UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC  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 April 24, 2010





 ̈           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: 001-05893





FREDERICK’S OF HOLLYWOOD
GROUP INC.


(Exact
name of Registrant as specified in its charter)





New
      York
                                      
                                      13-5651322(State or other jurisdiction of
                                      
                                      (I.R.S.
      Employerincorporation
      or organization)
                                      
                                      Identification
      Number)





1115
      Broadway, New York,
      NY
                  
                  10010(Address
      of principal executive offices)
                  
                  (Zip
      Code)





Registrant’s
telephone number, including area code (212) 798-4700




(Former
name, former address, and former fiscal year, if changed since last
report.)





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 xNo   ̈




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 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 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   ̈
                  Smaller
      reporting company  x(do
      not check if a smaller reporting
company)




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




Yes   ̈No  x




The
number of common shares outstanding on June 8, 2010 was
38,118,199.





FREDERICK’S
OF HOLLYWOOD GROUP INC.


QUARTERLY
REPORT ON FORM 10-Q


TABLE OF
CONTENTS





PagePART
      I.
                Financial
      InformationItem
      1.
                Financial
      Statements
                3Consolidated
      Balance Sheets at April 24, 2010 (Unaudited) and July 25, 2009
      (Audited)
                3Consolidated
      Statements of Operations (Unaudited) for the Three and Nine Months Ended
      April 24, 2010 and April 25, 2009
                4Consolidated
      Statements of Cash Flows (Unaudited) for the Nine Months Ended April 24,
      2010 and April 25, 2009
                5Notes
      to Consolidated Unaudited Financial Statements
                6 –
      14Item
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                15
      – 28Item
      3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                29Item
      4.
                Controls
      and Procedures
                29
      – 30PART
      II.
                Other
      InformationItem
      1.
                Legal
      Proceedings
                30Item
      1A.
                Risk
      Factors
                30Item
      6.
                Exhibits
                30Signatures
                
                31




2


PART  I.   FINANCIAL
INFORMATION





Item
1.  Financial Statements


FREDERICK’S
OF HOLLYWOOD GROUP INC.


CONSOLIDATED  BALANCE
SHEETS


(In
Thousands, Except Share Data)





April 24,
                              
                              
                              July 25,2010
                              
                              
                              2009(Unaudited)
                              
                              
                              (Audited)ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                              
                              $
                              1,026
                              
                              
                              $
                              555Accounts
      receivable
                              
                              
                              6,487
                              
                              
                              
                              2,643Income
      tax receivable
                              
                              
                              75
                              
                              
                              
                              172Merchandise
      inventories
                              
                              
                              18,830
                              
                              
                              
                              21,836Prepaid
      expenses and other current assets
                              
                              
                              2,062
                              
                              
                              
                              2,543Deferred
      income tax assets
                              
                              
                              2,292
                              
                              
                              
                              3,117Total
      current assets
                              
                              
                              30,772
                              
                              
                              
                              30,866PROPERTY
      AND EQUIPMENT, Net
                              
                              
                              17,605
                              
                              
                              
                              20,663INTANGIBLE
      AND OTHER ASSETS
                              
                              
                              25,461
                              
                              
                              
                              26,108TOTAL
      ASSETS
                              
                              $
                              73,838
                              
                              
                              $
                              77,637LIABILITIES
      AND SHAREHOLDERS’ EQUITYCURRENT
      LIABILITIES:Revolving
      credit and bridge facilities
                              
                              $
                              11,282
                              
                              
                              $
                              9,245Accounts
      payable and other accrued expenses
                              
                              
                              22,328
                              
                              
                              
                              22,723Deferred
      revenue from gift cards
                              
                              
                              1,820
                              
                              
                              
                              1,692Total
      current liabilities
                              
                              
                              35,430
                              
                              
                              
                              33,660DEFERRED
      RENT AND TENANT ALLOWANCES
                              
                              
                              5,106
                              
                              
                              
                              4,707LONG
      TERM DEBT – related party
                              
                              
                              13,944
                              
                              
                              
                              13,336OTHER
                              
                              
                              84
                              
                              
                              
                              16DEFERRED
      INCOME TAX LIABILITIES
                              
                              
                              11,328
                              
                              
                              
                              12,153TOTAL
      LIABILITIES
                              
                              
                              65,892
                              
                              
                              
                              63,872PREFERRED
      STOCK, $.01 par value – authorized, 10,000,000 shares at April 24, 2010
      and July 25, 2009; issued and outstanding 3,629,325 shares of Series A
      preferred stock at April 24, 2010 and July 25, 2009
                              
                              
                              7,500
                              
                              
                              
                              7,500COMMITMENTS
      AND CONTINGENCIES (NOTE 8)
                              
                              
                              -
                              
                              
                              
                              -SHAREHOLDERS’
      EQUITY:Common
      stock, $.01 par value – authorized, 200,000,000 shares at April 24, 2010
      and July 25, 2009; issued and outstanding 29,336,709 shares at April 24,
      2010 and 26,394,158 shares at July 25, 2009
                              
                              
                              293
                              
                              
                              
                              263Additional
      paid-in capital
                              
                              
                              63,695
                              
                              
                              
                              60,444Accumulated
      deficit
                              
                              
                              (63,472
                              )
                              
                              
                              (54,375
                              )Accumulated
      other comprehensive loss
                              
                              
                              (70
                              )
                              
                              
                              (67
                              )TOTAL
      SHAREHOLDERS’ EQUITY
                              
                              
                              446
                              
                              
                              
                              6,265TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
                              
                              $
                              73,838
                              
                              
                              $
                              77,637





See notes
to consolidated unaudited financial statements.


3


FREDERICK’S
OF HOLLYWOOD GROUP INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)


(In
Thousands, Except Per Share Amounts)





Three Months Ended
                    
                    
                    Nine Months EndedApril 24,
                    
                    
                    April 25,
                    
                    
                    April 24,
                    
                    
                    April 25,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Net
      sales
                    
                    $
                    43,391
                    
                    
                    $
                    46,766
                    
                    
                    $
                    121,920
                    
                    
                    $
                    141,847Cost
      of goods sold, buying and occupancy
                    
                    
                    25,956
                    
                    
                    
                    28,915
                    
                    
                    
                    77,848
                    
                    
                    
                    91,025Gross
      profit
                    
                    
                    17,435
                    
                    
                    
                    17,851
                    
                    
                    
                    44,072
                    
                    
                    
                    50,822Selling,
      general and administrative expenses
                    
                    
                    16,615
                    
                    
                    
                    19,459
                    
                    
                    
                    51,309
                    
                    
                    
                    57,646Goodwill
      impairment
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    19,100Operating
      income (loss)
                    
                    
                    820
                    
                    
                    
                    (1,608
                    )
                    
                    
                    (7,237
                    )
                    
                    
                    (25,924
                    )Interest
      expense, net
                    
                    
                    447
                    
                    
                    
                    337
                    
                    
                    
                    1,397
                    
                    
                    
                    1,186Income
      (loss) before income tax provision
                    
                    
                    373
                    
                    
                    
                    (1,945
                    )
                    
                    
                    (8,634
                    )
                    
                    
                    (27,110
                    )Income
      tax provision
                    
                    
                    23
                    
                    
                    
                    24
                    
                    
                    
                    70
                    
                    
                    
                    65Net
      income (loss)
                    
                    
                    350
                    
                    
                    
                    (1,969
                    )
                    
                    
                    (8,704
                    )
                    
                    
                    (27,175
                    )Less:
      Preferred stock dividends
                    
                    
                    132
                    
                    
                    
                    151
                    
                    
                    
                    393
                    
                    
                    
                    432Net
      income (loss) applicable to common shareholders
                    
                    $
                    218
                    
                    
                    $
                    (2,120
                    )
                    
                    $
                    (9,097
                    )
                    
                    $
                    (27,607
                    )Basic
      net income (loss) per share
                    
                    $
                    0.01
                    
                    
                    $
                    (0.08
                    )
                    
                    $
                    (0.34
                    )
                    
                    $
                    (1.05
                    )Diluted
      net income (loss) per share
                    
                    $
                    0.01
                    
                    
                    $
                    (0.08
                    )
                    
                    $
                    (0.34
                    )
                    
                    $
                    (1.05
                    )Weighted
      average shares outstanding – basic
                    
                    
                    27,642
                    
                    
                    
                    26,343
                    
                    
                    
                    26,820
                    
                    
                    
                    26,235Weighted
      average shares outstanding – diluted
                    
                    
                    27,835
                    
                    
                    
                    26,343
                    
                    
                    
                    26,820
                    
                    
                    
                    26,235





See notes
to consolidated unaudited financial statements.


4


FREDERICK’S
OF HOLLYWOOD GROUP INC.


CONSOLIDATED  STATEMENTS
OF CASH FLOWS


(Unaudited)


(In
Thousands)


Nine Months EndedApril 24, 2010
                    
                    
                    April 25, 2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                    
                    $
                    (8,704
                    )
                    
                    $
                    (27,175
                    )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activitiesGoodwill
      impairment
                    
                    
                    -
                    
                    
                    
                    19,100Depreciation
      and amortization
                    
                    
                    4,060
                    
                    
                    
                    4,436Provision
      for sales allowances and doubtful accounts
                    
                    
                    (100
                    )
                    
                    
                    (296
                    )Issuance
      of common stock for directors’ fees
                    
                    
                    45
                    
                    
                    
                    39Stock-based
      compensation expense
                    
                    
                    493
                    
                    
                    
                    637Amortization
      of deferred financing costs
                    
                    
                    138
                    
                    
                    
                    34Noncash
      accrued interest on long term debt – related party
                    
                    
                    608
                    
                    
                    
                    575Amortization
      of deferred rent and tenant allowances
                    
                    
                    292
                    
                    
                    
                    543Loss
      on disposal of property and equipment
                    
                    
                    180
                    
                    
                    
                    59Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    (3,731
                    )
                    
                    
                    1,908Merchandise
      inventories
                    
                    
                    3,006
                    
                    
                    
                    996Prepaid
      expenses and other current assets
                    
                    
                    481
                    
                    
                    
                    746Income
      tax receivable
                    
                    
                    97
                    
                    
                    
                    (43
                    )Other
      assets
                    
                    
                    129
                    
                    
                    
                    13Accounts
      payable and other accrued expenses
                    
                    
                    (914
                    )
                    
                    
                    458Deferred
      revenue from gift cards
                    
                    
                    128
                    
                    
                    
                    141Tenant
      improvements allowances
                    
                    
                    94
                    
                    
                    
                    575Net
      cash provided by (used in) operating activities
                    
                    
                    (3,698
                    )
                    
                    
                    2,746CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
                    
                    
                    (505
                    )
                    
                    
                    (3,682
                    )Net
      cash used in investing activities
                    
                    
                    (505
                    )
                    
                    
                    (3,682
                    )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      borrowings under revolving line of credit
                    
                    
                    37
                    
                    
                    
                    893Proceeds
      on bridge facility
                    
                    
                    2,000
                    
                    
                    
                    -Repayment
      of capital lease obligation
                    
                    
                    (31
                    )
                    
                    
                    (45
                    )Proceeds
      from sale of common stock
                    
                    
                    3,052
                    
                    
                    
                    -Cash
      paid for issuance costs
                    
                    
                    (309
                    )
                    
                    
                    -Payment
      of deferred financing costs
                    
                    
                    (75
                    )
                    
                    
                    -Net
      cash provided by financing activities
                    
                    
                    4,674
                    
                    
                    
                    848NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                    
                    
                    471
                    
                    
                    
                    (88
                    )CASH
      AND CASH EQUIVALENTS:Beginning
      of period
                    
                    
                    555
                    
                    
                    
                    791End
      of period
                    
                    $
                    1,026
                    
                    
                    $
                    703SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      paid during period for:Interest
                    
                    $
                    578
                    
                    
                    $
                    549Taxes
                    
                    $
                    55
                    
                    
                    $
                    37





See notes
to consolidated unaudited financial statements.


5


FREDERICK’S
OF HOLLYWOOD GROUP INC.


NOTES
TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS




1.
            Interim
      Financial Statements




In the
opinion of Frederick’s of Hollywood Group Inc. (the “Company”), the accompanying
consolidated unaudited financial statements contain all adjustments (consisting
of normal recurring accruals) necessary to present fairly the Company’s
financial position as of April 24, 2010 and the results of operations and cash
flows for the nine months ended April 24, 2010 and April 25, 2009.




The
consolidated unaudited financial statements and notes are presented as required
by Form 10-Q and do not contain certain information included in the Company’s
year-end financial statements.  The July 25, 2009 consolidated balance
sheet is from the Company’s audited financial statements.  The results
of operations for the three and nine months ended April 24, 2010 are not
necessarily indicative of the results to be expected for the full
year.  This Form 10-Q should be read in conjunction with the Company’s
audited consolidated financial statements and accompanying notes for the year
ended July 25, 2009 included in the Company’s 2009 Annual Report on Form 10-K
filed with the Securities and Exchange Commission (“SEC”) on October 23,
2009.




In
September and October 2009, the Company’s senior revolving credit facility (the
“Facility”) with Wells Fargo Retail Finance II, LLC (“Senior Lender”) was
amended to provide for a $2.0 million bridge facility to be repaid upon the
earlier of August 1, 2010 and the consummation of one or more financings in
which the Company receives net proceeds of at least an aggregate of $4.4 million
(a “Recapitalization Event”).  On March 16, 2010, the Company sold
2,907,051 shares of common stock in a private placement (“Private Placement”) to
accredited investors, raising net proceeds of approximately $2.7 million (see
Note 7).  Unless the Company raises the remaining approximately $1.7
million to complete a Recapitalization Event by August 1, 2010, the Company will
be in violation of a covenant under the Facility.  If such violation
is not waived by the Senior Lender, it will constitute an event of default under
the Facility whereby the Senior Lender will have the right to terminate the
Facility and declare all outstanding amounts under the Facility immediately due
and payable.  There can be no assurance that the Company will be able
to consummate a Recapitalization Event and repay the bridge facility as required
under the Facility or, if these events do not occur, that the Senior Lender will
continue the Facility.  If the Company cannot raise funds on
acceptable terms when needed or if the Senior Lender does not continue the
Facility, the Company may be required to curtail operations significantly and
seek alternative financing in order to continue as a going
concern.  See Note 6.


