a floating rate equal to a margin of 5.50% over the Index Rate or
7.25% over LIBOR. Prior to February 25, 2009, the loans under Tranche A bore
interest in accordance with a graduated pricing matrix based on the average
excess availability under the facility for the previous quarter. Additionally,
the loans under Tranche B bore interest at a floating rate equal to a margin of
3.50% over the Index Rate or 5.25% over LIBOR. The Index Rate is equal to the
higher of (i) the federal funds rate plus 125 basis points and (ii) the publicly
quoted rate as published by the Wall Street Journal as the “prime
rate”.  The Revolving Credit Agreement has a $75.0 million letter of
credit sub-limit, which reduces availability when utilized. The weighted average
interest rate was 5.2% and 5.5% for the thirteen weeks ended May 2, 2009 and May
3, 2008, respectively.





As of May
2, 2009, the Revolving Credit Agreement was limited by a borrowing base computed
primarily on the balance of Finlay Jewelry’s inventory and accounts receivable
and is secured by a first priority perfected security interest in all of Finlay
Jewelry’s (and any subsidiary’s) present and future tangible and intangible
assets. The Revolving Credit Agreement contains customary covenants, including
limitations on or relating to liens, indebtedness, investments, mergers,
acquisitions, affiliate transactions, management compensation and the payment of
dividends and other restricted payments. Furthermore, the Revolving Credit
Agreement includes a requirement to maintain an unused balance of not less than
$30.0 million at all times.


11


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
6 – SHORT AND LONG TERM DEBT (continued)





At May 2,
2009 and January 31, 2009, $128.7 million and $236.2 million was outstanding
under the Revolving Credit Facility, at which point the available borrowings
were $57.7 million and $42.7 million, respectively ($27.7 million and $12.7
million, respectively, of excess availability after taking into consideration
the $30.0 million minimum unused balance requirement discussed above). The
average       amounts outstanding were $190.1
million and $282.8 million for the thirteen weeks ended May 2, 2009 and May 3,
2008, respectively. Our lowest level of availability during the thirteen weeks
ended May 2, 2009 was $33.2 million, at which point outstanding borrowings under
the Revolving Credit Facility were $217.8 million ($3.2 million of excess
availability after taking into consideration the $30.0 million minimum unused
balance requirement discussed above).





Refer
to Note 13 for a discussion of a subsequent event relating to the Revolving
Credit Agreement.





At
both May 2, 2009 and January 31, 2009, we had outstanding letters of credit
totaling $8.5 million to guarantee various trade activities. The contract
amounts of the letters of credit approximate their fair value.





Long-term debt consisted of the
following:




May 2,
                    2009
                  
                  
                  January 31,
                    2009(in thousands)Senior
      Notes (a)
                  
                  $
                  40,582
                  
                  
                  $
                  40,582Second
      Lien Notes (b)
                  
                  
                  24,025
                  
                  
                  
                  23,334Third
      Lien Notes (b)
                  
                  
                  172,755
                  
                  
                  
                  169,031Total
                  
                  $
                  237,362
                  
                  
                  $
                  232,947





(a)
            The
      fair value of the Senior Notes, determined based on market quotes, was
      approximately $1.6 million at both May 2, 2009 and January 31,
      2009.


(b)
            It
      was not practicable to estimate the fair value of the Secured Notes
      (defined below) as there is no readily available market value and current
      rates for similar debt could not be
determined.





During
2004, Finlay Jewelry completed the sale of 8-3/8% Senior Notes, due June 1,
2012, having an aggregate principal amount of $200.0 million (the “Senior
Notes”).  Refer to Note 13 for a discussion of a subsequent event
relating to the Senior Notes. Interest on the Senior Notes is payable
semi-annually on June 1 and December 1 of each year. Finlay Jewelry incurred
approximately $5.2 million in costs associated with the sale of the Senior
Notes, of which $5.0 million was deferred and is being amortized over the term
of the Senior Notes.





In
November and December 2008, Finlay Jewelry executed several agreements (the
“Exchange and Purchase Agreements”) to exchange its Senior Notes held by certain
noteholders (the “Participating Noteholders”) for new 8.375%/8.945% Senior
Secured Third Lien Notes due June 1, 2012 (the “Third Lien Notes”).  In
addition, the Participating Noteholders purchased new 11.375%/12.125% Senior
Secured Second Lien Notes due June 1, 2012 (the “Second Lien Notes,” together
with the Third Lien Notes, the “Secured Notes”).





As part
of this transaction, the Participating Noteholders, who beneficially owned or
had investment management authority of approximately 80.0% of the Senior Notes,
(a) exchanged $159.4 million in principal amount of their Senior Notes for new
Third Lien Notes, and (b) purchased $22.8 million in principal amount of new
Second Lien Notes.





Interest
on the Secured Notes is payable semi-annually in arrears on June 1 and December
1 of each year.  Interest on the Second Lien Notes began to accrue as of
the issuance date and is payable beginning on June 1, 2009 in pay-in-kind
interest, or “PIK Interest,” at 12.125% per annum from the issuance date until
December 1, 2010, and thereafter in cash at 11.375% per annum.  Interest on
the Third Lien Notes began to accrue PIK Interest at 8.945% per annum as of June
1, 2008, which was paid in PIK Interest on December 1, 2008, and will be payable
in PIK Interest at 8.945% per annum from December 2, 2008 until December 1,
2010, and thereafter in cash at 8.375% per annum.  The PIK Interest on
the Secured Notes is payable upon maturity of the Secured Notes. Interest on the
Senior Notes continues to be payable in cash semi-annually on June 1 and
December 1 of each year.


12


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
6 – SHORT AND LONG TERM DEBT (continued)





As of May
2, 2009, there were approximately $196.8 million of Secured Notes outstanding
and $40.6 million of Senior Notes outstanding. The refinancing of the Senior
Notes enables Finlay Jewelry to eliminate $13.4 million of the cash interest
payment of $16.8 million that would have been payable annually on the Senior
Notes as the Secured Notes include PIK Interest until December 1,
2010.




The
Senior Notes are unsecured senior obligations and rank equally in right of
payment with all of the existing and future unsubordinated indebtedness of
Finlay Jewelry and senior to any future indebtedness of Finlay Jewelry that is
expressly subordinated to the Senior Notes. The Senior Notes are effectively
subordinated to Finlay Jewelry’s secured indebtedness, including obligations
under its Revolving Credit Agreement, to the extent of the value of the assets
securing such indebtedness, and effectively subordinated to the indebtedness and
other liabilities (including trade payables) of its subsidiaries. Finlay Jewelry
may redeem the Senior Notes, in whole or in part, at specified redemption
prices, plus accrued and unpaid interest, if any, to the date of the redemption.
Upon certain change of control events, each holder of the Senior Notes may
require Finlay Jewelry to purchase all or a portion of such holder's Senior
Notes at a purchase price equal to 101.0% of the principal amount thereof, plus
accrued interest to the purchase date.


The
Secured Notes are guaranteed on a senior basis by substantially all of Finlay
Jewelry’s wholly- owned subsidiaries and the Company.  The Second Lien
Notes are secured by perfected second priority liens and the Third Lien Notes
are secured by perfected third priority liens in the assets of all of Finlay
Jewelry’s wholly-owned subsidiaries and the Company.





The
indentures governing the Senior Notes and Secured Notes contain restrictions
relating to, among other things, the payment of dividends, redemptions or
repurchases of capital stock, the incurrence of additional indebtedness, the
making of certain investments, the creation of certain liens, the sale of
certain assets, entering into transactions with affiliates, engaging in mergers
and consolidations and the transfer of all or substantially all
assets.





In
connection with our strategic plan, a majority of the holders of the Third Lien
Notes entered into agreements with us and a majority of our trade vendors for
$24.9 million of trade accounts payable to be secured in accordance with the
terms of the Third Lien Notes. In addition, these trade vendors agreed to a
deferred payment schedule through August 2009 of the outstanding amounts. As a
result of an amendment to the agreements, the deferred payment schedule now
extends through October 2009. Refer to Note 13 for a discussion of the deferral
of such payments through October 2009.





Interest
expense, net for the thirteen weeks ended May 2, 2009 and May 3, 2008 was $13.1
million and $8.2 million, respectively.





NOTE
7 – INCOME TAXES





In
accordance with the FASB Interpretation No. 48, “Accounting for Uncertainty
in Income Taxes – an Interpretation of FASB Statement No. 109” (“FIN 48”), the
Company had unrecognized tax benefits of $1.5 million at both May 2, 2009 and
January 31, 2009. Included in the balance are $1.3 million of unrecognized tax
benefits that, if recognized, would affect the annual effective income tax
rate.


13


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
7 – INCOME TAXES (continued)





For
income tax reporting purposes, we have an October 31 year end. The Company files
a consolidated federal income tax return with Finlay Jewelry and its
wholly-owned subsidiaries and numerous consolidated and separate income tax
returns in many state and local jurisdictions. The tax years 2003 through 2008
remain open to examination by the major taxing jurisdictions to which we are
subject.  The Company recognizes accrued interest and penalties
related to unrecognized tax benefits in income tax expense, which is a
continuation of the Company’s historical accounting
policy.  Approximately $0.3 million in potential interest and
penalties are included as a component of the $1.5 million unrecognized tax
benefits at both May 2, 2009 and January 31, 2009. During the thirteen weeks
ended May 2, 2009, no unrecognized tax benefits were recognized as a result of
an expired statute of limitations. The Company anticipates $0.3 million of
unrecognized tax benefits will be recognized as a result of the settlement of
audits and the expiration of the statute of limitations prior to May 2, 2010. In
February 2009, we received $8.7 million from the Internal Revenue Service
related to net operating losses in the October 2008 federal tax
return.





A
valuation allowance against deferred tax assets is required when it is more
likely than not that a tax benefit will not be realized. Due to continued
losses, a valuation allowance in the amount of $28.6 million and $17.4 million
was required at May 2, 2009 and January 31, 2009, respectively.