The
Company has evaluated subsequent events through the date the financial
statements were issued.  The following events described below and in
Note 8 took place which requires disclosure:
  On May
18, 2010, the Company completed the transactions contemplated by the Debt
Exchange and Preferred Stock Conversion Agreement, dated as of February 1, 2010
(“Exchange and Conversion Agreement”), with accounts and funds managed by and/or
affiliated with Fursa Alternative Strategies LLC (collectively, “Fursa”), the
former holders of the Company’s long term debt – related party (the “Tranche C
Debt”) and Series A Preferred Stock and one of the Company’s largest
shareholders.
  At the
closing, the Company issued to Fursa an aggregate of 8,664,373 shares of common
stock upon exchange of approximately $14.3 million of outstanding Tranche C Debt
and accrued interest, and conversion of approximately $8.8 million of Series A
Preferred Stock, including accrued dividends, at an effective price of
approximately $2.66 per share.  This transaction will result in annual
savings of approximately $1,562,000 of interest and dividends.  This
transaction did not constitute a Recapitalization Event under the
Facility.
  The
Company also issued to Fursa three, five and seven-year warrants, each to
purchase 500,000 shares of common stock (for an aggregate of 1,500,000 shares of
common stock) at exercise prices of $2.00, $2.33 and $2.66 per share,
respectively.  The warrants are exercisable for cash or on a cashless
basis, at Fursa’s option.  At any time after the first anniversary of
the issuance date, the Company may redeem the warrants, in whole but not in
part, upon not less than 20 business days’ written notice to Fursa, at a
redemption price of $0.01 per share, if the last sale price of the common stock
is at least 200% of the exercise price of the warrants for 10 consecutive
trading days ending on the day prior to the date on which notice of redemption
is given to Fursa.  Following the transaction, Fursa’s aggregate
beneficial ownership of the Company’s common stock increased from approximately
33% to approximately 47%.


6


As a
result of the transaction, the balance sheet effect was an increase to
shareholders’ equity of approximately $23.0 million.  The following
unaudited pro forma balance sheet gives effect to the transactions contemplated
by the Exchange and Conversion Agreement as if they had occurred on April 24,
2010 and includes accrued interest of $294,000 on the Tranche C Debt and
$1,258,000 of accrued dividends related to the Series A Preferred Stock, which
are included in current liabilities.





April 24, 2010Actual
                  
                  
                  Unaudited
                    Pro Forma
                    Adjustments
                  
                  
                  Pro FormaTotal assets
                  
                  $
                  73,838
                  
                  
                  $
                  -
                  
                  
                  $
                  73,838Current
      liabilities
                  
                  $
                  35,430
                  
                  
                  
                  (1,552
                  )
                  
                  
                  33,878Long
      term debt – related party
                  
                  
                  13,944
                  
                  
                  
                  (13,944
                  )
                  
                  
                  -Other
      long term liabilities
                  
                  
                  16,518
                  
                  
                  
                  -
                  
                  
                  
                  16,518Preferred
      stock
                  
                  
                  7,500
                  
                  
                  
                  (7,500
                  )
                  
                  
                  -Shareholders’
      equity
                  
                  
                  446
                  
                  
                  
                  22,996
                  
                  
                  
                  23,442Total
      liabilities and shareholders’ equity
                  
                  $
                  73,838
                  
                  
                  $
                  -
                  
                  
                  $
                  73,838




2.
            Summary
      of Significant Accounting Policies




Revenue Recognition –The
Company records revenue at the point of sale for retail stores (“Stores”), at
the time of estimated receipt by the customer for catalog and website sales
(referred to collectively as “Direct”), and at the time of shipment to its
wholesale customers.  Outbound shipping charges billed to customers
are included in net sales.  The Company records an allowance for
estimated returns from its retail customers in the period of sale based on prior
experience.  At April 24, 2010 and July 25, 2009, the allowance for
estimated returns from the Company’s retail customers was $927,000 and $947,000,
respectively.  If actual returns are greater than expected, additional
sales allowances may be recorded in the future.  Retail sales are
recorded net of sales taxes collected from customers at the time of the
transaction.




The
Company records other revenues for shipping revenues, as well as for commissions
earned on direct sell-through programs, on a net basis as the Company acts as an
agent on behalf of the related vendor.  For the three months ended
April 24, 2010 and April 25, 2009, total other revenues recorded in net sales in
the accompanying consolidated statements of operations were $2,453,000 and
$2,638,000, respectively.  For the nine months ended April 24, 2010
and April 25, 2009, total other revenues recorded in net sales in the
accompanying consolidated statements of operations were $6,480,000 and
$7,149,000, respectively.




Gift
certificates and gift cards sold are carried as a liability and revenue is
recognized when the gift certificate or card is redeemed.  Customers
may receive a store credit in exchange for returned goods, which is carried as a
liability until redeemed.  To date, the Company has not recognized any
revenue associated with breakage from gift certificates, gift cards or store
credits because they do not have expiration dates.




Accounts Receivable/Allowance for
Doubtful Accounts and Sales Discounts – The Company’s accounts
receivable is comprised primarily of the retail segment’s amounts due from
commercial credit card companies and the wholesale segment’s trade
receivables.  Credit card receivables of $1,217,000 and $1,156,000 at
April 24, 2010 and July 25, 2009, respectively, represent amounts due from
commercial credit card companies, such as Visa, MasterCard and American Express,
which are generally received within a few days of the related
transactions.  The Company’s trade accounts receivable is net of
allowance for doubtful accounts and sales discounts.  An allowance for
doubtful accounts is determined through the analysis of the aging of accounts
receivable at the date of the financial statements.  An assessment of the
accounts receivable is made based on historical trends and an evaluation of the
impact of economic conditions.  This amount is not significant,
primarily due to the Company’s history of minimal bad debts.  An
allowance for sales discounts is based on discounts relating to open invoices
where trade discounts have been extended to customers, costs associated with
potential returns of products, as well as allowable customer markdowns and
operational charge backs, net of expected recoveries.  These
allowances are included as a reduction to net sales and are part of the
provision for allowances included in accounts receivable.  The
foregoing results from seasonal negotiations and historic deduction trends, net
of expected recoveries and the evaluation of current market conditions. As of
April 24, 2010 and July 25, 2009, the wholesale accounts receivable was net of
allowances of $533,000 and $633,000, respectively.  The wholesale
accounts receivable as of April 24, 2010, net of the $533,000 allowance, was
$5,654,000 and as of July 25, 2009, net of the $633,000 allowance, was
$1,263,000.  The Company believes its allowance for doubtful accounts
and sales discounts to be appropriate, and actual results should not differ
materially from those determined using necessary estimates.  However,
if the financial condition of the Company’s customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.  Also, if market conditions were to
worsen, management may take actions to increase customer incentive offerings,
possibly resulting in an incremental allowance at the time the incentive is
offered.


7


Merchandise Inventories –
Store inventories are valued at the lower of cost or market using the retail
inventory first-in, first-out (“FIFO”) method, and wholesale and Direct
inventories are valued at the lower of cost or market, on an average cost basis
that approximates the FIFO method.  Freight costs are included in
inventory and vendor promotional allowances are recorded as a reduction in
inventory cost.  These inventory methods inherently require management
judgments and estimates, such as the amount and timing of permanent markdowns to
clear unproductive or slow-moving inventory, which may impact the ending
inventory valuations and gross margins.  Markdowns are recorded when
the sales value of the inventory has diminished.  Factors considered
in the determination of permanent markdowns include current and anticipated
demand, customer preferences, age of the merchandise and fashion
trends.  Additionally, the Company reserves for planned but unexecuted
markdowns as well as estimated amounts equal to the difference between the cost
of inventory and the estimated market value based upon assumptions about future
demand, market conditions and the age of the inventory.  If actual
market conditions are less favorable than those projected by management,
additional inventory reserves may be required.  Historically,
management has found its inventory reserves to be appropriate, and actual
results generally do not differ materially from those determined using necessary
estimates.  Inventory reserves were $757,000 at April 24, 2010
and $1,557,000 at July 25, 2009.




Deferred Catalog Costs–
Deferred catalog costs represent direct-response advertising that is capitalized
and amortized over its expected period of future
benefit.  Direct-response advertising consists primarily of product
catalogs of FOH Holdings’ mail order subsidiary.  The capitalized
costs of the advertising are amortized over the expected revenue stream
following the mailing of the respective catalog, which is generally six
months.  The realization of the deferred catalog costs are also
evaluated as of each balance sheet date by comparing the capitalized costs for
each catalog, on a catalog by catalog basis, to the probable remaining future
net revenues.  Direct-responseadvertising
costs of $1,507,000 and $1,751,000 are included in prepaid expenses and other
current assets in the accompanying consolidated balance sheets at April 24, 2010
and July 25, 2009, respectively.  The Company believes that it
appropriately determines the expected period of future benefit as of the date of
its consolidated financial statements.  However, should actual sales
results differ from expected sales, deferred catalog costs may be written off on
an accelerated basis.




Impairment of Long-Lived
Assets – The Company reviews long-lived assets, including property and
equipment and its amortizable intangible assets, for impairment whenever events
or changes in circumstances indicate that the carrying value of an asset may not
be recoverable based on undiscounted cash flows.  The Company reviews
its indefinite lived intangible assets for impairment annually and in between
annual tests when circumstances or events have occurred that may indicate a
potential impairment has occurred.  If long-lived assets are impaired,
an impairment loss is recognized and is measured as the amount by which the
carrying value exceeds the estimated fair value of the
assets.  Management believes they have appropriately determined future
cash flows and operating performance; however, should actual results differ from
those expected, additional impairments may be required.  No impairment
was recorded for the nine months ended April 24, 2010 and April 25, 2009 related
to these long lived assets.




The
Company previously had goodwill, which represented the portion of the purchase
price that could not be attributed to specific tangible or identified intangible
assets recorded in connection with purchase accounting.  At January
24, 2009, since the Company’s market capitalization was significantly below its
book value, the Company performed an impairment analysis and determined that the
goodwill balances on both the retail and wholesale segments were impaired as a
result of its current and future projected financial results due to the poor
macroeconomic outlook and a reduction in wholesale business with Wal-Mart
Stores, Inc. (“Walmart”).  Accordingly, the Company recorded a
goodwill impairment charge of $19,100,000.  After recognizing the
impairment charge, the Company has no remaining goodwill on its consolidated
balance sheet as of January 24, 2009.


8


Accounting for Stock-Based
Compensation – The Company measures and recognizes compensation expense
for all share-based payment awards to employees and directors based on estimated
fair values on the grant date.  The Company recognizes the expense on
a straight-line basis over the requisite vesting period.




The value
of each stock option is estimated on the date of grant using the Black-Scholes
option-pricing model.  The fair value generated by the Black-Scholes
model may not be indicative of the future benefit, if any, that may be received
by the option holder.  The following assumptions were used for options
granted during the nine months ended April 24, 2010 and April 25,
2009:




Nine Months EndedApril 24,
                                
                                April 25,2010
                                
                                2009Risk-free interest rate
                                
                                3.00% - 3.04%
                                
                                1.99% - 3.34%Expected life (years)
                                
                                7
                                
                                5 –
      7Expected
      volatility
                                
                                79%
                                
                                60
      – 72%Dividend
      yield
                                
                                0.0%
                                
                                0.0%




During
the nine months ended April 24, 2010, the Company granted to four of its
employees options to purchase an aggregate of 87,500 shares of common stock
under the 2000 Performance Equity Plan.  Options to purchase 37,500
shares are exercisable at $1.16 per share and vest 20% each year over five
years.  Options to purchase 50,000 shares are exercisable at $1.12 per
share and vest 20% each year over five years.






During
the nine months ended April 25, 2009, the Company granted to two of its officers
and certain other employees options to purchase an aggregate of 127,500 shares
of common stock under the 2000 Performance Equity Plan and 360,000 shares of
common stock under the 1988 Non-Qualified Stock Option Plan.  These
options are identified as follows:




Number
                      of Options
                  
                  Exercise
                      Price
                  
                  Vesting Period120,000
                  
                  $
                  0.38
                  
                  immediately
      vested25,000
                  
                  $
                  0.96
                  
                  in
      full after six months25,000
                  
                  $
                  0.37
                  
                  monthly
      over six months240,000
                  
                  $
                  0.38
                  
                  50%
      at January 2, 2010 and 50% at January 2, 201157,500
                  
                  $
                  0.87
                  
                  20%
      each year over 5 years20,000
                  
                  $
                  0.17
                  
                  20%
      each year over 5
years




Income Taxes – Income taxes
are accounted for under an asset and liability approach that requires the
recognition of deferred income tax assets and liabilities for the expected
future consequences of events that have been recognized in the Company’s
financial statements and income tax returns.  The Company provides a
valuation allowance for deferred income tax assets when it is considered more
likely than not that all or a portion of such deferred income tax assets will
not be realized.  Due to the Company’s merger with FOH Holdings, Inc.
in January 2008, the Company underwent a change in control under Section 382 of
the Internal Revenue Code and, therefore, certain pre-merger net operating loss
carry-forwards are limited for future utilization.




Fair Value of Financial Instruments– The Company believes the carrying amounts of cash and cash equivalents,
accounts receivable, accounts payable, accrued expenses and the bridge facility
approximate fair value due to their short maturity.  The carrying amount of
the revolving line of credit approximates fair value, as these borrowings have
variable rates that reflect currently available terms and conditions for similar
debt.  The Company did not estimate the fair value of the Tranche C Debt
and Series A Preferred Stock owed to Fursa because (i) these related party
instruments were not traded and, therefore, no quoted market prices existed upon
which to base an estimate of fair value and (ii) there were no readily
determinable similar instruments on which to base an estimate of fair
value.  In addition, the Company believed that the long term
relationship it has developed and maintained with Fursa and the accommodations
that the Company has received from Fursa were factors that also contribute to
the impracticality in estimating fair value. See Note 1.


9




Supplemental Disclosure of Noncash
FinancingTransactions– During
the nine months ended April 24, 2010, the Company acquired equipment through a
capital lease for $167,000. Also, during the nine months ended April 24,
2010 and April 25, 2009, the Company accrued dividends of $393,000 and $432,000,
respectively, on its Series A Preferred Stock.




The
Company did not have any outstanding accounts payable and accrued expenses
related to purchases of property and equipment at April 24, 2010 and had
outstanding accounts payable and accrued expenses related to purchases of
property and equipment of $20,000, $163,000 and $248,000 at July 25, 2009, April
25, 2009 and July 26, 2008, respectively.




3.
            Effect
      of New Accounting Standards




In June
2009, the Financial Accounting Standards Board’s (“FASB”) Accounting Standards
Codification (“ASC”) became the single official source of authoritative U.S.
generally accepted accounting principles recognized by the FASB to be applied by
nongovernmental entities.  The ASC supersedes all existing non-SEC
accounting and reporting standards.  The ASC is effective for
financial statements issued for interim and annual periods ending after
September 15, 2009.  The Company adopted the ASC effective for its
October 24, 2009 financial statements.




In
September 2006, the FASB issued new accounting guidance that defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements.  In February 2008, the FASB deferred the
effective date of the new accounting guidance for all non-financial assets and
non-financial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually) to
fiscal years beginning after November 15, 2008. The Company’s adoption of this
new guidance for its non-financial assets and liabilities, effective July 26,
2009, did not have a material impact on the Company’s consolidated financial
statements.




In
December 2007, the FASB issued new accounting and disclosure guidance related to
noncontrolling interests in a subsidiary.  This new guidance was
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008.  The Company’s adoption of
this new guidance, effective July 26, 2009, did not have a material impact on
the Company’s consolidated financial statements.




In
June 2009, the FASB amended its guidance on accounting for variable
interest entities which replaces the quantitative-based risks and rewards
calculation for determining which enterprise has a controlling financial
interest in a variable interest entity with an approach focused on identifying
which enterprise has the power to direct the activities of a variable interest
entity and the obligation to absorb losses of the entity or the right to receive
benefits from the entity. The new guidance becomes effective for annual periods
beginning after November 15, 2009 and interim periods within those fiscal
years. The Company does not expect the adoption of this guidance to have a
material impact on its consolidated financial statements.




4.
            Merchandise Inventories




Merchandise
inventories consist of the following (in thousands):




April 24,
                  
                  
                  July 25,2010
                  
                  
                  2009Raw
      materials
                  
                  $
                  849
                  
                  
                  $
                  1,457Work-in
      process
                  
                  
                  356
                  
                  
                  
                  249Finished
      goods
                  
                  
                  17,625
                  
                  
                  
                  20,130$
                  18,830
                  
                  
                  $
                  21,836




10




5.
            Net
      Income (Loss) Per Share




Basic net
income (loss) per share has been computed by dividing the net income (loss)
applicable to common shareholders by the weighted average number of shares
outstanding.  Diluted net income (loss) per share has been computed by
dividing the net income (loss) applicable to common shareholders by the weighted
average number of shares outstanding and common share
equivalents.  The Company’s calculation of basic and diluted net
income (loss) per share is as follows (in thousands, except per share
amounts):




Three Months Ended
              
              
              Nine Months EndedApril 24,
              
              
              April 25,
              
              
              April 24,
              
              
              April 25,2010
              
              
              2009
              
              
              2010
              
              
              2009Net
      income (loss)
              
              $
              218
              (a)
              
              $
              (2,120
              )(b)
              
              $
              (9,097
              )(c)
              
              $
              (27,607
              )(d)BASIC:Basic
      weighted average number of shares outstanding
              
              
              27,642
              
              
              
              26,343
              
              
              
              26,820
              
              
              
              26,235Basic
      net income (loss) per share
              
              $
              0.01
              
              
              $
              (0.08
              )
              
              $
              (0.34
              )
              
              $
              (1.05
              )DILUTED:Basic
      weighted average number of shares outstanding
              
              
              27,642
              
              
              
              26,343
              
              
              
              26,820
              
              
              
              26,235Shares
      issuable upon conversion of stock options
              
              
              193
              
              
              
              -
              
              
              
              -
              
              
              
              -Total
      average number of equivalent shares outstanding
              
              
              27,835
              
              
              
              26,343
              
              
              
              26,820
              
              
              
              26,235Diluted
      net income (loss) per share
              
              $
              0.01
              
              
              $
              (0.08
              )
              
              $
              (0.34
              )
              
              $
              (1.05
              )





(a)
            Net
      of Series A preferred stock dividends of
$132.


(b)
            Net
      of Series A preferred stock dividends of
$151.


(c)
            Net
      of Series A preferred stock dividends of
$393.


(d)
            Net
      of Series A preferred stock dividends of
$432.





For the
nine months ended April 24, 2010, 213,000 potentially dilutive shares ranging in
price from $0.17 to $1.56 per share were not included in the computation of
diluted net loss per share since their effect would have been
anti-dilutive.




For the
three and nine months ended April 25, 2009, 5,000 and 2,000 potentially dilutive
shares at a price of $0.17 per share were not included in the computation of
diluted net loss per share since their effect would have been
anti-dilutive.




For the
nine months ended April 24, 2010, there were 1,658,000 shares of common stock
issuable upon exercise of stock options, 3,179,000 shares of common stock
issuable upon the exercise of warrants and 1,623,000 shares of common stock
issuable upon the conversion of the Company’s Series A Preferred Stock that also
were not included in the computation of diluted net loss per share since the
respective exercise and conversion prices of these instruments exceeded the
average market price of the common stock during the respective
periods.




For the
nine months ended April 25, 2009 there were 2,514,000 shares of common stock
issuable upon exercise of stock options, 598,000 shares of common stock issuable
upon the exercise of warrants and 1,512,000 shares of common stock issuable upon
the conversion of the Company’s Series A Preferred Stock that also were not
included in the computation of diluted net loss per share since the respective
exercise and conversion prices of these instruments exceeded the average market
price of the common stock during the respective periods.




6.
            Financing




Revolving
Credit and Bridge Facilities




The
Company’s and its U.S. subsidiaries’ Facility matures on January 28,
2012.


11


The
Facility is for a maximum amount of $50 million comprised of a $25 million line
of credit with a $15 million sub-limit for letters of credit, and up to an
additional $25 million commitment in increments of $5 million at the option of
the Company so long as the Company is in compliance with the terms of the
Facility.  The actual amount of credit available under the Facility is
determined using measurements based on the Company’s receivables, inventory and
other measures.  The Facility is secured by a first priority security
interest in the assets of the Company and its U.S.
subsidiaries.  Interest is payable monthly, in arrears, at interest
rates that were increased effective September 21, 2009 in connection with the
second amendment to the Facility described below.




On
November 4, 2008, the Company utilized the accordion feature under the Facility
to increase the borrowing limit from $25 million to $30 million.  In
utilizing the accordion feature, the Company’s minimum availability reserve
increased by $375,000 (7.5% of the $5,000,000 increase) to $2,250,000 (7.5% of
the $30,000,000) and the Company incurred a one-time closing fee of
$12,500.




On
September 21, 2009, the Facility was amended to provide for a $2.0 million
bridge facility at an annual interest rate of LIBOR plus 10%, to be repaid upon
the earlier of December 7, 2009 and the consummation of a financing in which the
Company receives net proceeds of at least $4.9 million. On October 23, 2009, the
Facility was further amended to extend the December 7, 2009 repayment date to
August 1, 2010 and to reduce the net proceeds that the Company is required to
receive in the Recapitalization Event to an aggregate of $4.4
million.  On March 16, 2010, the Company sold 2,907,051 shares of
common stock in the Private Placement to accredited investors, raising net
proceeds of approximately $2.7 million (see Note 7).  Unless the
Company raises the remaining approximately $1.7 million to complete a
Recapitalization Event by August 1, 2010, the Company will be in violation of a
covenant under the Facility.  If such violation is not waived by the
Senior Lender, it will constitute an event of default.




In
connection with the September and October 2009 amendments, the interest rates on
“Base Rate” loans and “LIBOR Rate” loans under the Facility were increased as
follows:




·
            “Base
      Rate” loan interest rates were increased from the Wells Fargo prime rate
      less 25 basis points to the Wells Fargo prime rate plus 175 basis points;
      and




·
            “LIBOR
      Rate” loan interest rates were increased from LIBOR plus 150 basis points
      to LIBOR plus 300 basis points.




The fee
on any unused portion of the Facility was also increased from 25 basis points to
50 basis points.  In addition, upon a Recapitalization Event, the
applicable percentages used in calculating the borrowing base under the Facility
will be reduced.  Although the Company’s sale of common stock in the
Private Placement described in Note 7 did not constitute a Recapitalization
Event, these percentages were reduced following the closing of the Private
Placement on March 16, 2010.




In
connection with the amendments to the Facility, the Company incurred a one-time
amendment fee of $150,000, one half of which has been paid and the remainder
will be paid upon the Recapitalization Event.  All other material
terms of the Facility remain unchanged.




As of
April 24, 2010, the Company had (i) $1,282,000 outstanding under the
Facility at a Base Rate of 5.0%, (ii) $8,000,000 outstanding under the Facility
at a LIBOR Rate of 3.25% and (iii) $2,000,000 outstanding under the bridge
facility at a rate of 10.25%.  For the nine months ended April
24, 2010, borrowings under the Facility (including the bridge facility) peaked
at $16,996,000 and the average borrowing during the period was approximately
$12,625,000.  In addition, at April 24, 2010, the Company had
$1,112,000 of outstanding letters of credit under the Facility.




As of
April 25, 2009, the Company had $11,986,000 outstanding under the Facility at a
rate of 3.0%.  For the nine months ended April 25, 2009,
borrowings under the Facility peaked at $26,386,000 and the average borrowing
during the period was approximately $15,771,000.  In addition, at
April 25, 2009, the Company had $1,808,000 of outstanding letters of credit
under the Facility.




The
Facility contains customary representations and warranties, affirmative and
restrictive covenants and events of default.  The restrictive
covenants limit the Company’s ability to create certain liens, make certain
types of borrowings and investments, liquidate or dissolve, engage in mergers,
consolidations, significant asset sales and affiliate transactions, dispose of
inventory, incur certain lease obligations, make capital expenditures, pay
dividends, redeem or repurchase outstanding equity and issue capital
stock.  In lieu of financial covenants, fixed charge coverage and
overall debt ratios, the Company also is required to maintain specified minimum
availability reserves. At April 24, 2010, the Company was in compliance with the
Facility’s covenants and minimum availability reserve
requirements.


12


Long
Term Debt – Related Party




As of
April 24, 2010, the Company and its U.S. subsidiaries had the Tranche C Debt in
the amount of $13,944,000 due to Fursa.  The Tranche C Debt was
scheduled to mature on July 28, 2012 and bore interest at the fixed rate of 7%
per annum with 1% payable in cash and 6% payable in kind.




The
Tranche C Debt was secured by substantially all of the Company’s assets and was
second in priority to the Facility.  The Tranche C Debt contained
customary representations and warranties, affirmative and restrictive covenants
and events of default substantially similar to, and no more restrictive than,
those contained in the Facility.  At April 24, 2010, the Company was
in compliance with the covenants contained in the term loan agreement, as
amended, governing the Tranche C Debt.




On May
18, 2010, the Company consummated the transactions contemplated by the Exchange
and Conversion Agreement with Fursa, pursuant to which the entire Tranche C
Debt and accrued interest was exchanged for shares of the Company’s common stock
as described in Note 1.




Preferred
Stock




As of
April 24, 2010, the Company had 3,629,325 shares of Series A 7.5% Convertible
Preferred Stock outstanding, which are owned by Fursa.  The Series A
Preferred Stock was convertible at any time at Fursa’s option into an aggregate
of 1,622,682 shares of common stock, subject to adjustment (see Note
7).  As of April 24, 2010, the Company had accrued dividends of
$1,258,000.




On May
18, 2010, the Company consummated the transactions contemplated by the Exchange
and Conversion Agreement with Fursa, pursuant to which all of the Series A
Preferred Stock and accrued dividends were converted into shares of the
Company’s common stock as described in Note 1.




7.
            Unregistered
      Sale of Equity Securities




On March
16, 2010, the Company completed the Private Placement to accredited investors of
2,907,051 shares of common stock at $1.05 per share, raising total gross
proceeds of approximately $3,052,000.  The investors in the Private
Placement also received two-and-a-half year Series A warrants to purchase up to
an aggregate of 1,162,820 shares of common stock at an exercise price of $1.25
per share, and five-year Series B warrants to purchase up to an aggregate of
1,162,820 shares of common stock at an exercise price of $1.55 per share. Both
warrants become exercisable on the six-month anniversary of the closing date.
Each of the Series A and Series B warrants are callable for $0.01 per warrant
commencing 30 days after their initial exercise date if the Company’s stock
price exceeds $2.25 per share and $3.10 per share, respectively, for seven
consecutive trading days and the average daily volume during such period exceeds
100,000 shares per trading day. Additionally, the Series B warrants may be
exercised by the holders on a cashless basis.