NOTE
8 – STOCK-BASED COMPENSATION





Stock
options outstanding under our stock incentive plans have been granted at prices
which are equal to the market value of our stock on the date of grant, generally
vest over three or five years and expire no later than ten years after the grant
date. During the thirteen weeks ended May 2, 2009 and May 3, 2008, we recognized
approximately $30,000 in stock-based compensation expense in each
period.





There
were no options cancelled, granted or exercised during the thirteen weeks ended
May 2, 2009.  The following table summarizes information with respect
to stock options outstanding and stock options exercisable at May 2,
2009:




Options OutstandingNumber
                      Outstanding
                    
                    
                    Wtd. Avg.
                      Ex. Price
                    
                    
                    Wtd. Avg.
                      Remaining
                      Contractual Life
                    
                    
                    Aggregate
                      Intrinsic
                      Value (000’s) (1)Outstanding
      at May 2, 2009
                    
                    
                    658,300
                    
                    
                    $
                    7.46
                    
                    
                    
                    4.45
                    
                    
                    $
                    -Exercisable
      at May 2, 2009
                    
                    
                    496,633
                    
                    
                    $
                    9.13
                    
                    
                    
                    3.05
                    
                    
                    $
                    -




(1)
              The
      aggregate intrinsic values in the table above are based on the closing
      price of our Common Stock as of the last business
      day       of the periods ended May 2,
      2009 and January 31, 2009, which were $0.11 and $0.03,
      respectively.





The
following table summarizes the changes in restricted stock outstanding during
the thirteen weeks ended May 2, 2009:




Restricted
                    Stock
                  
                  
                  Wtd. Avg.
                    Grant Date
                    Fair ValueBalance
      at January 31, 2009
                  
                  
                  1,046
                  
                  
                  $
                  8.70Vested
                  
                  
                  (1,046
                  )
                  
                  
                  8.70Balance
      at May 2, 2009
                  
                  
                  -
                  
                  
                  $
                  -





During
the thirteen weeks ended May 2, 2009 and May 3, 2008, total amortization expense
of restricted stock was $1,000 and $0.1 million, respectively.





The
following table summarizes the changes in restricted stock units (“RSUs”)
outstanding, including nonvested RSUs, during the thirteen weeks ended May 2,
2009:





RSUs(1)
                  
                  
                  Wtd. Avg.
                    Grant Date
                    Fair Value
                    Per AwardBalance
      at January 31, 2009
                  
                  
                  539,256
                  
                  
                  $
                  5.76Granted
                  
                  
                  117,389
                  
                  
                  
                  0.42Cancelled
                  
                  
                  (11,723
                  )
                  
                  
                  13.08Shares
      issued
                  
                  
                  (113,033
                  )
                  
                  
                  7.78Balance
      at May 2, 2009
                  
                  
                  531,889
                  
                  
                  $
                  3.99





(1)
            Refer
      to Note 9 for additional information regarding
  RSUs.


14


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
8 – STOCK-BASED COMPENSATION (continued)




During
the thirteen weeks ended May 2, 2009 and May 3, 2008, total amortization expense
of RSUs was $0.1 million and $0.2 million, respectively.





NOTE
9 – EXECUTIVE AND DIRECTOR DEFERRED COMPENSATION AND STOCK


PURCHASE
PLANS





In April
2003, the Board of Directors adopted the Executive Deferred Compensation and
Stock Purchase Plan (the “Executive Plan”) and the Director Deferred
Compensation and Stock Purchase Plan (the “Director Plan”, and together with the
Executive Plan, the “RSU Plans”), which were approved by our stockholders on
June 19, 2003. Under the RSU Plans, key executives and non-employee directors,
as directed by our Compensation Committee, were eligible to acquire RSUs. An RSU
is a unit of measurement equivalent to one share of Common Stock, but with none
of the attendant rights of a share of Common Stock. Two types of RSUs were
awarded under the RSU Plans: (i) participant RSUs, where a  plan
participant elected to defer, in the case of an executive employee, a portion of
his or her actual or target bonus, and in the case of a non-employee director,
his or her retainer fees and Committee chairmanship fees and receive
RSUs  in  lieu  thereof,  and (ii)
matching RSUs, where we credited a participant’s plan account with one matching
RSU for each participant RSU that a participant elected to purchase. While
participant RSUs are fully vested at all times, matching RSUs are subject to
vesting and forfeiture as set forth in the RSU Plans. At the time of
distribution under the RSU Plans, RSUs are converted into actual shares of
Common Stock. As of May 2, 2009, 531,889 RSUs were outstanding under the RSU
Plans.





The
shares of Common Stock issued upon distribution of RSUs under the RSU Plans are
provided by the Company’s 2007 Long Term Incentive Plan (the “2007
Plan”).  As a result of the unavailability of shares of Common Stock
under the 2007 Plan, effective as of May 22, 2008, the RSU Plans were amended to
provide that no new deferral agreements may be entered into after May 22, 2008
and that any executive deferral agreements regarding the 2008 bonus payable on
April 25, 2009 were effectively cancelled and such bonus amounts were paid to
the participants in cash on April 25, 2009, and that cash, rather than RSUs,
were paid for eligible directors’ fees deferred with respect to the third and
fourth quarters of 2008. In addition, no additional matching awards will be made
under the RSU Plans after May 22, 2008.





NOTE
10 – SEGMENT INFORMATION





In
accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and
Related Information”, we currently have two reporting segments: department store
based fine jewelry departments and stand-alone specialty jewelry stores. The
accounting policies of the segments are generally the same as those described in
Note 2. There are no intercompany sales between the segments.


15


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
10 – SEGMENT INFORMATION (continued)









Thirteen Weeks EndedMay 2, 2009
                
                
                May 3, 2008Department
      Store
                  Based
      Fine Jewelry
                  Departments
      (1)
                
                
                Stand-alone
                  Jewelry
                  Stores
                
                
                Total
                
                
                Department
      Store
                  Based
      Fine Jewelry
                  Departments
      (1)
                
                
                Stand-alone
                  Jewelry
                  Stores
                
                
                TotalSales
                
                $
                96,870
                
                
                $
                62,451
                
                
                $
                159,321
                
                
                $
                64,409
                
                
                $
                77,663
                
                
                $
                142,072Depreciation
      and amortization
                
                
                198
                
                
                
                1,096
                
                
                
                1,294
                
                
                
                2,285
                
                
                
                1,365
                
                
                
                3,650Loss
      from operations (2)
                
                
                (159
                )
                
                
                (12,102
                )
                
                
                (12,261
                )
                
                
                (9,545
                )
                
                
                (1,335
                )
                
                
                (10,880
                )Interest
      expense, net
                
                
                10,571
                
                
                
                2,485
                
                
                
                13,056
                
                
                
                5,235
                
                
                
                2,995
                
                
                
                8,230Benefit
      for income taxes
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (5,583
                )
                
                
                (1,628
                )
                
                
                (7,211
                )Total
      assets
                
                
                159,351
                
                
                
                270,672
                
                
                
                430,023
                
                
                
                408,678
                
                
                
                337,753
                
                
                
                746,431Capital
      expenditures
                
                
                -
                
                
                
                500
                
                
                
                500
                
                
                
                2,330
                
                
                
                3,823
                
                
                
                6,153







(1)
              Included
      in interest expense, net for the thirteen weeks ended May 2, 2009 is $5.0
      million related to the Senior Notes and Secured Notes. Additionally,
      included in interest expense, net for the thirteen weeks ended May 3, 2008
      is $4.2 million related to the Senior Notes. Refer to Note
    6.


(2)
              The
      LIFO method had the effect of decreasing the loss from operations by $16.6
      million or 12.1% in our licensed department store segment as we liquidated
      a substantial amount of inventory during the thirteen weeks ended May 2,
      2009, in connection with our strategic
plan.





NOTE
11 – LICENSE AGREEMENTS WITH DEPARTMENT STORES AND LEASE


AGREEMENTS





Our
operating leases consist primarily of office space rentals and the specialty
jewelry store locations, which leases expire on various dates through 2023. The
department store license agreements provide for the payment of fees based on
sales (i.e., contingent fees in the table below). Additionally, certain of the
specialty jewelry store leases require payment of contingent rent based on a
percentage of store sales in excess of a specified threshold. In connection with
our strategic plan, we anticipate closing approximately half of our specialty
jewelry stores and expect to incur significant lease termination costs.
Additionally, we have a number of leases for go forward specialty jewelry stores
that we intend to renegotiate with landlords.  License fees and lease
expense, included in SG&A, are as follows (in thousands):





Thirteen Weeks EndedMay 2,
                    2009
                  
                  
                  May 3,
                    2008(in thousands)Base
      rent
                  
                  $
                  10,379
                  
                  
                  $
                  9,835Contingent
      fees
                  
                  
                  15,752
                  
                  
                  
                  10,783Total
                  
                  $
                  26,131
                  
                  
                  $
                  20,618





NOTE
12 – COMMITMENTS, CONTINGENCIES AND OTHER





From time
to time, we are involved in legal proceedings, most of which arise out of our
operations in the normal course of business. As of June 12, 2009, we are not a
party to any legal proceedings that, individually or in the aggregate, are
reasonably expected to have a material adverse effect on our consolidated
financial statements. However, the results of these matters cannot be predicted
with certainty, and an unfavorable resolution of one or more of these matters
could have a material adverse effect on our consolidated financial
statements.





The
Senior Notes, the Secured Notes and the Revolving Credit Agreement currently
restrict the amount of annual distributions from Finlay Jewelry to
us.




16


FINLAY
ENTERPRISES, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
12 – COMMITMENTS, CONTINGENCIES AND OTHER (continued)




Our concentration of
credit risk consists principally of accounts receivable. In the department store
based jewelry departments, substantially all consumer credit risk is borne by
the host store rather than by us. During 2008, jewelry departments in store
groups owned by Macy’s accounted for approximately 41.0% of
our sales. During the thirteen weeks ended May 2, 2009, jewelry departments in
store groups owned by Macy’s accounted for approximately 39.0% of our
sales.  We believe that the inability of Macy’s to pay its receivables
could have a material adverse effect on our financial position or results of
operations.