Avalon
Securities Ltd. (“Avalon”) acted as placement agent in the
transaction.  Upon the closing, the Company paid Avalon approximately
$198,000 in cash commissions and issued to Avalon and its designees warrants to
purchase an aggregate of 218,030 shares of common stock at an exercise price of
$1.21 per share.  Except for the exercise price, these warrants are
identical to the Series B warrants issued to investors in the Private
Placement.  In addition, the Company paid approximately $111,000 in
other fees related to the Private Placement, $41,000 of which was paid to Avalon
in consulting fees.




As
discussed in Note 6, the Company is required to repay its $2.0 million bridge
facility with the Senior Lender upon the earlier of August 1, 2010 and the
consummation of a Recapitalization Event. As the Private Placement did not
constitute a Recapitalization Event, the Company was not required to use the
proceeds from the Private Placement to repay the bridge facility. However,
following the closing of the Private Placement, the percentages used in
calculating the borrowing base under the Facility were reduced.




13


As a
result of the Private Placement, pursuant to the anti-dilution adjustment
provisions contained in the Company’s Amended and Restated Certificate of
Incorporation governing the terms of the Series A Preferred Stock, the number of
shares of common stock issuable upon conversion of the Series A Preferred Stock
was increased from 1,512,219 shares to 1,622,682
shares.  Additionally, pursuant to the anti-dilution adjustment
provisions contained in the warrants issued to Fursa and Tokarz Investments, LLC
in connection with the Company’s merger with FOH Holdings, Inc., the number of
shares of common stock issuable upon exercise of such warrants was increased
from an aggregate of 596,592 shares to an aggregate of 635,076 shares and the
exercise price of such warrants was decreased from $3.52 per share to $3.31 per
share.




8.
            Commitments
      and Contingencies




Employment Agreement – On
June 1, 2010, the Company entered into an employment agreement with the
Company’s Chief Financial Officer for a three year term until June 1, 2013 at a
base salary of $310,000 per year.  Future commitments through the
fiscal year ending July 27, 2013 total $930,000.




Legal Matters –The Company
is involved from time to time in litigation incidental to its
business.  The Company believes that the outcome of such litigation
will not have a material adverse effect on its results of operations or
financial condition.




9.
            Segments




The
Company has two reportable segments – retail and wholesale.  Each
segment primarily sells women’s intimate apparel through different distribution
channels.  The retail segment sells products through the Company’s
retail stores, as well as its catalog and e-commerce website.  The
retail segment sells products purchased from the Company’s outside suppliers and
from the wholesale segment.  The wholesale segment is engaged in the
design, manufacture, distribution and sale of women’s intimate apparel to mass
merchandisers, specialty and department stores, discount retailers, national and
regional chains and direct mail catalog marketers throughout the United States
and Canada.  Canadian sales represented approximately 4% and 3% of
wholesale net sales for the nine months ended April 24, 2010 and April 25,
2009, respectively.


Sales and
transfers between segments generally are recorded at cost and treated as
transfers of inventory, and all intercompany revenues are eliminated in
consolidation.  Each segment’s performance is evaluated based upon
operating income or loss.  Corporate overhead expenses (exclusive of
expenses for senior management, certain other corporate-related expenses and
interest) are allocated to the segments based upon specific usage or other
allocation methods.


Net sales, operating income (loss) and
total assets for each segment are as follows:


($ in thousands)
                      
                      Three Months Ended
                      
                      
                      Nine Months EndedApril 24,
                      
                      
                      April 25,
                      
                      
                      April 24,
                      
                      
                      April 25,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Net Sales:Retail
                      
                      $
                      36,882
                      
                      
                      $
                      39,397
                      
                      
                      $
                      104,739
                      
                      
                      $
                      110,878Wholesale
                      
                      
                      6,509
                      
                      
                      
                      7,369
                      
                      
                      
                      17,181
                      
                      
                      
                      30,969Total
      net sales
                      
                      $
                      43,391
                      
                      
                      $
                      46,766
                      
                      
                      $
                      121,920
                      
                      
                      $
                      141,847Operating
      Income (Loss):Retail
                      
                      $
                      1,974
                      
                      
                      $
                      1,248
                      
                      
                      $
                      (964
                      )
                      
                      $
                      (7,341
                      )Wholesale
                      
                      
                      (604
                      )
                      
                      
                      (2,182
                      )
                      
                      
                      (4,742
                      )
                      
                      
                      (16,886
                      )Total
      operating income (loss)
                      
                      $
                      1,370
                      
                      
                      $
                      (934
                      )
                      
                      $
                      (5,706
                      )
                      
                      $
                      (24,227
                      )Less
      Unallocated Corporate Expenses:Corporate
      expenses
                      
                      $
                      550
                      
                      
                      $
                      674
                      
                      
                      $
                      1,531
                      
                      
                      $
                      1,697Interest
      expense
                      
                      
                      447
                      
                      
                      
                      337
                      
                      
                      
                      1,397
                      
                      
                      
                      1,186Total
      unallocated expenses
                      
                      $
                      997
                      
                      
                      $
                      1,011
                      
                      
                      $
                      2,928
                      
                      
                      $
                      2,883Income
      (loss) before income tax provision
                      
                      $
                      373
                      
                      
                      $
                      (1,945
                      )
                      
                      $
                      (8,634
                      )
                      
                      $
                      (27,110
                      )Total
      AssetsRetail
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      55,501
                      
                      
                      $
                      62,233Wholesale
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      18,337
                      
                      
                      
                      20,927Total
      Assets
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      73,838
                      
                      
                      $
                      83,160


14


ITEM
      2.
            MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS




Forward-Looking
Statements




When used in this Form 10-Q of
Frederick’s of Hollywood Group Inc. and in our future filings with the
Securities and Exchange Commission (“SEC”), the words or phrases “will likely
result,” “management expects” or “we expect,” “will continue,” “is anticipated,”
“estimated” or similar expressions are intended to identify “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act
of 1995.  Readers are cautioned not to place undue reliance on any
such forward-looking statements, each of which speaks only as of the date
made.  We have no obligation to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect
anticipated or unanticipated events or circumstances occurring after the date of
such statements.




Such statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical earnings and those presently anticipated or
projected.  These risks are included in “Item 1: Business,” “Item 1A:
Risk Factors” and “Item 7: Management’s Discussion and Analysis of Financial
Condition and Results of Operations” of our Form 10-K for the year ended July
25, 2009.  In assessing forward-looking statements contained herein,
readers are urged to carefully read those statements.  Among the
factors that could cause actual results to differ materially are: competition;
business conditions and industry growth; rapidly changing consumer preferences
and trends; general economic conditions; large variations in sales volume with
significant customers; addition or loss of significant customers; continued
compliance with government regulations; loss of key personnel; labor practices;
product development; management of growth; increases of costs of operations or
inability to meet efficiency or cost reduction objectives; timing of orders and
deliveries of products; and foreign government regulations and risks of doing
business abroad.




Corporate
History




Frederick’s of Hollywood Group Inc.
(the “Company”) is a New York corporation incorporated on April 10, 1935. On
January 28, 2008, the Company consummated a merger with FOH Holdings, Inc., a
privately-held Delaware corporation (“FOH Holdings”).  As a result of
the transaction, FOH Holdings became a wholly-owned subsidiary of the
Company.  FOH Holdings is the parent company of Frederick’s of
Hollywood, Inc.  Upon consummation of the merger, the Company changed
its name from Movie Star, Inc. to Frederick’s of Hollywood Group Inc. and its
trading symbol on the NYSE Amex was changed to “FOH.”




As used in this Form 10-Q, the
“Company,” “we,” “our” or “us” refers to the operations and financial results of
Frederick’s of Hollywood Group Inc., together with FOH Holdings, Inc. and its
subsidiaries on a consolidated basis.




Overview




We
conduct our business through two operating divisions that represent two distinct
business reporting segments:  the multi-channel retail division and
the wholesale division.  We believe this method of segment reporting
reflects both the way our business segments are managed and the way each
segment’s performance is evaluated.  The retail segment includes our
Frederick’s of Hollywood retail stores, catalog and website
operations.  The wholesale segment includes our wholesale operations
in the United States and Canada.




Through
our multi-channel retail division, we sell women’s intimate apparel and related
products under our proprietary Frederick’s of Hollywood® brand
exclusively through our mall-based specialty retail stores in the United States,
which we refer to as “Stores,” and through our catalog and website at www.fredericks.com,
which we refer to collectively as “Direct.”  As of April 24, 2010, we
operated 128 Frederick’s of Hollywood stores nationwide.




Through our wholesale division, we
design, manufacture, source, distribute and sell women’s intimate apparel to
mass merchandisers, specialty and department stores, discount retailers,
national and regional chains, and direct mail catalog marketers throughout the
United States and Canada.


15


Operating
Initiatives




Our efforts remain focused on
continuing to implement changes in our business strategy as described below that
we believe over time will both increase revenues and reduce costs.  Some of
these initiatives have had an immediate impact on our operating results and we
expect that others will take more time.  However, we cannot be certain that
these initiatives will be successful.  These key initiatives
include:




·
            Capitalizing on the
      Frederick’s of Hollywood
brand.




o
            Entering into licensing
      arrangements.During the second quarter of fiscal year
      2010, we launched a licensing program for the Frederick’s of Hollywood
      brand by hiring a leading licensing firm to manage our global licensing
      initiatives.  In May 2010, we entered into an exclusive,
      multi-year international licensing agreement with Blue By Yoo to
      manufacture, distribute and market a new line of women’s swimwear under
      the Frederick’s of Hollywood®
      brand.  In addition to selling the swimwear line through our
      retail stores, catalog and website, Blue By Yoo will also distribute the
      product line to department stores, specialty retail chains, boutique
      stores, intimate apparel stores and resort
  outlets.




o
            Identifying and implementing
      other licensing initiatives.  In addition to swimwear, we
      have identified domestic and international licensing opportunities to
      allow us to expand beyond intimate apparel and into a lifestyle
      brand.  These opportunities include product categories such as
      fragrance, jewelry, accessories, shoes, headwear, handbags and costumes,
      as well as partnering with international distributors in countries such as
      Korea, Brazil, Japan, China and Canada.  We are currently in
      discussions with several potential
licensees.




o
            Developing Frederick’s of
      Hollywood brand extension opportunities.During the
      fourth quarter of fiscal year 2009, we developed a branding/product
      development strategy targeting our wholesale division’s mass merchandising
      customers.  To implement this strategy, we created new product lines
      heavily influenced by our retail creative and design teams.  We
      have been using the wholesale brand name, Cinema Etoile®,
      for some of these products and plan to strategically use the Frederick’s
      of Hollywood brand name and brand extensions for other products sold to
      select wholesale customers.  We experienced an increase in open
      orders during the third quarter of fiscal year 2010 as a result of this
      initiative.




·
            Expanded marketing
      efforts.




o
            eCommerce.




§
            Online social media
      campaign.  In an effort to expand the base of customers
      visiting our website, www.fredericks.com,
      we retained WhittmanHart Interactive, a brand building digital agency, to
      help increase our exposure to customers through a complete social media
      and online marketing campaign.  The campaign, which was launched
      in February 2010, focuses on emerging platforms, mobile, community and
      social media to maximize customer awareness of our latest fashion trends
      and promotions.




§
            Search marketing
      initiatives.  During the first quarter of fiscal year 2010, we
      retained a new search marketing agency to assist us with improving our
      search marketing program.  As a result, we have been able to
      employ more efficient search marketing techniques, which has resulted in
      reduced marketing costs.




o
            Strategic marketing
      partnership.  In May 2010, we entered into an integrated
      marketing and media partnership agreement with Hard Rock Hotel &
      Casino Las Vegas (“HRH”).  Through the partnership, we are
      planning to promote the Frederick’s of Hollywood brand and products across
      multiple venues, including social networking, product integration, cross
      promotion and unique events.  We will have on-site presence
      throughout HRH, including event participation at the hotel’s clubs and
      pools, retail presence throughout HRH and featured Frederick’s of
      Hollywood branded merchandise will be promoted through various HRH sales
      channels.




16




o
            Catalog.  Due
      to rising paper, production and mailing costs, we reduced annual catalog
      circulation from approximately 18.7 million in fiscal year 2008 to
      approximately 17.6 million in fiscal year 2009 and expect a further
      reduction to 16.6 million in fiscal year 2010.  We achieved this
      reduction by targeting customers through improved analysis and monitoring
      of their purchasing habits and by executing a more focused marketing
      strategy.  Also during fiscal year 2010, we have been rolling out
      various cost effective alternatives to full size catalog mailings such as
      postcards, gift guides and personalized “look books,” which we expect will
      represent approximately 10% of our total mailings for fiscal year
      2010.




·
            Continuing to reduce operating
      expenses.  While the macroeconomic environment continues
      to present challenges to both our retail and wholesale divisions, on an
      operational basis (which includes our wholesale division for the period
      prior to the merger from August 2007 through January 2008), we reduced our
      selling, general and administrative expenses from approximately
      $91,000,000 in the fiscal year ended July 26, 2008 to $74,496,000 in the
      fiscal year ended July 25, 2009, and have reduced expenses during the
      first nine months of fiscal year 2010 by an additional
      $6,337,000.  We are continuing to focus on reducing expenses and
      expect further reductions for the remainder of fiscal year 2010 and in
      fiscal year 2011.  These cuts include reducing personnel through
      the elimination and consolidation of executive and support positions,
      transitioning certain manufacturing support functions previously performed
      by domestic personnel to our facilities in Asia or to third party
      manufacturers, decreasing the use of outside consultants, and
      consolidating employee benefits and
insurance.




·
            Elimination of Philippines
      on-site manufacturing operations.  In order to reduce our
      overall manufacturing costs and operational risk, we are eliminating our
      on-site manufacturing operations at our Philippines facility, which we
      anticipate will be substantially completed by the end of fiscal year
      2010.  As a result, we expect our gross profit to improve by
      approximately $1.5 million.




·
            Carefully monitoring store
      performance.  We continuously monitor store performance
      and from time to time close underperforming stores.  During
      fiscal year 2009, we closed six underperforming stores upon expiration of
      the respective leases.  For fiscal year 2010, we have focused on
      improving the profitability of our existing stores.  We closed
      four stores and opened two stores during the nine months ended April 24,
      2010 and currently expect to close an additional three underperforming
      stores through the remainder of the fiscal year upon expiration of the
      respective leases.




Critical
Accounting Policies and Estimates




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the appropriate
application of certain accounting policies, many of which require estimates and
assumptions about future events and their impact on amounts reported in the
financial statements and related notes.  Since future events and their
impact cannot be determined with certainty, the actual results will inevitably
differ from our estimates.  Such differences could be material to the
financial statements.




Management
believes that the application of accounting policies, and the estimates
inherently required by the policies, are reasonable.  These accounting
policies and estimates are constantly re-evaluated, and adjustments are made
when facts and circumstances dictate a change.  Historically,
management has found the application of accounting policies to be appropriate,
and actual results generally do not differ materially from those determined
using necessary estimates.




Our
accounting policies are more fully described in Note 2 to the unaudited
consolidated financial statements contained elsewhere in this report. Management
has identified certain critical accounting policies that are described
below.




Our most significant areas of
estimation and assumption are:




·
            determination
      of appropriate levels of reserves for accounts receivable allowances and
      sales discounts;




·
            estimation
      of expected customer merchandise
returns;




·
            determination
      of the appropriate amount and timing of markdowns to clear unproductive or
      slow-moving retail inventory and overall inventory
      obsolescence;




17


·
            estimation
      of deferred catalog costs and the amount of future benefit to be derived
      from the catalogs;




·
            estimation
      of future cash flows used to assess the recoverability of long-lived
      assets, including trademarks and goodwill;
and




·
            estimation
      of the net deferred income tax asset valuation
  allowance.




Revenue Recognition –We
record revenue at the point of sale for Stores, at the time of estimated receipt
by the customer for Direct sales, and at the time of shipment to our wholesale
customers.  Outbound shipping charges billed to customers are included
in net sales.  We record an allowance for estimated returns from our
retail customers in the period of sale based on prior experience.  At
April 24, 2010 and July 25, 2009, the allowance for estimated returns from our
retail customers was $927,000 and $947,000, respectively.  If actual
returns are greater than expected, additional sales allowances may be recorded
in the future.  Retail sales are recorded net of sales taxes collected
from customers at the time of the transaction.




We record
other revenues for shipping revenues, as well as for commissions earned on
direct sell-through programs, on a net basis as we act as an agent on behalf of
the related vendor.  For the three months ended April 24, 2010 and April
25, 2009, total other revenues recorded in net sales in the consolidated
statements of operations contained elsewhere in this report were $2,453,000 and
$2,638,000, respectively.  For the nine months ended April 24,
2010 and April 25, 2009, total other revenues recorded in net sales in the
consolidated statements of operations contained elsewhere in this report were
$6,480,000 and $7,149,000, respectively.




Gift
certificates and gift cards sold are carried as a liability and revenue is
recognized when the gift certificate or card is redeemed.  Customers
may receive a store credit in exchange for returned goods, which is carried as a
liability until redeemed.  To date, we have not recognized any revenue
associated with breakage from gift certificates, gift cards or store credits
because they do not have expiration dates.




Accounts Receivable/Allowance for
Doubtful Accounts and Sales Discounts – Our accounts receivable is
comprised primarily of the retail segment’s amounts due from commercial credit
card companies and the wholesale segment’s trade receivables.  Credit
card receivables of $1,217,000 and $1,156,000 at April 24, 2010 and July 25,
2009, respectively, represent amounts due from commercial credit card companies,
such as Visa, MasterCard and American Express, which are generally received
within a few days of the related transactions.  Our trade accounts
receivable is net of allowance for doubtful accounts and sales
discounts.  An allowance for doubtful accounts is determined through
the analysis of the aging of accounts receivable at the date of the financial
statements.  An assessment of the accounts receivable is made based on
historical trends and an evaluation of the impact of economic
conditions.  This amount is not significant, primarily due to our
history of minimal bad debts.  An allowance for sales discounts is
based on discounts relating to open invoices where trade discounts have been
extended to customers, costs associated with potential returns of products, as
well as allowable customer markdowns and operational charge backs, net of
expected recoveries.  These allowances are included as a reduction to
net sales and are part of the provision for allowances included in accounts
receivable.  The foregoing results from seasonal negotiations and
historic deduction trends, net of expected recoveries and the evaluation of
current market conditions.  As of April 24, 2010 and July 25, 2009,
accounts receivable was net of allowances of $533,000 and $633,000,
respectively.  The wholesale accounts receivable as of April 24, 2010,
net of the $533,000 allowance, was $5,654,000 and as of July 25, 2009, net of
the $633,000 allowance, was $1,263,000.  We believe our allowance for
doubtful accounts and sales discounts are appropriate, and actual results do not
differ materially from those determined using necessary
estimates.  However, if the financial condition of our customers were
to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.  Also, if market conditions
were to worsen, management may take actions to increase customer incentive
offerings, possibly resulting in an incremental allowance at the time the
incentive is offered.




Merchandise Inventories –
Retail store inventories are valued at the lower of cost or market using the
retail inventory first-in, first-out (“FIFO”) method, and wholesale and Direct
inventories are valued at the lower of cost or market, on an average cost basis
that approximates the FIFO method.  Freight costs are included in
inventory and vendor promotional allowances are recorded as a reduction in
inventory cost.  These inventory methods inherently require management
judgments and estimates, such as the amount and timing of permanent markdowns to
clear unproductive or slow-moving inventory, which may impact the ending
inventory valuations as well as gross margins.  Markdowns are recorded
when the sales value of the inventory has diminished.  Factors
considered in the determination of permanent markdowns include current and
anticipated demand, customer preferences, age of the merchandise and fashion
trends.  Additionally, we reserve for planned but unexecuted markdowns
as well as estimated amounts equal to the difference between the cost of
inventory and the estimated market value based upon assumptions about future
demand, market conditions and the age of the inventory.  If actual
market conditions are less favorable than those projected by management,
additional inventory reserves may be required.  Historically,
management has found its inventory reserves to be appropriate, and actual
results generally do not differ materially from those determined using necessary
estimates.  Inventory reserves were $757,000 at April 24, 2010, and
$1,557,000 at July 25, 2009.


18


Deferred Catalog Costs –
Deferred catalog costs represent direct-response advertising that is capitalized
and amortized over its expected period of future
benefit.  Direct-response advertising consists primarily of product
catalogs of FOH Holdings’ mail order subsidiary.  The capitalized
costs of the advertising are amortized over the expected revenue stream
following the mailing of the respective catalog, which is generally six
months.  The realization of the deferred catalog costs are also
evaluated as of each balance sheet date by comparing the capitalized costs for
each catalog, on a catalog by catalog basis, to the probable remaining future
net revenues.  Direct-responseadvertising
costs of $1,507,000 and $1,751,000 are included in prepaid expenses and other
current assets in the accompanying consolidated balance sheets at April 24, 2010
and July 25, 2009, respectively. We believe that we have appropriately
determined the expected period of future benefit as of the date of our
consolidated financial statements; however, should actual sales results differ
from expected sales, deferred catalog costs may be written off on an accelerated
basis.




Impairment of Long-Lived
Assets – We review long-lived assets, including property and equipment
and our amortizable intangible assets, for impairment whenever events or changes
in circumstances indicate that the carrying value of an asset may not be
recoverable based on undiscounted cash flows.  We review our
indefinite lived intangible assets for impairment annually and in between annual
tests when circumstances or events have occurred that may indicate a potential
impairment has occurred.  If long-lived assets are impaired, an
impairment loss is recognized and is measured as the amount by which the
carrying value exceeds the estimated fair value of the assets. Management
believes they have appropriately determined future cash flows and operating
performance; however, should actual results differ from those expected,
additional impairment may be required.  No impairment was recorded for
the three and nine months ended April 24, 2010 and April 25, 2009 related to
these long lived assets.




We
previously had goodwill which represented the portion of the purchase price that
could not be attributed to specific tangible or identified intangible assets
recorded in connection with purchase accounting.  At January 24, 2009,
since our market capitalization was significantly below its book value, we
performed an impairment analysis and determined that the goodwill balances on
both the retail and wholesale segments were impaired as a result of its current
and future projected financial results due to the poor macroeconomic outlook and
a reduction in wholesale business with Walmart.  Accordingly, we
recorded a goodwill impairment charge of $19,100,000.  After
recognizing the impairment charge, we have no remaining goodwill on our
consolidated balance sheet as of January 24, 2009.




Income Taxes– Income taxes
are accounted for under an asset and liability approach that requires the
recognition of deferred income tax assets and liabilities for the expected
future consequences of events that have been recognized in our financial
statements and income tax returns.  We provide a valuation allowance
for deferred income tax assets when it is considered more likely than not that
all or a portion of such deferred income tax assets will not be realized. Due to
the merger, we underwent a change in control under Section 382 of the Internal
Revenue Code and, therefore, certain pre-merger net operating loss carryforwards
are limited for future utilization.




Results
of Operations




Management
considers certain key indicators when reviewing our results of operations and
liquidity and capital resources.  Because the results of operations
for both our retail and wholesale divisions are subject to seasonal variations,
retail sales are reviewed against comparable store sales for the similar period
in the prior year and wholesale sales are reviewed in conjunction with our
backlog of orders to determine the total position for the year.  When
reviewing sales, a material factor that we consider is the gross profit
percentage.  We also consider our selling, general and administrative
expenses as a key indicator in evaluating our financial
performance.  Inventory, accounts receivable and our outstanding
borrowings are the main indicators we consider when we review our liquidity and
capital resources, particularly the size and age of the inventory and accounts
receivable.  We review all of our key indicators against the prior
year and our operating projections in order to evaluate our operating
performance and financial condition.


19


The
following table sets forth each specified item as a dollar amount and as a
percentage of net sales in each fiscal period, and should be read in conjunction
with the consolidated financial statements included elsewhere in this report (in
thousands, except for percentages, which percentages may not add due to
rounding):




Three Months Ended
                      
                      
                      Nine Months EndedApril 24, 2010
                      
                      
                      April 25, 2009
                      
                      
                      April 24, 2010
                      
                      
                      April 25, 2009Net
      sales
                      
                      $
                      43,391
                      
                      
                      
                      100.0
                      %
                      
                      $
                      46,766
                      
                      
                      
                      100.0
                      %
                      
                      $
                      121,920
                      
                      
                      
                      100.0
                      %
                      
                      $
                      141,847
                      
                      
                      
                      100.0
                      %Cost
      of goods sold, buying and occupancy
                      
                      
                      25,956
                      
                      
                      
                      59.8
                      %
                      
                      
                      28,915
                      
                      
                      
                      61.8
                      %
                      
                      
                      77,848
                      
                      
                      
                      63.9
                      %
                      
                      
                      91,025
                      
                      
                      
                      64.2
                      %Gross
      profit
                      
                      
                      17,435
                      
                      
                      
                      40.2
                      %
                      
                      
                      17,851
                      
                      
                      
                      38.2
                      %
                      
                      
                      44,072
                      
                      
                      
                      36.1
                      %
                      
                      
                      50,822
                      
                      
                      
                      35.8
                      %Selling,
      general and administrative expenses
                      
                      
                      16,615
                      
                      
                      
                      38.3
                      %
                      
                      
                      19,459
                      
                      
                      
                      41.6
                      %
                      
                      
                      51,309
                      
                      
                      
                      42.1
                      %
                      
                      
                      57,646
                      
                      
                      
                      40.6
                      %Goodwill
      impairment
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      19,100
                      
                      
                      
                      13.5
                      %Operating
      income (loss)
                      
                      
                      820
                      
                      
                      
                      1.9
                      %
                      
                      
                      (1,608
                      )
                      
                      
                      (3.4
                      )%
                      
                      
                      (7,237
                      )
                      
                      
                      (5.9
                      )%
                      
                      
                      (25,924
                      )
                      
                      
                      (18.3
                      )%Interest
      expense, net
                      
                      
                      447
                      
                      
                      
                      1.0
                      %
                      
                      
                      337
                      
                      
                      
                      0.7
                      %
                      
                      
                      1,397
                      
                      
                      
                      1.1
                      %
                      
                      
                      1,186
                      
                      
                      
                      (0.8
                      )%Income
      (loss) before income tax provision
                      
                      
                      373
                      
                      
                      
                      0.9
                      %
                      
                      
                      (1,945
                      )
                      
                      
                      (4.1
                      )%
                      
                      
                      (8,634
                      )
                      
                      
                      (7.0
                      )%
                      
                      
                      (27,110
                      )
                      
                      
                      (19.1
                      )%Income
      tax provision
                      
                      
                      23
                      
                      
                      
                      0.1
                      %
                      
                      
                      24
                      
                      
                      
                      0.1
                      %
                      
                      
                      70
                      
                      
                      
                      0.1
                      %
                      
                      
                      65
                      
                      
                      