In 2008, approximately 42.0% of sales
were generated by merchandise obtained from our ten largest vendors and
approximately 6.0% of sales were generated by merchandise obtained from our
largest vendor.





We have not provided any third-party
financial guarantees as of May 2, 2009.





Refer to Note 6 for a discussion of
letters of credit outstanding.





NOTE
13 – SUBSEQUENT EVENTS





Effective
June 1, 2009, the Revolving Credit Facility was further reduced by $50.0 million
decreasing the revolving line of credit to $216.6 million from $266.6 million.
Additionally, as a consequence of certain events of default referred to in Note
6, the lenders have imposed the default interest rate and any interest due and
payable shall be at a rate that is 2.00% in excess of the interest otherwise
payable under the Revolving Credit Agreement. Effective June 1, 2009, the loans
under Tranche A (up to $179.1 million) will bear interest at a floating rate
equal to a margin of 5.00% over the Index Rate or 6.75% over LIBOR.
Additionally, the loans under Tranche B (up to $37.5 million) will bear interest
at a floating rate equal to a margin of 7.50% over the Index Rate or 9.25% over
LIBOR.





In
February 2009, in connection with our strategic plan, a majority of the holders
of the Third Lien Notes entered into agreements with us and a majority of our
trade accounts payable vendors for $24.9 million of trade accounts payable to be
secured in accordance with the terms of the Third Lien Notes. At that time,
these trade vendors agreed to a deferred payment schedule through August 2009 of
the outstanding amounts. In May 2009, a significant number of these vendors
entered into an amendment to the agreement which calls for a delay of 60 days,
such that the deferred payment schedule now extends through October 2009. We
have paid the first two scheduled installments and three installment payments
are remaining through October 2009.





In
conjunction with the execution of our strategic plan, we have initiated a formal
process whereby parties may indicate their interest in our business or
assets.





On June
1, 2009, the semi-annual interest payment of $1.7 million was due to the holders
of the Senior Notes and was not paid by Finlay Jewelry. The indenture relating
to the Senior Notes provides for a 30-day grace period.  It
is unlikely that Finlay Jewelry will make the interest payment within
the grace period.  Failure to make the payment within the 30-day grace
period will trigger an event of default under the indenture relating to the
Senior Notes and an event of default under the Revolving Credit
Agreement.  If this were to occur, the trustee or the holders of at least
25% of the outstanding Senior Notes may declare the Senior Notes to be
immediately due and payable and the lenders under the Revolving Credit Agreement
may accelerate repayment of the current outstanding
balance.  Additionally, an acceleration of the Senior Notes will
constitute an event of default under the Secured Notes.


17


Item
2. Management’s
Discussion and Analysis of Financial Condition and Results
of


Operations




The
following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is organized as follows:




·
            Executive
      Overview –This section provides a general description of our
      business and a brief discussion of the opportunities, risks and
      uncertainties that we focus on in the operation of our
      business.





·
            Results of
      Operations –This section provides an analysis of the significant
      line items on the Consolidated Statements of
  Operations.





·
            Liquidity
      and Capital Resources –This section provides an analysis of
      liquidity, cash flows, sources and uses of cash and financial
      position.





·
            Seasonality
      –This
      section describes the effects of seasonality on our
    business.





·
            Critical
      Accounting Policies and Estimates –This section addresses those
      accounting policies that are considered important to our financial
      condition and results of operations, and require us to exercise subjective
      or complex judgments in their application. All of our significant
      accounting policies, including critical accounting policies, are
      summarized in Note 2 of Notes to the Consolidated Financial Statements
      included in our Form 10-K.





·
            Special
      Note Regarding Forward-Looking Statements –This section provides
      cautionary information about forward-looking statements and a description
      of certain risks and uncertainties that could cause actual results to
      differ materially from our historical results or current expectations or
      projections.





This
MD&A has been updated for the purpose of restating our financial statements
for stores which have been treated as discontinued operations.





Executive
Overview





We
currently have two operating segments – licensed department store based fine
jewelry departments and stand-alone specialty jewelry stores. Our licensed fine
jewelry departments are located in major department stores where we sell
moderately priced jewelry, with an average sales price of approximately $270 per
item. Our stand-alone specialty jewelry stores sell luxury priced jewelry at an
average sales price of approximately $1,275 per item. As of May 2, 2009, we
operated a total of 476 locations, including 369 department store based fine
jewelry departments in four host store groups, in 31 states, as well as 107
stand-alone jewelry stores operating as 68 Bailey Banks & Biddle stores in
24 states, 34 Carlyle stores in nine states and five Congress stores in
southwest Florida.





As a
result of the decline in our licensed department store based business over the
past several years coupled with challenging economic conditions in 2008 and
2009, we announced in February 2009, our plan to exit the licensed department
store based business. In addition, we anticipate closing approximately half of
our specialty jewelry stores in 2009. The implementation of our strategic plan
will result in a significant reduction in our sales from over $750.0 million
from our two business segments in 2008 to a go forward specialty jewelry store
business that is expected to achieve annual sales in the range of $150.0 million
to $200.0 million.  The plan includes the liquidation of inventory and the
termination of license agreements or leases in the affected department store
based fine jewelry departments and specialty jewelry stores.


18


We view
the execution of this strategic plan as crucial to strengthening the financial
condition of our specialty jewelry store business. We are in the process of
reducing our cost structure to levels appropriate to support the specialty
jewelry store business, which includes significantly reducing headcount in our
administrative and distribution center functions as well as eliminating sales
associate positions in the affected department stores and specialty store
locations. By the end of May 2009, we reduced headcount by approximately 190
positions in our administrative and distribution centers and have eliminated
approximately 1,900 sales associate positions in the licensed department store
based business. We expect to complete the strategic plan by the end of
2009.  In conjunction with the execution of our strategic plan, we
have initiated a formal process whereby parties may indicate their interest in
our business or assets.  There can be no assurances that the
implementation of our strategic plan will be successful or that the net sales
proceeds from the liquidation of inventory in the closing locations will be
sufficient to repay the outstanding balance under Finlay Jewelry’s Revolving
Credit Facility.





In
conjunction with the adoption of this strategic plan, Finlay Jewelry amended its
Revolving Credit Agreement in February 2009, as adjusted in March 2009, to
reduce the senior secured revolving line of credit from $550.0 million to $266.6
million and to increase the interest rates thereunder. The amendment also
requires us to comply with various milestones in connection with the strategic
plan, to provide additional financial reporting to the lenders and to maintain
compliance with a variance covenant from the approved restructuring budget.
Additionally, the Revolving Credit Agreement now matures in February 2010. The
net sales proceeds from the liquidation of inventory will be used to repay our
outstanding balance under Finlay Jewelry’s Revolving Credit Facility in 2009. As
a result of the liquidation in the locations we plan to close, the outstanding
balance under the Revolving Credit Facility has been reduced from $236.2 million
as of January 31, 2009 to $128.7 million as of May 2, 2009. At the end of May
2009, we had $75.2 million of availability ($45.2 million of excess availability
after taking into consideration the $30.0 million minimum unused balance
requirement under the Finlay Jewelry’s Revolving Credit Agreement), at which
point the outstanding borrowings under the Revolving Credit Facility were $96.9
million. Our lowest level of availability during the thirteen weeks ended May 2,
2009 was $33.2 million ($3.2 million of excess availability after taking into
consideration the $30.0 million minimum unused balance requirement under the
Revolving Credit Agreement), at which point the outstanding borrowings under the
Revolving Credit Agreement were $217.8 million. Refer to Note 6 of Notes to the
Consolidated Financial Statements.





Effective
with the February 2009 amendment to the Revolving Credit Agreement, we are
required to achieve certain weekly targeted percentages of our sales and cash
receipts and maintain cash disbursements below certain targeted percentages as
set forth in our operating plan, and we are currently in default of this
covenant.  Although the lenders reserve all rights and remedies under
the Revolving Credit Agreement and can accelerate repayment of the outstanding
balance at any time, they have not exercised such rights at this time other than
to impose the default interest rate effective June 1, 2009, as discussed
below.  As a result of cross-default provisions, an acceleration would
enable the holders of our long-term debt to declare a default and demand
repayment as well.





Effective
June 1, 2009, the Revolving Credit Facility was further reduced by $50.0
million, decreasing the revolving line of credit to $216.6 million, from $266.6
million. Additionally, as a consequence of certain events of default noted
above, the lenders have imposed the default interest rate and any interest due
and payable shall be at a rate that is 2.00% in excess of the interest otherwise
payable under the Revolving Credit Agreement. Effective June 1, 2009, the loans
under Tranche A (up to $179.1 million) will bear interest at a floating rate
equal to a margin of 5.00% over the Index Rate or 6.75% over LIBOR.
Additionally, the loans under Tranche B (up to $37.5 million) will bear interest
at a floating rate equal to a margin of 7.50% over the Index Rate or 9.25% over
LIBOR.





Our
ability to continue as a going concern is dependent on the successful
implementation of our strategic plan, the repayment of the amounts due under the
Revolving Credit Facility and our ability to obtain a new line of credit on or
before the maturity date of the Revolving Credit Agreement. In addition, we
experienced a significant operating loss in 2008, we have incurred an operating
loss in the first quarter of 2009, and we are expected to incur operating losses
for the reminder of 2009. As discussed above, we are in default of certain
covenants under the Revolving Credit Agreement. These uncertainties raise
substantial doubt about our ability to continue as a going
concern.


19





On March
22, 2009, we completed the sale of certain assets to Bloomingdale’s. The assets
included inventory and fixed assets for the 34 departments that we operated in
Bloomingdale’s for a purchase price of approximately $33.4
million.  The proceeds from this transaction were used to pay-down a
portion of the outstanding balance under Finlay Jewelry’s Revolving Credit
Facility.





With
respect to the exiting of the department store based business and the
anticipated closing of approximately half of our specialty jewelry stores in
2009, we expect to record a pre-tax charge in the range of $10.0 to $12.0
million for severance and retention costs, lease termination costs and other
items.  We incurred charges of $1.6 million for severance costs during
the thirteen weeks ended May 2, 2009.