                      0.0
                      %Net
      income (loss)
                      
                      
                      350
                      
                      
                      
                      0.8
                      %
                      
                      
                      (1,969
                      )
                      
                      
                      (4.2
                      )%
                      
                      
                      (8,704
                      )
                      
                      
                      (7.1
                      )%
                      
                      
                      (27,175
                      )
                      
                      
                      (19.1
                      )%Less:
      Preferred stock Dividends
                      
                      
                      132
                      
                      
                      
                      
                      
                      
                      
                      151
                      
                      
                      
                      
                      
                      
                      
                      393
                      
                      
                      
                      
                      
                      
                      
                      432Net
      income (loss) applicable to common shareholders
                      
                      $
                      218
                      
                      
                      
                      
                      
                      
                      $
                      (2,120
                      )
                      
                      
                      
                      
                      
                      $
                      (9,097
                      )
                      
                      
                      
                      
                      
                      $
                      (27,607
                      )





Net
Sales




Net sales
for the three and nine months ended April 24, 2010 decreased to
$43,391,000 and $121,920,000, respectively, as compared to $46,766,000 and
$141,847,000 for the three and nine months ended April 25, 2009,
respectively, and were comprised of retail and wholesale sales as follows (in
thousands):




Three Months Ended
                  
                  
                  Nine Months EndedApril 24,
                      2010
                  
                  
                  April 25,
                      2009
                  
                  
                  Increase/
                      (Decrease)
                  
                  
                  April 24,
                      2010
                  
                  
                  April 25,
                      2009
                  
                  
                  Increase/
                      (Decrease)Retail
      Stores
                  
                  $
                  22,451
                  
                  
                  $
                  24,550
                  
                  
                  $
                  (2,099
                  )
                  
                  $
                  65,584
                  
                  
                  $
                  70,087
                  
                  
                  $
                  (4,503
                  )Retail
      Direct (catalog and internet)
                  
                  
                  14,431
                  
                  
                  
                  14,847
                  
                  
                  
                  (416
                  )
                  
                  
                  39,155
                  
                  
                  
                  40,791
                  
                  
                  
                  (1,636
                  )Total
      Retail
                  
                  
                  36,882
                  
                  
                  
                  39,397
                  
                  
                  
                  (2,515
                  )
                  
                  
                  104,739
                  
                  
                  
                  110,878
                  
                  
                  
                  (6,139
                  )Total
      Wholesale
                  
                  
                  6,509
                  
                  
                  
                  7,369
                  
                  
                  
                  (860
                  )
                  
                  
                  17,181
                  
                  
                  
                  30,969
                  
                  
                  
                  (13,788
                  )Total
      net sales
                  
                  $
                  43,391
                  
                  
                  $
                  46,766
                  
                  
                  $
                  (3,375
                  )
                  
                  $
                  121,920
                  
                  
                  $
                  141,847
                  
                  
                  $
                  (19,927
                  )




The
changes in retail net sales were as follows:




·
              Total
      store sales for the three and nine months ended April 24, 2010
      decreased by $2,099,000 or 8.5% and $4,503,000 or 6.4%, respectively, as
      compared to the three and nine months ended April 25,
      2009.




·
              Comparable
      store sales for the three and nine months ended April 24, 2010
      decreased by $1,815,000 or 7.7% and $3,984,000 or 6.1%, respectively, as
      compared to the three and nine months ended April 25, 2009 as a
      result of reduced traffic in our stores due to a reduction in consumer
      discretionary spending.  Comparable store sales are defined as
      net sales for stores that have been open for at least one complete
      year.




·
              Direct
      sales, which are comprised of sales from our catalog and website
      operations, for the three and nine months ended April 24, 2010
      decreased by $416,000 or 2.8% and $1,636,000 or 4.0%, respectively, as
      compared to the three and nine months ended April 25,
      2009.  The decrease for the three and nine month period was due
      to a decrease in the number of orders placed by our Direct customers,
      which was attributable to a reduction in consumer discretionary
      spending.


20


The following chart sets forth the
wholesale division’s net sales for the three and nine months ended April 24,
2010 as compared to the three and nine months ended April 25, 2009 (in
thousands):




Three Months Ended
                  
                  
                  Nine Months EndedApril 24,
                      2010
                  
                  
                  April 25,
                      2009
                  
                  
                  Increase/
                      (Decrease)
                  
                  
                  April 24,
                      2010
                  
                  
                  April 25,
                      2009
                  
                  
                  Increase/
                      (Decrease)United
      States
                  
                  $
                  6,289
                  
                  
                  $
                  7,296
                  
                  
                  
                  (1,007
                  )
                  
                  $
                  16,445
                  
                  
                  $
                  29,967
                  
                  
                  
                  (13,522
                  )Canada
                  
                  
                  220
                  
                  
                  
                  73
                  
                  
                  
                  147
                  
                  
                  
                  736
                  
                  
                  
                  1,002
                  
                  
                  
                  (266
                  )Total
                  
                  $
                  6,509
                  
                  
                  $
                  7,369
                  
                  
                  $
                  (860
                  )
                  
                  $
                  17,181
                  
                  
                  $
                  30,969
                  
                  
                  $
                  (13,788
                  )


The decrease in net sales of $860,000
for the three months ended April 24, 2010 was the result of a net decrease of
$2,150,000 in sales to all of our accounts other than Walmart, partially offset
by an increase in net sales to Walmart of $1,290,000.  The $13,788,000
decrease in sales for the nine months ended April 24, 2010 was the result of a
decrease in sales to Walmart of $7,528,000 and a net decrease in sales to all
other customers of $6,260,000.  The reduction in net sales to Walmart
for the nine months ended April 24, 2010 is primarily the result of Walmart
shifting its focus to product categories that differ from those Walmart
historically purchased from us.  Walmart is also producing its own
merchandise for sale to its customers and selecting competing
vendors.  The decrease in sales to all other customers for the three
and nine months ended April 24, 2010 is the result of a decrease in consumer
spending resulting from the challenging macroeconomic environment, as well as
our retail customers sourcing and producing merchandise themselves and selecting
competing vendors.




The wholesale division’s backlog of
open orders as of April 24, 2010 and April 25, 2009 was as follows:




(in thousands, except for percentages)Backlog of
                      orders at
                      April 24,
                      2010
                  
                  
                  % of
                      total
                      orders
                  
                  
                  Backlog of
                      orders at
                      April 25,
                      2009
                  
                  
                  % of
                      total
                      orders
                  
                  
                  Increase /
                      (decrease)
                      from prior
                      year
                  
                  
                  % of
                      Increase /
                      (decrease)
                      from prior
                      yearUnited
      States
                  
                  $
                  6,518
                  
                  
                  
                  98.9
                  %
                  
                  $
                  5,306
                  
                  
                  
                  96.4
                  %
                  
                  $
                  1,212
                  
                  
                  
                  22.8
                  %Canada
                  
                  
                  71
                  
                  
                  
                  1.1
                  %
                  
                  
                  197
                  
                  
                  
                  3.6
                  %
                  
                  
                  (126
                  )
                  
                  
                  (64.0
                  )%Total
                  
                  $
                  6,589
                  
                  
                  
                  100.0
                  %
                  
                  $
                  5,503
                  
                  
                  
                  100.0
                  %
                  
                  $
                  1,086
                  
                  
                  
                  19.7
                  %





The
backlog of orders was $6,589,000 as of April 24, 2010 and $5,503,000 as of April
25, 2009.  Orders are booked upon receipt.  Our retail
customers producing products themselves and selecting competing vendors with
branding capabilities are material trends that have adversely affected our
wholesale sales.  In response, we developed a branding/product
development strategy targeting our wholesale division’s
customers.  The increase in open orders is the result of our new
product lines, which are heavily influenced by our retail creative and design
teams.  As one of our key strategic initiatives, we are continuing to
offer product under the wholesale brand name, Cinema Etoile®, as well
as develop Frederick’s of Hollywood brand extension opportunities with select
wholesale customers.




Gross
Profit




Three Months Ended
                  
                  
                  Nine Months EndedApril 24,
                      2010
                  
                  
                  April 25,
                      2009
                  
                  
                  Increase/
                      (Decrease)
                  
                  
                  April 24,
                      2010
                  
                  
                  April 25,
                      2009
                  
                  
                  Increase/
                      (Decrease)Retail
      gross margin
                  
                  
                  41.5
                  %
                  
                  
                  41.8
                  %
                  
                  
                  (0.3
                  )%
                  
                  
                  37.9
                  %
                  
                  
                  38.8
                  %
                  
                  
                  (0.9
                  )%Wholesale
      gross margin
                  
                  
                  32.8
                  %
                  
                  
                  18.8
                  %
                  
                  
                  14.0
                  %
                  
                  
                  25.3
                  %
                  
                  
                  25.3
                  %
                  
                  
                  0.0
                  %Total
      gross margin
                  
                  
                  40.2
                  %
                  
                  
                  38.2
                  %
                  
                  
                  2.0
                  %
                  
                  
                  36.1
                  %
                  
                  
                  35.8
                  %
                  
                  
                  0.3
                  %


Gross
margin (gross profit as a percentage of net sales) for the three and nine months
ended April 24, 2010 was 40.2% and 36.1%, respectively, as compared to
38.2% and 35.8% for the three and nine months ended April 25, 2009,
respectively.  The higher total gross margin for the three months
ended April 24, 2010 reflects a slightly lower gross margin for retail and a
higher gross margin for wholesale, and the higher gross margin for the nine
months ended April 24, 2010 reflects a lower gross margin for retail while
wholesale remained flat.  The largest contributors to the decrease in
gross margin for the retail division were the following:


21


·
            Our
      product margin was higher by 0.1 percentage point and lower by 0.4
      percentage points for the three and nine months ended April 24, 2010 as
      compared to the three and nine months ended April 25, 2009,
      respectively.  The lower product margin for the nine months
      ended April 24, 2010 was primarily the result of an increase in markdowns
      and promotions.




·
            Occupancy
      costs, which consist of rent, common area maintenance, utilities and real
      estate taxes, decreased by $129,000 and $515,000 for the three and nine
      months ended April 24, 2010 as compared to the three and nine months ended
      April 25, 2009, respectively; however, as a percentage of sales, occupancy
      costs increased by 0.6 and 0.3 percentage points for the three and nine
      month periods as a result of lower retail sales.  The decrease
      in occupancy costs for the three and nine months ended April 24, 2010 is
      attributable to reductions in repair and maintenance costs, real estate
      consulting fees and negotiated rent
reductions.




·
            Depreciation
      decreased by $92,000 and $155,000 for the three and nine months ended
      April 24, 2010 as compared to the three and nine months ended April 25,
      2009, respectively.  As a percentage of sales, depreciation was
      slightly lower by 0.1 percentage points for the three months ended April
      24, 2010 and was flat for the nine months ended April 24, 2010 as compared
      to the three and nine months ended April 25,
  2009.




·
            Freight
      costs decreased by $145,000 and $415,000 for the three and nine months
      ended April 24, 2010 as compared to the three and nine months
      ended April 25, 2009, respectively.  As a percentage of
      sales, freight costs decreased by 0.1 and 0.2 percentage points for the
      three and nine months ended April 24, 2010 as compared to the three and
      nine months ended April 25, 2009, respectively.  This decrease
      was primarily due to lower sales, reductions in the number of shipments
      sent to our stores and in expedited shipments, as well as freight rebates
      received in the three and nine months ended April 24, 2010 that were not
      received in the same period of the prior
year.




·
            Costs
      associated with our retail distribution center decreased by $45,000 and
      $173,000 for the three and nine months ended April 24, 2010 as
      compared to the three and nine months ended April 25, 2009,
      respectively.  As a percentage of sales, retail distribution
      costs remained flat for the three and nine months ended April 24, 2010 as
      compared to the three and nine months ended April 25,
  2009.




The
higher gross margin for our wholesale division during the three months ended
April 24, 2010 as compared to the three months ended April 25, 2009 was the
result of lower closeout sales, an improved product mix and transitioning
certain manufacturing support functions previously performed by domestic
personnel to our facilities in Asia or to third party manufacturers.




Selling,
General and Administrative Expenses




(in thousands)
                    
                    Three Months Ended
                    
                    
                    Nine Months EndedApril 24,
                        2010
                    
                    
                    April 25,
                        2009
                    
                    
                    Increase/
                        (Decrease)
                    
                    
                    April 24,
                        2010
                    
                    
                    April 25,
                        2009
                    
                    
                    Increase/
                        (Decrease)Retail
                    
                    $
                    13,323
                    
                    
                    $
                    15,218
                    
                    
                    $
                    (1,895
                    )
                    
                    $
                    40,696
                    
                    
                    $
                    43,649
                    
                    
                    $
                    (2,953
                    )Wholesale
                    
                    
                    2,742
                    
                    
                    
                    3,567
                    
                    
                    
                    (825
                    )
                    
                    
                    9,082
                    
                    
                    
                    12,300
                    
                    
                    
                    (3,218
                    )Unallocated
      corporate executive office
                    
                    
                    550
                    
                    
                    
                    674
                    
                    
                    
                    (124
                    )
                    
                    
                    1,531
                    
                    
                    
                    1,697
                    
                    
                    
                    (166
                    )Total
                    
                    $
                    16,615
                    
                    
                    $
                    19,459
                    
                    
                    $
                    (2,844
                    )
                    
                    $
                    51,309
                    
                    
                    $
                    57,646
                    
                    
                    $
                    (6,337
                    )


Selling,
general and administrative expenses for the three months ended April 24, 2010
decreased by $2,844,000 to $16,615,000 or 38.3% of sales, from $19,459,000 or
41.6% of sales for the three months ended April 25, 2009.  Selling,
general and administrative expenses for the nine months ended April 24,
2010 decreased by $6,337,000 to $51,309,000 or 42.1% of sales, from $57,646,000
or 40.6% of sales for the nine months ended April 25, 2009.