In
connection with our strategic plan, a majority of the holders of the Third Lien
Notes entered into agreements with us and a majority of our trade vendors for
$24.9 million of trade accounts payable to be secured in accordance with the
terms of the Third Lien Notes. In addition, these trade vendors agreed to a
deferred payment schedule through August 2009 of the outstanding amounts. Refer
to Note 13 of Notes to the Consolidated Financial Statements for a discussion of
the deferral of such payments through October 2009.





First
Quarter Highlights





Total
sales were $159.3 million for the thirteen weeks ended May 2, 2009 compared to
$142.1 million for the thirteen weeks ended May 3, 2008, an increase of
12.1%.  Total sales for the first quarter of 2009 included $62.5
million of sales generated by our stand-alone jewelry stores compared to $77.7
million in the first quarter of 2008, a decrease which relates to a decline in
consumer spending in a continued weak economic environment. The increase in
total sales primarily related to increased sales volume as we liquidated
inventory at lower margins in our licensed department store based business.
Gross margin increased by $3.8 million compared to 2008, and, as a percentage of
sales, gross margin decreased by 2.4% from 43.6% to 41.2%.  The
decrease in gross margin as a percentage of sales, primarily relates to lower
margins at the licensed department stores scheduled to close as we liquidate
inventory. Furthermore, the LIFO method had the effect of increasing gross
margin for the thirteen weeks ended May 2, 2009 by $16.6 million or 12.1%, as we
liquidated a substantial amount of inventory as part of our strategic
plan.  SG&A increased $7.5 million, and, as a percentage of sales,
decreased 0.6%, from 48.7% to 48.1%, primarily due to the impact of higher sales
levels in the current period as compared to the prior year period. SG&A also
includes severance costs of $1.6 million for the reduction of headcount in our
administrative and distribution center functions as well as the elimination of
field personnel associated with the licensed department store
closings.  Furthermore, SG&A includes $2.5 million for consulting
fees associated with our strategic plan to restructure the business. The loss
from operations in our stand-alone jewelry stores of $12.1 million in the first
quarter of 2009 compared to a loss of $1.3 million in the prior year period was
attributable to a decrease in sales as a result of a decline in consumer
spending and a constant level of costs to operate the stand-alone jewelry
stores.





Borrowings
under the Revolving Credit Agreement decreased by $107.5 million at May 2, 2009
as compared to January 31, 2009, which reflects the pay-down of the revolving
credit facility from proceeds generated as we liquidate inventory in our
licensed department store based business. The proceeds from the sale of assets
to Bloomingdale’s of approximately $33.4 million, were used to pay-down a
portion of the outstanding balance under Finlay Jewelry’s Revolving Credit
Facility.  The lowest level of availability during the thirteen weeks
ended May 2, 2009 was $33.2 million ($3.2 million of excess availability after
taking into consideration the $30.0 million minimum unused balance requirement
under Finlay Jewelry’s Revolving Credit Agreement), at which point the
outstanding borrowings under the Revolving Credit Agreement were $217.8 million.
At the end of May 2009, we had $75.2 million of availability ($45.2 million of
excess availability after taking into consideration the $30.0 million minimum
unused balance requirement under the Finlay Jewelry’s Revolving Credit
Agreement), at which point the outstanding borrowings under the Revolving Credit
Facility were $96.9 million. Refer to Notes 1 and 6 of Notes to the Consolidated
Financial Statements.


20





Strategies
and Opportunities in the Specialty Jewelry Store Business





We plan
to pursue the following key initiatives:





·
                Implement
      our strategic plan;


·
            Refinance
      or replace Finlay Jewelry’s Revolving Credit Agreement to improve
      liquidity;





·
            Consolidate
      our specialty jewelry store businesses under one management
      team;





·
              Reduce
      expenses;





·
              Improve
      comparable store sales;





·
              Focus
      on improved marketing initiatives to more efficiently reach and expand our
      customer base; and





·
              Maintain
      high customer service
standards.





Risks
and Uncertainties





The risks
and challenges facing our business include:





·
            Our ability to continue as a
      going concern;





·
            Implementation of our strategic
      plan;





·
            Substantial debt leverage and our
      ability to identify a new banking
  relationship;





·
            Default of financial covenants
      under Finlay Jewelry’s Revolving Credit Agreement and potential
      acceleration of debt;





·
            Our ability to continue our
      current customer credit programs with our third party providers;
      and





·
            Continued decrease in consumer
      discretionary spending in the current macro-economic environment and the
      impact on our liquidity
needs.





Our
ability to continue as a going concern is dependent on the successful
implementation of our strategic plan, the repayment of the amounts due under the
Revolving Credit Facility and our ability to secure a new line of credit on or
before the maturity date of the Revolving Credit Agreement. In addition, we
experienced a significant operating loss in 2008, we have incurred operating
losses in the first quarter of 2009, and are expected to continue to incur
operating losses for the remainder of 2009. As discussed above, we are in
default of certain covenants under the Revolving Credit Agreement. These
uncertainties raise substantial doubt about our ability to continue as a going
concern.





The current banking and credit crisis,
the high unemployment rate, continued home foreclosures, the rising cost of
basic necessities, and the reality that the U.S. has entered a recession,
created a highly challenging retail environment during 2008 that continued in
the first quarter of 2009. These conditions have negatively impacted our
liquidity position and operating performance. There can be no assurances that
the implementation of our strategic plan will be successful. There can be no
assurancesthat our
business operations, working capital and borrowing availability will be
sufficient to meet current estimates of working capital requirements as well as
to allow Finlay Jewelry to maintain compliance with the $30.0 million minimum
unused balance and other covenants required by the Revolving Credit Agreement.
If we are unable to implement our strategic plan and improve our liquidity
and/or operating performance, we may be required to further curtail our
operations or pursue other available options, although we can provide no assurance
that any such steps will allow us to meet our obligations as they become
due.


21





We currently have a significant amount
of debt.  As of May 2, 2009, we had $40.6 million of debt outstanding
under Finlay Jewelry’s Senior Notes, $172.8 million outstanding under the Third
Lien Notes and $24.0 million outstanding under the Second Lien Notes. These debt
instruments are all due on June 1, 2012. On June 1, 2009, the semi-annual
interest payment of $1.7 million was due to the holders of the Senior Notes and
was not paid by Finlay Jewelry. The indenture relating to the Senior Notes
provides for a 30-day grace period.  It is unlikely that Finlay
Jewelry will make the interest payment within the grace
period.  Failure to make the payment within the 30-day grace period
will trigger an event of default under the indenture relating to the Senior
Notes and an event of default under the Revolving Credit Agreement. 
If this were to occur, the trustee or the holders of at least 25% of the
outstanding Senior Notes may declare the Senior Notes to be immediately due and
payable and the lenders under the Revolving Credit Agreement may accelerate
repayment of the current outstanding balance. Additionally,an acceleration of the Senior Notes will constitute an event of default
under the Secured Notes.  Moreover, at May 2, 2009, borrowings
under the Revolving Credit Facility were $128.7 million. At the end of May 2009,
we had $75.2 million of availability ($45.2 million of excess availability
after  taking into consideration the $30.0 million minimum unused
balance requirement under the Finlay Jewelry’s Revolving Credit Agreement), at
which point the outstanding borrowings under the Revolving Credit Facility were
$96.9 million. We may not be able to refinance or restructure our long-term debt
before it becomes due. Moreover, the net sales proceeds from the liquidation of
inventory in the closing locations may not be sufficient to repay the
outstanding balance under Finlay Jewelry’s Revolving Credit Facility, which now
matures in February 2010.





Effective
with the February 2009 amendment to the Revolving Credit Agreement, we are
required to achieve certain weekly targeted percentages of our sales and cash
receipts and maintain cash disbursements below certain targeted percentages as
set forth in our operating plan. We are currently in default of this
covenant.  Although the lenders reserve all rights and remedies under
the Revolving Credit Agreement and can accelerate repayment of the outstanding
balance at any time, they have not exercised such rights at this time other than
to impose the default interest rate effective June 1, 2009, as discussed
below.  As a result of cross-default provisions, an acceleration would
enable the holders of our long-term debt to declare a default and demand
repayment as well.





As a
result of these defaults, the lenders under the Revolving Credit Agreement are
no longer obligated to permit us to borrow under the facility or issue letters
of credit for our account.  We received a letter dated as of March 12,
2009, from GE (as agent under the Revolving Credit Agreement), pursuant to which
GE, on behalf of all the lenders, reserved all rights and remedies under the
Revolving Credit Agreement. GE and the lenders may, but are not obligated to,
continue to issue letters of credit and permit us to borrow under the Revolving
Credit Facility and GE and the lenders may terminate the Revolving Credit
Agreement and/or demand immediate repayment at any time.





Effective
June 1, 2009, the Revolving Credit Facility was further reduced by $50.0 million
bringing the revolving line of credit down to $216.6 million, from $266.6
million. Additionally, as a consequence of certain events of default noted
above, the lenders have imposed the default interest rate and any interest due
and payable will be at a rate that is 2.00% in excess of the interest otherwise
payable under the Revolving Credit Agreement. Effective June 1, 2009, the loans
under Tranche A (up to $179.1 million) will bear interest at a floating rate
equal to a margin of 5.00% over the Index Rate or 6.75% over LIBOR.
Additionally, the loans under Tranche B (up to $37.5 million) will bear interest
at a floating rate equal to a margin of 7.50% over the Index Rate or 9.25% over
LIBOR.





A
continuation of the recent deterioration of significant portions of the global
financial markets could further negatively impact our performance. Declines in
discretionary spending or in the availability of consumer credit could further
reduce the volume of merchandise we sell, as well as the sales prices for the
merchandise offered, and accordingly, our gross margin. In addition, concerns
about the stability of the U.S. financial markets generally have reduced the
availability of funding to certain financial institutions, leading to a
tightening of credit, reduction of business activity, and increased market
volatility. These negative economic conditions may result in financial
difficulties for our vendors, the department stores and malls in which we
operate and the financial institutions that are counterparties to our credit
facilities, which could negatively affect us. It is not clear at this time what
impact the federal government’s liquidity and funding initiatives that have been
announced or that may be initiated in the future, will have on the financial
markets, on the broader U.S. and global economies, or ultimately on
us.


22





Results of
Operations





The
following table sets forth operating results as a percentage of sales for the
periods indicated. The discussion that follows should be read in conjunction
with the following table:





Thirteen Weeks EndedMay 2,
                                  2009
                                
                                
                                May 3,
                                  2008Statement
      of Operations Data:Sales
                                
                                
                                100.0
                                %
                                
                                
                                100.0
                                %Cost
      of sales
                                
                                
                                58.8
                                
                                
                                
                                56.4Gross
      margin
                                
                                
                                41.2
                                
                                
                                
                                43.6Selling,
      general and administrative expenses
                                
                                
                                48.1
                                
                                
                                
                                48.7Depreciation
      and amortization
                                
                                
                                0.8
                                
                                
                                
                                2.6Loss
      from operations
                                
                                
                                (7.7
                                )
                                
                                
                                (7.7
                                )Interest
      expense, net
                                
                                
                                8.2
                                
                                
                                
                                5.8Loss
      from continuing operations beforeincome
taxes
                                
                                
                                (15.9
                                )
                                
                                
                                (13.5
                                )Benefit
      for income taxes
                                
                                
                                -
                                
                                
                                
                                (5.1
                                )Loss
      from continuing operations
                                
                                
                                (15.9
                                )
                                
                                
                                (8.4
                                )Discontinued
      operations, net of tax
                                
                                
                                (2.1
                                )
                                
                                
                                0.6Net
      loss
                                
                                
                                (18.0
                                )%
                                
                                
                                (7.8
                                )%





Thirteen
Weeks Ended May 2, 2009 Compared with Thirteen Weeks Ended May 3,
2008





Sales.
Sales for the thirteen weeks ended May 2, 2009 increased $17.2 million, or
12.1%, compared to the 2008 first quarter. Sales include $96.9 million from the
department store based fine jewelry departments for the thirteen weeks ended May
2, 2009, which represented a 50.4% increase compared to $64.4 million for the
thirteen weeks ended May 3, 2008. The increase is related to an increase in
sales volume pertaining to the liquidation of inventory in the licensed
department store locations. Sales also include $62.5 million in sales generated
by our stand-alone jewelry stores in 2009 compared to $77.7 million in 2008, a
decrease which primarily relates to a decline in consumer spending in a
continued weak economic environment.





During
the thirteen weeks ended May 2, 2009, we closed 193 of our licensed department
store based fine jewelry departments, as follows:





Store Group
                  
                  Number of
                    LocationsBon-Ton
                  
                  
                  72Dillard’s
                  
                  
                  52Lord
      & Taylor
                  
                  
                  36Bloomingdale’s
                  
                  
                  34194





These
departments are included in discontinued operations in the accompanying
Consolidated Statements of Operations.





Gross
margin.  Gross margin increased by $3.8 million in the first
quarter of 2009 compared to 2008. As a percentage of sales, gross margin
decreased by 2.4% from 43.6% to 41.2%.  The components of this
decrease in gross margin are as follows:





Component
                                                  
                                                  %
                                                  
                                                  ReasonMerchandise
      cost of sales
                                                  
                                                  
                                                  (16.4
                                                  )%
                                                  Increase
      in cost of sales is due to increased volume in the closing locations as we
      liquidated a substantial amount of inventory as part of our strategic
      plan.LIFO
                                                  
                                                  
                                                  12.1
                                                  
                                                  Decrease
      in the LIFO provision is due to decreased inventory as we liquidated a
      substantial amount of inventory as part of our strategic
    plan.Other
                                                  
                                                  
                                                  1.9
                                                  
                                                  Decrease
      in various other components of cost of sales.Net
      decrease
                                                  
                                                  
                                                  (2.4
                                                  )%




23




Selling, general
and administrative expenses. The components of SG&A include payroll
expense, license fees, rent expense, net advertising expenditures and other
field and administrative expenses. SG&A increased $7.5 million, or 10.8%,
and decreased by 0.6%, as a percentage of sales, from 48.7% to 48.1%. The
components of this decrease in SG&A are as follows:





Component
                                                      
                                                      %
                                                      
                                                      ReasonLicense
      and lease fees
                                                      
                                                      
                                                      1.9
                                                      %
                                                      As
      a result of removing the departments that closed in 2008 and 2009, the
      increase is primarily due to the higher penetration of rent for the
      stand-alone jewelry stores, at higher rates, versus
  2008.Payroll
      expenses
                                                      
                                                      
                                                      (2.4
                                                      )
                                                      Decrease
      is primarily due to the elimination of sales associate positions in the
      licensed departments that closed.Net
      advertising expenditures
                                                      
                                                      
                                                      (1.6
                                                      )
                                                      Decrease
      is due to the elimination of the advertising programs relating to the
      planned closing locations.Other
                                                      
                                                      
                                                      1.5
                                                      
                                                      Increase
      is primarily related to consulting fees of $2.5 million and severance
      costs of $1.6 million associated with our strategic plans to restructure
      the business.Total
      decrease
                                                      
                                                      
                                                      (0.6
                                                      )%





Depreciation and
amortization. Depreciation and amortization for the thirteen weeks ended
May 2, 2009 and May 3, 2008 totaled $1.3 million and $3.7 million, respectively.
The decrease is associated with the write-off of fixed assets in
2008.





Interest expense,
net. Net interest expense increased by $4.8 million primarily as a result
of the write-off of deferred financing costs totaling $3.1 million, as well as
increased amortization of deferred financing costs totaling $1.7 million.
Average borrowings under the Revolving Credit Agreement, the Senior Notes and
the Secured Notes, decreased to $426.1 million for the first quarter of 2009
compared to $482.2 million for the comparable 2008 period, which reflects the
pay-down of the outstanding balance under the Revolving Credit Agreement. The
weighted average interest rate on all outstanding borrowings was approximately
7.4% for the first quarter of 2009 compared with 6.7% for the comparable period
in 2008.





Benefit for
income taxes.The income tax benefit for the 2008 period reflects an
effective tax rate of 37.7% as compared to no effective tax rate in 2009. The
2009 benefit was eliminated as a result of a required increase in the valuation
allowance against deferred tax assets.





Discontinued
operations.Discontinued operations for the thirteen weeks ended May 2,
2009 and May 2, 2008 includes the results of operations from the licensed
departments stores which closed in the first quarter of 2009 and during 2008.
Total sales generated from these departments during the thirteen weeks ended May
2, 2009 and May 3, 2008, were $21.5 million and $63.0 million, respectively.
Gross margin as a percentage of sales, related to discontinued departments
decreased 22.1% from 47.9% in 2008, to 25.8% in 2009, as we liquidated inventory
in the closing departments.  The net loss from discontinued operations
for 2009 was $3.4 million compared to net income from discontinued operations of
$0.9 million during the comparable period in 2008.





Net loss.Net loss of $28.7 million for the 2009 period compares to a net loss of
$11.0 million in the prior year period as a result of the factors discussed
above.





Liquidity and Capital
Resources





As
discussed above, in February 2009, we announced the adoption of our strategic
plan to exit the licensed department store based business. In addition, we
anticipate closing approximately half of our specialty jewelry stores in 2009.
In conjunction with the adoption of this strategic plan, Finlay Jewelry amended
its Revolving Credit Agreement in February 2009, as adjusted in March and June
2009, to reduce the Revolving Credit Agreement from $550.0 million to $216.6
million and to increase the interest rates thereunder. The February 2009
amendment also requires us to comply with various milestones in connection with
the strategic plan, to provide additional financial reporting to the lenders and
to maintain compliance with a variance covenant from the approved restructuring
budget.  Additionally, the Revolving Credit Agreement now matures in
February 2010. The net sales proceeds from the liquidation  of
inventory will be used to repay our outstanding balance under Finlay Jewelry’s
Revolving Credit Facility in 2009.  In conjunction with the execution
of our strategic plan, we have initiated a formal process whereby parties may
indicate their interest in our business or assets.


24





Effective
with the February 2009 amendment to the Revolving Credit Agreement, we are
required to achieve certain weekly targeted percentages of our sales and cash
receipts and maintain cash disbursements below certain targeted percentages as
set forth in our operating plan. We are currently in default of this
covenant.  Although the lenders reserve all rights and remedies under
the Revolving Credit Agreement and can accelerate repayment of the outstanding
balance at any time, they have not exercised such rights at this time other than
to impose the default interest rate effective June 1, 2009, as discussed
below.  As a result of cross-default provisions, an acceleration would
enable the holders of our long-term debt to declare a default and demand
repayment as well.





As a
result of these defaults, the lenders under the Revolving Credit Agreement are
no longer obligated to permit us to borrow under the facility or issue letters
of credit for our account.  We received a letter dated as of March 12,
2009, from GE (as agent under the Revolving Credit Agreement), pursuant to which
GE, on behalf of all the lenders, reserved all rights and remedies under the
Revolving Credit Agreement. GE and the lenders may, but are not obligated to,
continue to issue letters of credit and permit us to borrow under the Revolving
Credit Facility and GE and the lenders may terminate the Revolving Credit
Agreement and/or demand immediate repayment at any time.





If GE and
the lenders were to demand immediate repayment, there can be no assurances that
we will be able to obtain alternate financing on terms acceptable to
us.  In the event that we are unable to secure adequate borrowing
under the Revolving Credit Agreement or an alternate financing source, our cash
balance and cash flows from operations may be inadequate to meet our
obligations, which may prevent us from operating.





Effective
June 1, 2009, the Revolving Credit Facility was further reduced by $50.0 million
decreasing the revolving line of credit to $216.6 million, from $266.6 million.
Additionally, as a consequence of certain events of default noted above, the
lenders have imposed the default interest rate and any interest due and payable
shall be at a rate that is 2.00% in excess of the interest otherwise payable
under the Revolving Credit Agreement. Effective June 1, 2009, the loans under
Tranche A (up to $179.1 million) will bear interest at a floating rate equal to
a margin of 5.00% over the Index Rate or 6.75% over LIBOR. Additionally, the
loans under Tranche B (up to $37.5 million) will bear interest at a floating
rate equal to a margin of 7.50% over the Index Rate or 9.25% over
LIBOR.