The
retail division’s selling, general and administrative expenses decreased by
$1,895,000 to $13,323,000 for the three months ended April 24, 2010 from
$15,218,000 for the three months ended April 25, 2009.  This decrease
resulted primarily from the following:


22


·
            Store
      selling, general and administrative expenses decreased by $675,000, which
      was primarily due to a decrease in salaries and salary-related costs of
      $354,000, lower telephone costs of approximately $128,000 and lower store
      closing costs of $89,000.  The decrease in salaries and
      salary-related costs is the result of lower store coverage requirements as
      well as a reduction in head count as compared to the same period in the
      prior year.  The lower telephone costs were the result of the
      cancellation of a telephone contract that required us to maintain a more
      expensive connection between our stores and our retail division corporate
      office.  As a result of the conversion to the new system, we
      expect our annual savings to be in excess of $500,000. The lower store
      closing costs resulted from a decline in the number of store closures
      compared to the prior year and a lower value of the remaining assets in
      stores closed during the current
year.




·
            Direct
      selling, general and administrative expenses decreased by
      $1,282,000.  This decrease was primarily due to a $1,104,000
      decrease in catalog costs resulting from a reduction in paper, printing
      and postage costs, which was attributable to our  strategic
      decrease in circulation as compared to the same period in the prior year
      and our roll out of various cost effective alternatives to full size
      catalogs such as postcards and more personalized “look books”. Also
      contributing to the decrease were retroactive credits that we received for
      prior printing costs.




The
retail division’s selling, general and administrative expenses decreased by
$2,953,000 to $40,696,000 for the nine months ended April 24, 2010 from
$43,649,000 for the nine months ended April 25, 2009.  This
decrease resulted primarily from the following:




·
            Expenses
      related to the retail division’s overhead decreased by $494,000, which was
      primarily due to a decrease in salaries and salary-related costs of
      $281,000 resulting from a reduction in full-time personnel, partially
      offset by an increase in temporary personnel to fill various positions and
      a decrease in stock compensation expense of
  $65,000.




·
            Store
      selling, general and administrative expenses decreased by $888,000, which
      was primarily due to a decrease in salaries and salary-related costs of
      $629,000 and lower telephone costs of approximately $237,000, partially
      offset by a loss on the disposal of telephone equipment of $169,000 and
      related cancelation fees of $190,000.  The decrease in salaries
      and salary-related costs is the result of lower coverage requirements as
      well as a reduction in head count as compared to the same period in the
      prior year.  The lower telephone costs resulted from the
      cancelation of a telephone contract that required us to maintain a more
      expensive connection between our stores and our retail division corporate
      office.  As a result of the conversion to the new system, we
      expect our annual savings to be in excess of
  $500,000.




·
            Direct
      selling, general and administrative expenses decreased by $1,706,000,
      primarily as a result of a $1,891,000 reduction in catalog costs and a
      $799,000 reduction in marketing expenses.  The reduction in
      catalog costs was due to a strategic decrease in circulation compared to
      the same period in the prior year and our roll out of various cost
      effective alternatives to full size catalog mailings such as postcards,
      gift guides and more personalized “look books.”  The decrease in
      marketing expenses was due to lower commissions earned by affiliates and
      lower search engine fees.  These decreases were partially offset
      by an increase in equipment maintenance costs of $410,000 associated with
      our website platform and as a result of a lawsuit we settled in the prior
      year related to the unsuccessful launch of a website platform in fiscal
      year 2008, pursuant to which we received a lump sum cash payment and other
      non-cash consideration totaling
$756,000.




The
wholesale division’s selling, general and administrative expenses decreased by
$825,000 to $2,742,000 for the three months ended April 24, 2010 from $3,567,000
for the three months ended April 25, 2009, and decreased by $3,218,000 to
$9,082,000 for the nine months ended April 24, 2010 from $12,300,000 for
the nine months ended April 25, 2009.  This decrease is primarily
the result of (1) a reduction in salaries and salary-related costs of $295,000
and $1,255,000 and related benefits of $32,000 and $149,000 for the respective
three and nine month periods, which resulted from a lower headcount, (2) a
$18,000 and $482,000 decrease in shipping-related costs for the respective three
and nine month periods, which resulted from lower sales, (3) a $141,000 and
$302,000 decrease in commission costs for the respective three and nine month
periods, which resulted from lower commissionable sales and (4) an overall
general decrease in selling, general and administrative
expenses.


23


The
unallocated expenses related to the corporate executive office decreased by
$124,000 to $550,000 for the three months ended April 24, 2010 from $674,000 for
the three months ended April 25, 2009, and decreased by $166,000 to $1,531,000
for the nine months ended April 24, 2010 from $1,697,000 for the nine
months ended April 25, 2009.  These expenses include costs
associated with our Chief Executive Officer, Chief Financial Officer and our
Board of Directors.




Goodwill
Impairment




As our market capitalization was
significantly below our book value at January 24, 2009, we performed an
impairment analysis.  We determined that the goodwill balances on both
the retail and wholesale segments were impaired as a result of our current and
future projected financial results due to the poor macroeconomic outlook and a
reduction in wholesale business with Walmart.  Accordingly, we
recorded a goodwill impairment charge of $19,100,000.  After
recognizing the impairment charge, we had no remaining goodwill on our
consolidated balance sheet as of January 24, 2009.




Interest
Expense, Net




For the
three and nine months ended April 24, 2010, net interest expense was
$447,000 and $1,397,000, respectively, as compared to $337,000 and $1,186,000
for the three and nine months ended April 25, 2009.  The
increases are primarily the result of higher interest rates and financing fees,
partially offset by overall lower borrowing levels.




Income
Tax Provision




Our
income tax provision for the three and nine months ended April 24, 2010 and
April 25, 2009 primarily represents minimum and net worth taxes due in various
states.  Due to the uncertainty of realization in future periods, no
tax benefit has been recognized on the net losses for these
periods.  Accordingly, a full valuation allowance has been established
on the current loss and all net deferred tax assets existing at the end of the
period excluding the deferred tax liability related to trademarks, which have an
indefinite life.  In addition, the future realization of tax benefits
related to certain net operating losses will be subject to limitations under
Section 382 of the Internal Revenue Code.




Liquidity
and Capital Resources




Cash
Used in Operations




Net cash
used in operating activities for the nine months ended April 24, 2010 was
$3,698,000, resulting primarily from the following:




·
            a
      net loss of $8,704,000 for the nine months ended April 24,
      2010;




·
            an
      increase in accounts receivable of $3,731,000, which was primarily due to
      higher wholesale sales during the last two months (March and April) of the
      three months ended April 24, 2010 as compared to the last two months (June
      and July) of the year ended July 25, 2009;
and




·
            a
      decrease in accounts payable and other accrued expenses of $914,000, which
      resulted from a decrease in accrued liabilities, partially offset by
      extended vendor payables.




These decreases in cash flow were
partially offset by:




·
            a
      decrease in merchandise inventories of $3,006,000 due to reductions in
      both the retail and wholesale finished goods inventory levels, which is
      primarily the result of reductions in excess
  inventory;




·
            a
      decrease in prepaid expenses and other current assets of $481,000, which
      was primarily due to a decrease in prepaid
  advertising;




·
            non-cash
      expenses of $4,060,000 for depreciation and
  amortization;




·
            non-cash
      accrued interest on long term related party debt of
    $608,000;




·
            non-cash
      expenses of $493,000 for stock-based
  compensation;




·
            non-cash
      expenses of $292,000 for amortization of deferred rent and tenant
      allowances;


24


·
            non-cash
      loss on disposal of property and equipment of $180,000;
  and




·
            non-cash
      amortization of deferred financing costs of
  $138,000.




Cash
Used in Investing Activities




Cash used
in investing activities for the nine months ended April 24, 2010 was $505,000,
which resulted primarily from purchases of property and equipment for the
opening of two new stores during the period as well as other general corporate
expenditures.




Cash
Provided by Financing Activities




Net cash
provided by financing activities for the nine months ended April 24, 2010 was
$4,674,000, resulting primarily from net borrowings of $2,000,000 from our
bridge facility and net proceeds of $2,743,000 from the sale of common stock in
the Private Placement (defined below).




Private
Placement




On March 16, 2010, we completed a
private placement to accredited investors of 2,907,051 shares of common stock at
$1.05 per share, raising total gross proceeds of approximately $3,052,000
(“Private Placement”).  The investors in the Private Placement also
received two-and-a-half year Series A warrants to purchase up to an aggregate of
1,162,820 shares of common stock at an exercise price of $1.25 per share, and
five-year Series B warrants to purchase up to an aggregate of 1,162,820 shares
of common stock at an exercise price of $1.55 per share. Both warrants become
exercisable on the six-month anniversary of the closing date. Each of the Series
A and Series B warrants are callable for $0.01 per warrant commencing 30 days
after their initial exercise date if our stock price exceeds $2.25 per share and
$3.10 per share, respectively, for seven consecutive trading days and the
average daily volume during such period exceeds 100,000 shares per trading day.
Additionally, the Series B warrants may be exercised by the holders on a
cashless basis.




Avalon Securities Ltd. (“Avalon”) acted
as placement agent in the transaction.  Upon the closing, we paid
Avalon approximately $198,000 in cash commissions and issued to Avalon and its
designees warrants to purchase an aggregate of 218,030 shares of common stock at
an exercise price of $1.21 per share.  Except for the exercise price,
these warrants are identical to the Series B warrants issued to investors in the
Private Placement.  In addition, we paid approximately $111,000 in
other fees related to the Private Placement, $41,000 of which was paid to Avalon
in consulting fees.




As discussed below in “Revolving Credit and Bridge
Facilities,” we are required to repay our $2.0 million bridge facility
with Wells Fargo Retail Finance II, LLC (the “Senior Lender”) upon the earlier
of August 1, 2010 and the consummation of a Recapitalization Event (defined
below). As the Private Placement did not constitute a Recapitalization Event, we
were not required to use the proceeds from the Private Placement to repay the
bridge facility. However, following the closing of the Private Placement, the
percentages used in calculating the borrowing base under the senior credit
facility (the “Facility”) with the Senior Lender were reduced.




As a result of the Private Placement,
pursuant to the anti-dilution adjustment provisions contained in our Amended and
Restated Certificate of Incorporation governing the terms of the Series A
Preferred Stock, the number of shares of common stock issuable upon conversion
of the Series A Preferred Stock was increased from 1,512,219 shares to 1,622,682
shares.  Additionally, pursuant to the anti-dilution adjustment
provisions contained in the warrants issued to Fursa and Tokarz Investments, LLC
in connection with our merger with FOH Holdings, Inc., the number of shares of
common stock issuable upon exercise of such warrants was increased from an
aggregate of 596,592 shares to an aggregate of 635,076 shares and the exercise
price of such warrants was decreased from $3.52 per share to $3.31 per
share.




Revolving
Credit and Bridge Facilities




We and our U.S. subsidiaries have a
Facility with the Senior Lender.  The Facility matures on January 28,
2012.


25


The Facility is for a maximum amount of
$50 million comprised of a $25 million line of credit with a $15 million
sub-limit for letters of credit, and up to an additional $25 million commitment
in increments of $5 million at our option so long as we are in compliance with
the terms of the Facility.  The actual amount of credit available
under the Facility is determined by using measurements based on our receivables,
inventory and other measures.  The Facility is secured by a first
priority security interest in our assets.  Interest is payable
monthly, in arrears, at interest rates that were increased in connection with
the second amendment to the Facility described below.




On November 4, 2008, the borrowers
utilized the accordion feature under the Facility to increase the borrowing
limit from $25 million to $30 million.  In utilizing the accordion
feature, our minimum availability reserve increased by $375,000 (7.5% of the
$5,000,000 increase) to $2,250,000 (7.5% of the $30,000,000) and we incurred a
one-time closing fee of $12,500.




On
September 21, 2009, the Facility was amended to provide for a $2.0 million
bridge facility at an annual interest rate of LIBOR plus 10%, to be repaid upon
the earlier of December 7, 2009 and the consummation of a financing in which we
receive net proceeds of at least $4.9 million.  On October 23, 2009,
the Facility was further amended to extend the December 7, 2009 repayment date
to August 1, 2010 and to reduce the net proceeds that we are required to receive
in one or more financings to an aggregate of $4.4 million (a “Recapitalization
Event”).  On March 16, 2010, we completed the Private Placement,
raising net proceeds of approximately $2.7 million.  Unless we raise
the remaining approximately $1.7 million to complete a Recapitalization Event by
August 1, 2010, we will be in violation of a covenant under the
Facility.  If such violation is not waived by the Senior Lender, it
will constitute an event of default under the Facility whereby the Senior Lender
will have the right to terminate the Facility and declare all outstanding
amounts under the Facility immediately due and payable.




In
connection with the September and October amendments, the interest rates on
“Base Rate” loans and “LIBOR Rate” loans under the Facility, as amended, were
increased as follows:




·
            “Base
      Rate” loan interest rates were increased from the Wells Fargo prime rate
      less 25 basis points to the Wells Fargo prime rate plus 175 basis points;
      and




·
            “LIBOR
      Rate” loan interest rates were increased from LIBOR plus 150 basis points
      to LIBOR plus 300 basis points.




The fee on any unused portion of the
Facility was also increased from 25 basis points to 50 basis
points.  In addition, upon a Recapitalization Event, the applicable
percentages used in calculating the borrowing base under the Facility were
reduced.  Although our sale of common stock in the Private Placement
did not constitute a Recapitalization Event, these percentages were reduced
following the closing of the Private Placement on March 16, 2010.