Our
ability to continue as a going concern is dependent on the successful
implementation of our strategic plan, the repayment of the amounts due under the
Revolving Credit Facility and our ability to secure a new line of credit on or
before the maturity date of the Revolving Credit Agreement. In addition, we
experienced a significant operating loss in 2008, we have incurred an operating
loss in the first quarter of 2009, and we are expected to incur operating losses
for the remainder of 2009. As discussed above, we are in default of certain
covenants under the Revolving Credit Agreement. These uncertainties raise
substantial doubt about our ability to continue as a going concern. Accordingly,
the independent auditor’s report accompanying our 2008 Form 10-K contains a
going concern explanatory paragraph, which also constitutes a default under the
Revolving Credit Agreement.





Information
about our financial position as of May 2, 2009 and January 31, 2009 is presented
in the following table:


May 2,
                    2009
                  
                  
                  January 31,
                    2009(
      in thousands)Cash
      and cash equivalents
                  
                  $
                  4,714
                  
                  
                  $
                  3,414Working
      capital
                  
                  
                  143,729
                  
                  
                  
                  166,227Short-term
      debt
                  
                  
                  128,650
                  
                  
                  
                  236,241Long-term
      debt
                  
                  
                  237,362
                  
                  
                  
                  232,947Stockholders’
      equity (deficit)
                  
                  
                  (21,656
                  )
                  
                  
                  6,923




25




Our
primary capital requirements are to repay the amounts outstanding under
t he
Revolving Credit Facility and to fund working capital for go forward specialty
jewelry locations, as well as license fees to host store groups and rent
payments for the stand-alone specialty jewelry stores. For the thirteen weeks
ended May 2, 2009, capital expenditures totaled $0.5 million.





Cash
flows provided by (used in) operating, investing and financing activities for
the thirteen weeks ended May 2, 2009 and May 3, 2008 were as
follows:





Thirteen Weeks EndedMay 2,
                    
                    
                    May 3,2009
                    
                    
                    2008(
      in thousands)Operating
      activities
                    
                    $
                    81,116
                    
                    
                    $
                    (71,890
                    )Investing
      activities
                    
                    
                    32,814
                    
                    
                    
                    (11,735
                    )Financing
      activities
                    
                    
                    (112,630
                    )
                    
                    
                    83,657Net
      increase in cash and cash equivalents
                    
                    $
                    1,300
                    
                    
                    $
                    32





Operating
Activities





During
2009,the primary
source of our liquidity is expected to be cash flows from operating activities
as we liquidate inventory in the closing department store and specialty jewelry
store locations as well as excess inventory in the go forward specialty jewelry
stores. The key component of operating cash flow is merchandise sales. Operating
cash outflows include payments to vendors for inventory, services and supplies,
payments for employee payroll, license fees, rent and payments of interest and
taxes. Net cash flows provided by operating activities were $81.1 million for
the thirteen weeks ended May 2, 2009, as compared with net cash flows used in
operating activities of $71.9 million in the comparable prior year period.
Inventory levels at May 2, 2009 decreased by $98.4 million, or 22.2%, as
compared to January 31, 2009, primarily related to a $51.3 million decrease in
inventory in our licensed fine jewelry departments and a $40.1 million decrease
in inventory in our stand alone specialty jewelry stores as a result of our
initiatives to liquidate inventory in an effort to reduce on hand inventory
levels and positively impact cash flows.





Our
operations involving licensed fine jewelry departments substantially preclude
customer receivables as our license agreements typically require host stores to
remit sales proceeds for each month (without regard to whether such sales were
cash, store credit or national credit card) to us approximately three weeks
after the end of such month. Our working capital balance was $143.7 million at
May 2, 2009, a decrease of $22.5 million from January 31, 2009.





The seasonality of our business causes
working capital requirements, and therefore, borrowings under the Revolving
Credit Agreement, to reach their highest level in the months of October,
November and December in anticipation of the year-end holiday season.
Accordingly, we experience seasonal cash needs as inventory levels
peak.





Investing
Activities





Net cash
provided by investing activities of $32.8 million for the thirteen weeks ended
May 2, 2009 primarily relates to cash proceeds from the sale of certain assets
to Bloomingdale’s. The assets included inventory and fixed assets for the 34
departments that we operated in Bloomingdale’s for a purchase price of
approximately $33.4 million. The proceeds from this transaction were used to
pay-down a portion of the outstanding balance under the Revolving Credit
Facility. Net cash used in investing activities for the thirteen weeks ended May
3, 2008 totaled $11.7 million and primarily related to capital expenditures
amounting to $6.2 million primarily for opening new locations and renovating
existing locations and $5.6 million associated with the acquisition of Bailey
Banks & Biddle.


26





Financing
Activities





Net cash used in financing activities
was $112.6 million for the thirteen weeks ended May 2, 2009, consisting
primarily of proceeds from, and principal repayments on, the Revolving Credit
Facility. Net cash provided by financing activities was $83.7 million for the
thirteen weeks ended May 3, 2008.





The Revolving Credit Agreement,
recently amended in February 2009, as adjusted in March 2009, provides Finlay
Jewelry with a line of credit up to $266.6 million to finance working capital
needs. Effective February 25, 2009, the loans under Tranche A (up to $229.1
million) bore interest at a floating rate equal to a margin of 3.00% over the
Index Rate or 4.75% over LIBOR. Additionally, the loans under Tranche B (up to
$37.5 million) bore interest at a floating rate equal to a margin of 5.50% over
the Index Rate or 7.25% over LIBOR. Prior to February 25, 2009, the loans under
Tranche A bore interest in accordance with a graduated pricing matrix based on
the average excess availability under the facility for the previous quarter.
Additionally, the loans under Tranche B bore interest at a floating rate equal
to a margin of 3.50% over the Index Rate or 5.25% over LIBOR. The Index Rate is
equal to the higher of (i) the federal funds rate plus 125 basis points and (ii)
the publicly quoted rate as published by the Wall Street Journal as the “prime
rate”. The weighted average interest rate was 5.2% and 5.5% for the thirteen
weeks ended May 2, 2009 and May 3, 2008, respectively.





Effective
June 1, 2009, the Revolving Credit Facility was further reduced by $50.0
million, decreasing the revolving line of credit to $216.6 million from $266.6
million. Additionally, as a result of certain events of default, the lenders
have imposed the default interest rate and any interest due and payable shall be
at a rate that is 2.00% in excess of the interest otherwise payable under the
Revolving Credit Agreement. Effective June 1, 2009, the loans under Tranche A
(up to $179.1 million) will bear interest at a floating rate equal to a margin
of 5.00% over the Index Rate or 6.75% over LIBOR. Additionally, the loans under
Tranche B (up to $37.5 million) will bear interest at a floating rate equal to a
margin of 7.50% over the Index Rate or 9.25% over LIBOR.





Borrowings
under the Revolving Credit Facility were $128.7 million at May 2, 2009, compared
to $236.2 million at January 31, 2009. At the end of May 2009, we had $75.2
million of availability ($45.2 million of excess availability after taking into
consideration the $30.0 million minimum unused balance requirement under the
Finlay Jewelry’s Revolving Credit Agreement), at which point the outstanding
borrowings under the Revolving Credit Facility were $96.9 million. The average
amounts outstanding under the Revolving Credit Facility were $190.1 million and
$282.8 million for the thirteen weeks ended May 2, 2009 and May 3, 2008,
respectively.  At May 2, 2009 we had $57.7 million of availability
($27.7 million of excess availability after taking into consideration the $30.0
million minimum unused balance requirement). Our lowest level of availability
during the thirteen weeks ended May 2, 2009 was $33.2 million, at which point
outstanding borrowings under the Revolving Credit Facility were $217.8 million
($3.2 million of excess availability after taking into consideration the $30.0
million minimum unused balance requirement).





The
Revolving Credit Agreement contains customary covenants, including limitations
on, or relating to, liens, indebtedness, investments, mergers, acquisitions,
affiliate transactions, management compensation and the payment of dividends and
other restricted payments. We are required to maintain a minimum of $30.0
million of availability under the facility and, as of May 2, 2009, we were in
compliance with this requirement. Effective with the February 2009 amendment to
the Revolving Credit Agreement, we are required to achieve certain weekly
targeted percentages of our sales and cash receipts and maintain cash
disbursements below certain targeted percentages as set forth in our operating
plan, and we are currently in default of this covenant.  Although the
lenders reserve all rights and remedies under the Revolving Credit Agreement and
can accelerate repayment of the outstanding balance at any time, they have not
exercised such rights at this time other than to impose the default interest
rate effective June 1, 2009, as discussed above.





In 2008,
Finlay Jewelry executed several agreements to exchange $159.4 million of its
Senior Notes held by the Participating Noteholders for new Third Lien
Notes. In addition, the Participating Noteholders purchased $22.8 million
of new Second Lien Notes.


27





Interest
on the Secured Notes is payable semi-annually in arrears on June 1 and December
1 of each year.  Interest on the Second Lien Notes began to accrue as of
the issuance date and is payable beginning on June 1, 2009 in pay-in-kind
interest or PIK Interest at 12.125% per annum from the issuance date until
December 1, 2010, and thereafter in cash at 11.375% per annum.  Interest on
the Third Lien Notes began to accrue PIK Interest at 8.945% per annum as of June
1, 2008, which was paid in PIK Interest on December 1, 2008, and will be payable
in PIK Interest at 8.945% per annum from December 2, 2008 until December 1,
2010, and thereafter in cash at 8.375% per annum.  The PIK Interest on
the Secured Notes is payable upon maturity of the Secured Notes. Interest on the
Senior Notes continues to be payable in cash semi-annually on June 1 and
December 1 of each year. On June 1, 2009, the semi-annual interest payment of
$1.7 million was due to the holders of the Senior Notes and was not paid by
Finlay Jewelry. The indenture relating to the Senior Notes provides for a 30-day
grace period.  It is unlikely that Finlay Jewelry will make the
interest payment within the grace period.  Failure to make the payment
within the 30-day grace period will trigger an event of default under the
indenture relating to the Senior Notes and an event of default under the
Revolving Credit Agreement.  If this were to occur, the trustee or the
holders of at least 25% of the outstanding Senior Notes may declare the Senior
Notes to be immediately due and payable and the lenders under the Revolving
Credit Agreement may accelerate repayment of the current outstanding
balance.  Additionally, an acceleration of the Senior Notes will
constitute an event of default under the Secured Notes.