In
connection with the amendments, we incurred a one-time amendment fee of
$150,000, one half of which has been paid and the remainder will be paid upon
the Recapitalization Event.  All other material terms of the Facility
remain unchanged.




The
Facility contains customary representations and warranties, affirmative and
restrictive covenants and events of default.  The restrictive
covenants limit our ability to create certain liens, make certain types of
borrowings and investments, liquidate or dissolve, engage in mergers,
consolidations, significant asset sales and affiliate transactions, dispose of
inventory, incur certain lease obligations, make capital expenditures, pay
dividends, redeem or repurchase outstanding equity and issue capital
stock.  In lieu of financial covenants, fixed charge coverage and
overall debt ratios, we also are required to maintain specified minimum
availability reserves.  At April 24, 2010, we were in compliance with
the Facility’s covenants and minimum availability reserve
requirements.




As of April 24, 2010, we had (i)
$1,282,000 outstanding under the Facility at a Base Rate of 5.0%, (ii)
$8,000,000 outstanding under the Facility at a LIBOR Rate of 3.25% and (iii)
$2,000,000 outstanding under the bridge facility at a rate of
10.25%.  For the nine months ended April 24, 2010, borrowings
under the Facility (including the bridge facility) peaked at $16,996,000 and the
average borrowing during the period was approximately $12,625,000.  In
addition, at April 24, 2010, we had $1,112,000 of outstanding letters of credit
under the Facility.




Long
Term Debt – Related Party




As of
April 24, 2010, we had $13,944,000 of long term debt due to certain funds and
accounts affiliated with, managed by, or over which Fursa Alternative
Strategies, LLC or any of its affiliates exercises investment authority,
including, without limitation, with respect to voting and dispositive rights
(collectively, “Fursa”).  This debt is referred to as “Tranche C Debt”
and was scheduled to mature on July 28, 2012.  This debt bore interest
at the fixed rate of 7% per annum with 1% payable in cash and 6% payable in
kind.


26


The Tranche C Debt was secured by
substantially all of our assets and was second in priority to the Facility. The
Tranche C Debt contained customary representations and warranties, affirmative
and restrictive covenants and events of default substantially similar to, and no
more restrictive than, those contained in the Facility.  At April 24,
2010, we were in compliance with the covenants contained in the term loan
agreement, as amended, governing the Tranche C Debt.




On May
18, 2010, we consummated the transactions contemplated by the Debt Exchange and
Preferred Stock Conversion Agreement, dated as of February 1, 2010 (“Exchange
and Conversion Agreement”) with Fursa, pursuant to which the entire Tranche C
Debt and accrued interest was exchanged for shares of our common stock as
discussed in “Debt Exchange
and Preferred Stock Conversion” below and in Note 1 included in the Notes
to the consolidated financial statements contained elsewhere in this
report.




Preferred
Stock




As of
April 24, 2010, we had 3,629,325 shares of Series A 7.5% Convertible Preferred
Stock outstanding which is owned by Fursa.  The Series A Preferred
Stock was convertible at any time at the option of the holders into an aggregate
of 1,622,682 shares of common stock, subject to adjustment.  As of April
24, 2010, we had accrued dividends of $1,258,000




On May
18, 2010, we consummated the transactions contemplated by the Exchange and
Conversion Agreement with Fursa, pursuant to which all of the Series A Preferred
Stock and accrued dividends were converted into shares of common stock as
discussed in “Debt Exchange
and Preferred Stock Conversion” below and in Note 1 included in the Notes
to the consolidated financial statements contained elsewhere in this
report.




Debt
Exchange and Preferred Stock Conversion




On May 18, 2010, we completed the
transactions contemplated by the Exchange and Conversion Agreement with Fursa,
the former holders of our Tranche C Debt and Series A Preferred Stock and
one of our largest shareholders.
  At the closing, we issued to Fursa an
aggregate of 8,664,373 shares of common stock upon exchange of approximately
$14.3 million of outstanding Tranche C Debt and accrued interest, and conversion
of approximately $8.8 million of Series A Preferred Stock, including accrued
dividends, at an effective price of approximately $2.66 per
share.  This transaction will result in annual savings of
approximately $1,562,000 of accrued interest and dividends.  This
transaction did not constitute a Recapitalization Event under the
Facility.
  We also issued to Fursa three, five and
seven-year warrants, each to purchase 500,000 shares of common stock (for an
aggregate of 1,500,000 shares of common stock) at exercise prices of $2.00,
$2.33 and $2.66 per share, respectively.  The warrants are exercisable
for cash or on a cashless basis, at Fursa’s option.  At any time after
the first anniversary of the issuance date, we may redeem the warrants, in whole
but not in part, upon not less than 20 business days’ written notice to Fursa,
at a redemption price of $0.01 per share, if the last sale price of the common
stock is at least 200% of the exercise price of the warrants for 10 consecutive
trading days ending on the day prior to the date on which notice of redemption
is given to Fursa.  Following the transaction, Fursa’s aggregate
beneficial ownership of our common stock increased from approximately 33% to
approximately 47%.
  As a result of the transaction, the
balance sheet effect was an increase to shareholders’ equity of approximately
$23.0 million.  An unaudited pro forma balance sheet that gives effect
to the Debt Exchange and Preferred Stock Conversion transaction as if it had
occurred on April 24, 2010 is included in Note 1 of the Notes to the
consolidated financial statements contained elsewhere in this
report.


Future
Financing Requirements




For the
nine months ended April 24, 2010, our working capital decreased by $1,864,000 to
($4,658,000), primarily due to our loss from operations.  Our Facility
does not contain any working capital covenants and we are in compliance with our
minimum availability reserve requirements.  However, our business
continues to be affected by limited working capital and it is critical to our
business that we meet our projected operating cash flows.  We plan to
continue to carefully manage our working capital and look for ways to improve
our working capital position.


27


We
believe that the available borrowings under the Facility, along with our
projected operating cash flows, will be sufficient to cover our working capital
requirements and capital expenditures through the end of fiscal year 2010. In September and October
2009, the Facility was amended to provide for a $2.0 million bridge facility to
be repaid upon the earlier of August 1, 2010 and the consummation of a
Recapitalization Event.  On March 16, 2010, we completed the Private
Placement, raising net proceeds of approximately $2.7 million.  Unless
we raise the remaining approximately $1.7 million to complete a Recapitalization
Event by August 1, 2010, we will be in violation of a covenant under the
Facility.  If such violation is not waived by the Senior Lender, it
will constitute an event of default under the Facility whereby the Senior Lender
will have the right to terminate the Facility and declare all outstanding
amounts under the Facility immediately due and payable.  We are
actively seeking to obtain additional financing in order to comply with the
requirements of the Facility.  There can be no assurance that we will
be able to consummate a Recapitalization Event and repay the bridge facility as
required under the Facility or, if these events do not occur, that the Senior
Lender will continue the Facility.  If we cannot raise funds on
acceptable terms when needed or if the Senior Lender does not continue the
Facility, we may be required to curtail our operations significantly and seek
alternative financing in order to continue as a going concern.




We have managed our capital
expenditures for fiscal year 2010 to be less than $1,000,000, primarily for new
store openings and remodelings, improvements to our information technology
systems and other general corporate expenditures.




Off
Balance Sheet Arrangements




We are
not a party to any material off-balance sheet financing arrangements except
relating to open letters of credit as described in Note 6, “Financing,” included in the
Notes to the consolidated unaudited financial statements contained elsewhere in
this report, and Note 10 to the consolidated audited financial statements
included in our Annual Report on Form 10-K for the year ended July 25,
2009.




Effect
of New Accounting Standards




See Note 3, “Effect of New Accounting
Standards,” included in the Notes to the consolidated unaudited financial
statements contained elsewhere in this report for a discussion of recent
accounting developments and their impact on our consolidated financial
statements.  None of the new accounting standards are anticipated to
materially impact us.




Seasonality
and Inflation




Our
retail and wholesale businesses both experience seasonal sales
patterns.  Sales and earnings for the retail division typically peak
during the second and third fiscal quarters (November through April), primarily
during the holiday season in November and December, as well as the Valentine’s
Day holiday in the month of February.  As a result, we maintain higher
inventory levels during these peak selling periods. Sales and earnings for the
wholesale division typically peak in the first and second fiscal quarters
(August through January).  Orders from the wholesale division’s
customers are typically placed four to six months prior to the expected shipment
date to such customers.




We do not
believe that our operating results have been materially affected by inflation
during the preceding three years.  There can be no assurance, however,
that our operating results will not be affected by inflation in the
future.




Imports




Transactions
with our foreign manufacturers and suppliers are subject to the risks of doing
business outside of the United States.  Our import and offshore
operations are subject to constraints imposed by agreements between the United
States and the foreign countries in which we do business.  These
agreements often impose quotas on the amount and type of goods that can be
imported into the United States from these countries.  Such agreements
also allow the United States to impose, at any time, restraints on the
importation of categories of merchandise that, under the terms of the
agreements, are not subject to specified limits.  Our imported
products are also subject to United States customs duties and, in the ordinary
course of business, we are from time to time subject to claims by the United
States Customs Service for duties and other charges.  The United
States and other countries in which our products are manufactured may, from time
to time, impose new quotas, duties, tariffs or other restrictions, or adversely
adjust presently prevailing quotas, duty or tariff levels, which could adversely
affect our operations and our ability to continue to import products at current
or increased levels.  We cannot predict the likelihood or frequency of
any such events occurring.


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ITEM 3. – QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK




Interest
Rate Risks




We are
exposed to interest rate risk associated with our Facility and bridge
facility.  As of April 24, 2010, we had $9,282,000 outstanding under
the Facility and $2,000,000 outstanding under the bridge facility. Interest
accrues on outstanding borrowings under the Facility at an agreed to reference
rate, which was, at our election, either the Wells Fargo prime rate plus 175
basis points (5.0% at April 24, 2010) or LIBOR plus 300 basis
points.  Interest accrues on outstanding borrowings under the bridge
facility at an annual interest rate of LIBOR plus 10% (10.25% as of April 24,
2010).  For the nine months ended April 24, 2010, borrowings
under the Facility (including the bridge facility) peaked at $16,996,000 and the
average borrowing during the period was approximately $12,625,000.  An
increase or decrease in the interest rate by 100 basis points from the levels at
April 24, 2010 would increase or decrease annual interest expenses by
approximately $113,000.




Foreign
Currency Risks




We enter into a significant amount of
purchase obligations outside of the United States, all of which are negotiated
and settled in U.S. dollars.  Therefore, on our current open purchase
order position we have no exposure to foreign currency exchange
risks.  However, significant fluctuations in foreign currency rates
would have an impact on our future purchases.





ITEM
4. – CONTROLS AND PROCEDURES




Evaluation
of Disclosure Controls and Procedures


Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed in company reports filed or
submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission’s rules and
forms.  Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed in company reports filed or submitted under the Exchange Act is
accumulated and communicated to management, including our chief executive
officer and chief financial officer, as appropriate to allow timely decisions
regarding required disclosure.


As
required by Rules 13a-15 and 15d-15 under the Exchange Act, our chief executive
officer and chief financial officer performed an evaluation of the effectiveness
of the design and operation of our disclosure controls and procedures as of
April 24, 2010.  Based upon their evaluation, they concluded that our
disclosure controls and procedures were effective.


Internal
Control Over Financial Reporting


Our
internal control over financial reporting is a process designed by, or under the
supervision of, our chief executive officer and chief financial officer and
effected by our board of directors, management and other personnel, to provide
reasonable assurance regarding the reliability of our financial reporting and
the preparation of our financial statements for external purposes in accordance
with generally accepted accounting principles in the United
States.  Internal control over financial reporting includes policies
and procedures that pertain to the maintenance of records that in reasonable
detail accurately and fairly reflect the transactions and dispositions of our
assets; provide reasonable assurance that transactions are recorded as necessary
to permit preparation of our financial statements in accordance with generally
accepted accounting principles in the United States, and that our receipts and
expenditures are being made only in accordance with the authorization of our
board of directors and management; and provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or
disposition of our assets that could have a material effect on our financial
statements.


29


Changes
in Internal Control Over Financial Reporting


During
the three months ended April 24, 2010, there were no changes made in our
internal control over financial reporting (as such term is defined in Rule
13a-15(f) under the Exchange Act) that have materially effected, or are
reasonably likely to materially effect, our internal control over financial
reporting.


PART
      II
            OTHER
      INFORMATION




ITEM
1 – LEGAL PROCEEDINGS




We are involved from time to time in
litigation incidental to our business.  We believe that the outcome of
such litigation will not have a material adverse effect on our results of
operations or financial condition.




ITEM
1A – RISK FACTORS




There are no material changes from the
risk factors set forth in the “Risk Factors” section of our Annual Report on
Form 10-K filed with the SEC on October 23, 2009.  Please refer to
this section for disclosures regarding the risks and uncertainties in our
business.




ITEM
6 – EXHIBITS




Exhibit No.
              
              Description31.1
              
              Certification
      by Chief Executive Officer and Principal Executive
  Officer31.2
              
              Certification
      by Chief Financial Officer and Principal Accounting
  Officer32
              
              Section
      1350 Certification


30





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 hereunto duly
authorized.





FREDERICK’S
      OF HOLLYWOOD GROUP INC.Date:
      June 8, 2010
              By:
              /s/ Thomas J. LynchTHOMAS
      J. LYNCHChief
      Executive Officer andPrincipal
      Executive OfficerDate:
      June 8, 2010
              By:
              /s/ Thomas RendeTHOMAS
      RENDEChief
      Financial Officer andPrincipal
      Accounting Officer


31