As a
result of the above transactions, as of May 2, 2009, there were approximately
$196.8 million of Secured Notes outstanding and $40.6 million of Senior Notes
outstanding. The amounts required to satisfy the aggregate of Finlay Jewelry’s
interest expense totaled $6.4 million and $4.0 million for the thirteen weeks
ended May 2, 2009, and May 3, 2008, respectively. The refinancing of the Senior
Notes enables Finlay Jewelry to eliminate a significant portion of the cash
interest payment of $16.8 million that would have been payable annually on the
Senior Notes as the Secured Notes include PIK Interest until December 1,
2010.





The
indentures related to the Senior Notes and the Secured Notes contain
restrictions relating to, among other things, the payment of dividends,
redemptions or repurchases of capital stock, the incurrence of additional
indebtedness, the making of certain investments, the creation of certain liens,
the sale of certain assets, entering into transactions with affiliates, engaging
in mergers and consolidations and the transfer of all or substantially all
assets.  We were in compliance with all such covenants as of May 2,
2009.





As a
result of our deteriorating liquidity position during the past twelve months,
many of our key vendors curtailed their historical credit
terms.  Further, many of these vendors are party to the secured
position negotiated in February 2009, as modified in May 2009 under the terms of
the Third Lien Notes for $24.9 million of trade payable
balances.  Additional restrictions on the credit limits or payment
terms that we have with our vendors could have an adverse impact on our
liquidity position.





There can
be no assurances that we can successfully implement our strategic plan or that
the net sales proceeds will be sufficient to repay the outstanding balance under
the Revolving Credit Facility. Additionally, there can be no assurances that we
will be able to secure a new line of credit on or before the date of maturity of
the Revolving Credit Agreement in February 2010, and, accordingly our liquidity
and ability to timely pay our obligations when due could be adversely
affected.  If we cannot successfully implement our strategic plan,
repay amounts due under the Revolving Credit Facility and secure such new
financing, we may be unable to maintain a level of liquidity necessary to
continue to operate our business.





Further,
we are a highly leveraged company. We may not be able to refinance or
restructure our long-term debt before it becomes due in 2012. A significant
amount of our operating cash flows will be used to pay interest with respect to
the Revolving Credit Facility, the Secured Notes (beginning on December 1, 2010)
and the Senior Notes.


28


Off-Balance Sheet
Arrangements





We
have not created, and are not party to, any off-balance sheet entities or
arrangements for the purpose of raising capital, incurring debt or operating our
business. We do not have any arrangements or relationships with entities that
are not consolidated into the financial statements that are reasonably likely to
materially affect our liquidity or the availability of capital
resources.





Seasonality





Our
business is highly seasonal, with a significant portion of our sales and income
from operations generated during the fourth quarter of each year, which includes
the year-end holiday season. The fourth quarter of 2008 accounted for an average
of approximately 41.0% of our annual sales. We have typically experienced net
losses in the first three quarters of our fiscal year. During these periods,
working capital requirements
have been funded by borrowings under the Revolving Credit Agreement.
Accordingly, the results for any of the first three quarters of any given fiscal
year, taken individually or in the aggregate, are not indicative of annual
results.





Inflation





The effect of inflation on our results
of operations has not been material in the periods discussed.





Critical Accounting Policies
and Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires the appropriate application of
certain accounting policies, many of which require us to make estimates and
assumptions about future events and their impact on amounts reported in our
financial statements and related notes. We believe the application of our
accounting policies, and the estimates inherently required therein, are
reasonable. These accounting policies and estimates are periodically
re-evaluated, as appropriate, and adjustments are made when facts and
circumstances dictate a change. However, since future events and their impact
cannot be determined with certainty, actual results may differ from our
estimates, and such differences could be material to the consolidated financial
statements. Historically, we have found our application of accounting policies
to be appropriate, and actual results have not differed materially from those
determined using necessary estimates. There have been no changes in our
significant accounting policies since January 31, 2009. Our significant
accounting policies relate to merchandise inventories, vendor allowances,
long-lived assets, revenue recognition, self-insurance reserves, income taxes
and accounting for acquisitions. A summary of our significant accounting
policies and a description of accounting policies that we believe are most
critical may be found in Note 2 of Notes to the Consolidated Financial
Statements included in our Form 10-K.





Special Note Regarding
Forward-Looking Statements





This Form
10-Q includes forward-looking statements. All statements other than statements
of historical information provided herein are forward-looking statements and may
contain information about financial results, economic conditions, trends and
known uncertainties. You can identify these forward-looking statements by the
use of words like "strategy," "expect," "plan," "believe," "will," "estimate,"
"intend," "project," "goals," "target," "anticipating," "hope" and other words
of similar meaning. You can also identify them by the fact that they do not
relate strictly to historical or current facts. The forward-looking statements
contained herein are subject to certain risks and uncertainties that could cause
actual results, performance or achievements to differ materially from those
reflected in, or implied by, the forward-looking statements. Factors that might
cause such a difference include, but are not limited to, those discussed under
MD&A.  Important factors that could cause actual results to differ
materially include, but are not limited to:





·
            Our
      ability to continue as a going
concern;





·
            Our
      ability to successfully implement our strategic plan to exit the licensed
      department store based business and close approximately half of our
      specialty jewelry stores;


29





·
            Our
      high degree of leverage and our ability to refinance Finlay Jewelry’s
      long-term debt and/or obtain a  new revolving line of credit to
      operate our go forward specialty jewelry
stores;





·
            The
      fact that the lenders can demand immediate repayment of the current
      outstanding balance under the Revolving Credit Agreement at any
      time;





·
            The
      fact that if Finlay Jewelry does not pay the June 1, 2009 interest payment
      due under the Senior Notes indenture within the grace period, the trustee
      or holders of the Senior Notes can demand immediate repayment of the
      Senior Notes at any time;





·
            Low
      or negative growth in the economy or in the financial markets which
      reduces discretionary spending on goods perceived to be luxury
      items;





·
            The
      transition of our senior management
team;





·
            Our
      ability to renegotiate certain on-going leases for specialty jewelry
      stores on more favorable terms or to negotiate new leases with acceptable
      terms;





·
            The
      seasonality of the retail jewelry
business;





·
            Our
      ability to continue to obtain merchandise from our vendors on acceptable
      credit terms;





·
            Our
      ability to continue our current customer credit programs with our third
      party providers;





·
            The
      impact of fluctuations in gold and diamond
  prices;





·
            Competition
      in the retail jewelry business and fluctuations in our quarterly
      results;





·
            The
      availability to us of alternate sources of merchandise supply in the case
      of an abrupt loss of any significant
supplier;





·
            Our
      ability to identify and rapidly respond to fashion trends as well as our
      ability to maintain flexible return privileges on owned
      merchandise;





·
            Our
      ability to increase comparable store
sales;





·
            Our
      ability to regain compliance with applicable contractual covenants and to
      maintain such compliance;





·
            Changes
      in regulatory requirements which are applicable to our
      business;





·
            The
      impact of future claims and legal actions arising in the ordinary course
      of business; and





·
            Attacks
      or threats of attacks by terrorists or war which may negatively impact the
      economy and/or the financial markets and reduce discretionary
      spending.




Readers
are cautioned not to unduly rely on these forward-looking statements, which
reflect management's analysis, judgment, belief or expectation only as of the
date hereof. We undertake no obligation to publicly revise these forward-looking
statements to reflect events or circumstances that arise after the date hereof
or to reflect the occurrence of unanticipated events. In addition to the
disclosure contained herein, readers should carefully review any disclosure of
risks and uncertainties contained in other documents we file or have filed from
time to time with the Commission. A complete discussion of forward-looking
information and risk factors that may affect our future results, may be found in
Item 1A – “Risk Factors” included in our Form 10-K and in Part II of this
report.


30





Item
3. Quantitative and
Qualitative Disclosures About Market Risk





Interest
Rate Risk





We are exposed to market risk through
the interest rate on our borrowings under the Revolving Credit Agreement, which
has a variable interest rate. Based on the average amounts outstanding under the
Revolving Credit Agreement for 2008, a 100 basis point increase in interest
rates would have resulted in an increase in interest expense of approximately
$3.1 million in 2008. In seeking to minimize the risks from interest rate
fluctuations, we manage exposures through our regular operating and financing
activities.





Commodity
Risk





We
principally address commodity risk through retail price points. Our commodity
risk exposure to diamond, gold and other merchandise categories is market price
fluctuations, and we currently do not engage in any hedging
activities.





Item
4. Controls and
Procedures





Disclosure
Controls and Procedures





Our
management evaluated, with the participation of our Chief Executive Officer and
Chief Financial Officer, the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end
of the period covered by this report. Based on that evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective as of the end of the period covered by
this report to ensure that information required to be disclosed in the reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Commission’s rules and
forms, and that such information is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required
disclosure.





Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that our disclosure controls and procedures will
detect or uncover every situation involving the failure of persons within the
Company to disclose material information required to be set forth in our
periodic reports.





Changes
in Internal Controls over Financial Reporting





Our management, with the participation
of our Chief Executive Officer and Chief Financial Officer, also conducted an
evaluation of our internal control over financial reporting, as defined in
Exchange Act Rule 13a-15(f), to determine whether any changes occurred during
the quarter ended May 2, 2009 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Based on that evaluation, there was no such change during the quarter ended May
2, 2009.





A control
system, no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all controls systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. We
conduct periodic evaluations of our controls to enhance, where necessary, our
procedures and controls. Because of the inherent limitations in a cost-effective
control system, misstatements due to error or fraud may occur and not be
detected.


31


PART
II – OTHER INFORMATION





Item
1.  Legal
Proceedings





From time
to time, we are involved in legal proceedings, most of which arise out of our
operations in the normal course of business.  As of June 12, 2009, we are
not a party to any legal proceedings that, individually or in the aggregate, are
reasonably expected to have a material adverse effect on our consolidated
financial statements. However, the results of these matters cannot be predicted
with certainty, and an unfavorable resolution of one or more of these matters
could have a material adverse effect on our consolidated financial
statements.





Item
1A. Risk
Factors





We are
subject to a variety of risks which could materially affect our business,
financial condition or future results, including but not limited to those
referenced under the heading “Executive Overview — Risks and Uncertainties” in
Item 2 — “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” of this Form 10-Q and those discussed in Item 1A – “Risk
Factors” in our Form 10-K for the year ended January 31, 2009.  Except
as set forth under “Executive Overview — Risks and Uncertainties” and elsewhere
in Item 2 – “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” of this Form 10-Q, we do not believe there have been any
material changes to the risk factors previously disclosed in our Form 10-K for
the year ended January 31, 2009, except as follows:





We are not in compliance
with certain financial covenants under the Revolving Credit
Agreement.





Effective
with the February 2009 amendment to the Revolving Credit Agreement, we are
required to achieve certain weekly targeted percentages of our sales and cash
receipts and maintain cash disbursements below certain targeted percentages as
set forth in our operating plan, and we are currently in default of this
covenant.  Although the lenders reserve all rights and remedies under
the Revolving Credit Agreement and can accelerate repayment of the outstanding
balance at any time, they have not exercised such rights at this time other than
to impose the default interest rate effective June 1, 2009, as discussed
below.  As a result of cross-default provisions, an acceleration would
enable the holders of our long-term debt to declare a default and demand
repayment as well.  As a consequence of the events of default,
effective June 1, 2009, the lenders have imposed the default interest rate and
any interest due and payable under the Revolving Credit Agreement shall be at a
rate that is 2.00% in excess of the interest otherwise payable. If our lenders
or the holders of our long-term debt accelerate repayment, we may be unable to
continue operating our business.





If Finlay Jewelry does not
pay the interest payment due under the Senior Notes indenture within the grace
period, the trustee or holders of the Senior Notes can demand immediate
repayment of the Senior Notes at any time.





On June 1, 2009, the semi-annual
interest payment was due to the holders of the Senior Notes and was not paid by
Finlay Jewelry. The indenture relating to the Senior Notes provides for a 30-day
grace period. It is unlikely that Finlay Jewelry will make the interest payment
within the grace period. Failure to make the payment within the 30-day grace
period will trigger an event of default under the indenture relating to the
Senior Notes and an event of default under the Revolving Credit Agreement. If
this were to occur, the trustee or the holders of a least 25% of the outstanding
Senior Notes may demand immediate repayment of the Senior Notes at any
time.  Additionally,an acceleration of the Senior Notes will
constitute an event of default under the Secured Notes.  If our lenders or the holders of the
Senior Notes accelerate repayment, we may be unable to continue operating our
business.


32





The actual cost and benefits
of our strategic plan to exit the licensed department store based business and
close approximately half of our specialty jewelry stores in 2009 may differ from
our expectations.





The
implementation of our strategic plan will result in an 85.0% reduction in
headcount in sales associate positions in the affected department and specialty
store locations as well as administrative functions at the Company's New York
headquarters.  The plan includes the liquidation of inventory and the
termination of license agreements or leases in the affected department store
based fine jewelry departments and specialty jewelry stores.  With
respect to these actions, we expect to record a pre-tax charge in the range of
$10.0 million to $12.0 million for severance and retention costs, lease
termination costs and other items.  Our estimates relating to these
actions may be further refined depending on subsequent developments or
additional analysis.  Additionally, there are a number of risks and
uncertainties with respect to these actions that could cause actual results to
differ significantly from our expectations, and could otherwise have a negative
impact on our business, financial condition and prospects.





Item
2. Unregistered Sales
of Equity Securities and Use of Proceeds





Issuer
Purchases of Equity Securities





There
were no shares of Common Stock repurchased by the Company during the first
quarter of 2009. The Company’s stock repurchase program expired on September 30,
2005 and has not been renewed.





Item
5.  Other
Information




Leslie A.
Philip, Executive Vice President and Chief Merchandising Officer of the Company
and Finlay Jewelry, retired from Finlay effective May 26, 2009.  In
connection with her planned retirement, on May 21, 2009, Finlay Jewelry and Ms.
Philip entered into a Severance Agreement and General Release (the “Agreement”).
Pursuant to the terms of the Agreement, Ms. Philip is entitled to certain
benefits under Finlay Jewelry’s regular policies and to certain conditional
benefits following her retirement.




Under the
terms of the Agreement, Ms. Philip has agreed, among other things, to release
Finlay from all claims and to not disclose confidential or proprietary
information obtained during her employment. Pursuant to the Agreement, Ms.
Philip will receive, subject to her compliance with these obligations, a
severance payment in the amount of twelve weeks’ salary, or $112,082.31, less
applicable taxes and other withholding, payable in six
installments.  Any payment in excess of two months’ base salary (the
“Mitigated Benefits”) will be reduced by an amount equal to the gross amounts
Ms. Philip receives or earns from employment or engagement in any business or
activity with Finlay during the period for which the Mitigated Benefits are
payable (“Other Income”).  As a condition to receipt of payment of the
Mitigated Benefits, Ms. Philip is required, no later than seven days prior to
the date such payment is due, certify in writing all amounts of Other Income
earned during the preceding payroll period so that the appropriate offsets can
be made.




This
summary should be read in conjunction with, and is qualified in its entirety by
reference to, the Agreement, a copy of which is attached as Exhibit 10.31 to
this Form 10-Q and is incorporated herein by reference.


33





Item
6.  Exhibits





Exhibit No.
                                      
                                      Description2.1
                                      
                                      Agreement
      and Plan of Merger, dated May 19, 2005, by and among Finlay Jewelry, FFJ
      Acquisition Corp., Carlyle & Co. Jewelers, certain stockholders of
      Carlyle & Co. Jewelers and Russell L. Cohen (as stockholders’ agent)
      (incorporated by reference to Exhibit 2.1 filed as part of the Current
      Report on Form 8-K filed by the Company on May 25,
  2005).2.2(a)
                                      
                                      Asset
      Purchase Agreement, dated September 27, 2007, by and among Zale
      Corporation, Zale Delaware, Inc., TXDC, L.P., Finlay Jewelry and, for
      limited purposes, the Company (incorporated by reference to Exhibit 2.2(a)
      filed as part of the Quarterly Report on Form 10-Q for the period ended
      November 3, 2007 filed by the Company on December 13,
    2007).2.2(b)
                                      
                                      Letter
      Agreement, dated November 9, 2007, amending the Asset Purchase Agreement,
      dated September 27, 2007, by and among Zale Corporation, Zale Delaware,
      Inc., TXDC, L.P., Finlay Jewelry and, for limited purposes, the Company
      (incorporated by reference to Exhibit 2.2(b) filed as part of the
      Quarterly Report on Form 10-Q for the period ended November 3, 2007 filed
      by the Company on December 13, 2007).3.1
                                      
                                      Certificate
      of Incorporation of the Company, as amended (incorporated by reference to
      Exhibit 3.1filed as part of
      the Annual Report on Form 10-K for the period ended January 28, 1995 filed
      by the Company on April 12, 1995).3.2
                                      
                                      Amended
      and Restated By-Laws of the Company, dated as of December 4, 2007
      (incorporated by reference to Exhibit 3.2 filed as part of the Current
      Report on Form 8-K filed by the Company on December 10,
    2007).3.2(a)
                                      
                                      Amendment
      to the Amended and Restated By-Laws of the Company, dated as of December
      3, 2008 (incorporated by reference to Exhibit 3.2(a) filed as part of the
      Current Report on Form 8-K filed by the Company on December 9,
      2008).10.2(a)(iii)
                                      
                                      Retention
      Bonus Agreement, dated as of March 11, 2009, among the Company, Finlay
      Jewelry and Arthur E. Reiner (incorporated by reference to Exhibit 10.1
      filed as part of the Current Report on Form 8-K filed by the Company on
      March 12, 2009).10.8(i)
                                      
                                      Limited
      Consent and Amendment No. 2, dated as of February 25, 2009, to Fourth
      Amended and Restated Credit Agreement, among Finlay Jewelry, Carlyle &
      Co. Jewelers LLC, and L. Congress, Inc., as borrowers, the Company, Finlay
      Jewelry, Inc., Finlay Merchandising & Buying LLC, eFinlay, Inc. and
      Park Promenade LLC, as credit parties, General Electric Capital
      Corporation, as agent for the lenders, and the lenders parties thereto
      (incorporated by reference to Exhibit 10.1 filed as part of the Current
      Report on Form 8-K filed by the Company on March 3,
  2009).10.22
                                      
                                      Finlay
      Executive Severance Pay Plan, amended and restated effective March 19,
      2009 (incorporated by reference to Exhibit 10.22 filed as part of the
      Annual Report on Form 10-K for the period ended January 31, 2009 filed by
      the Company on May 1, 2009).10.31
                                      
                                      Severance
      Agreement and General Release, dated as of May 21, 2009, between Finlay
      Jewelry and Leslie
Philip.


34


31.1
            
            Certification
      of principal executive officer pursuant to the Sarbanes-Oxley Act of 2002,
      Section 302.31.2
            
            Certification
      of principal financial officer pursuant to the Sarbanes-Oxley Act of 2002,
      Section 302.32.1
            
            Certification
      of principal executive officer pursuant to the Sarbanes-Oxley Act of 2002,
      Section 906.32.2
            
            Certification
      of principal financial officer pursuant to the Sarbanes-Oxley Act of 2002,
      Section 906.




35




SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





Date:
      June 16, 2009
                FINLAY
      ENTERPRISES, INC.By:
                /s/ Bruce E. ZurlnickBruce
      E. ZurlnickSenior
      Vice President, Treasurerand
      Chief Financial Officer(As
      both a duly authorized officer ofregistrant
      and as principal financialofficer
      of registrant)


36