The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the caption "Business-Risk Factors." This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our financial statements and related notes included elsewhere in this Form 10-K.

Overview

We are a retailer of distinctive modern design products to both residential and commercial customers. Our clients purchase through three integrated sales points. Approximately 58% of our orders occur in our studios generating approximately 73% of the dollar value of our order sales demand. The remaining 42% of our orders are transacted via our website and phone center. We have developed a national presence in modern design furnishings and a brand recognized for design excellence among our customers and the design community. In the process we have created a differentiated business model that enables us to provide products to our customers in a more convenient, efficient and economical manner than was previously available to them. Our policy of maintaining core products in stock represents a departure from the approach taken by many other modern design furnishings retailers.

In fiscal year 2007, we introduced an extended lead-time program, allowing our clients to personalize their product, if they wish to meet their unique needs. Based upon our success last year, we launched an expanded offering in accessories in the fourth quarter of 2007, which we call "Tools for Living." We believe this new product line will increase our presence in providing modern design solutions for our customers. This category currently features approximately 100 new products, ranging in price from under $20 to over $1,000. The products all share smart design, functionality and modern aesthetics.

Each product is unique in how it solves a problem or makes something more comfortable or easier to use. These products carry significantly better gross margins than our base business. This as an opportunity to offer our existing customers a solution to their everyday problems, as well as providing an introduction to DWR for new clients. If Tools for Living achieves a sufficient level of market acceptance, we will continue to grow the product line and explore other design-driven opportunities. Our relationships with both internationally recognized and emerging designers continue to grow and allow us to offer our customers an array of innovative and often hard-to-find merchandise.

Our business strategy is based upon the premise that multiple, integrated sales points improve customer convenience, reinforce brand awareness, enhance customer knowledge of our products and produce operational benefits that ultimately improve market penetration and returns on capital. We believe most traditional retailers initially established their presence with one sales point and subsequently added additional sales points as they grow, thereby making integration across sales points more difficult.

We have experienced significant growth in customers and sales since our founding in 1998. We began selling products through the phone and online in the second half of 1999, and we opened our first studio in November 2000. We base our decisions on where to open new studios by categorizing markets into "tiers" based on household population statistics and supporting sales data collected from our other sales points. Our experience indicates that studio openings significantly improve our overall market penetration rates in the markets in which they are located. In addition, we have seen our online sales increase in markets where we have studios compared to markets where we do not have studios.

In recent years, we have continued to increase sales as our studio base grows. Studios have increased in number from one at the end of 2000 to 66 studios and one outlet operating in 24 states and the District of Columbia as of December 29, 2007. During fiscal year 2007, we opened three new studios and one replacement studio. We expect to open between three and five new studios and two or three Tools for Living stores in fiscal 2008, in major urban markets. We have entered into leases for two of the studio locations as of December 29, 2007, that we expect to open in the first quarter of 2008. We expect to open the remaining locations late in the third quarter or early fourth quarter of 2008.

We plan to reduce our catalog circulation in fiscal year 2008. However, our catalog-related expense is expected to increase as a result of the postal increases enacted in late 2007. In the second quarter of fiscal 2008, we will re-launch our website on a new and improved platform. We believe these enhancements to our web capabilities may provide us with significant future growth opportunities. Overall, our objectives for 2008 are to finish our turnaround, strengthen our expense controls and, most importantly, begin to realize the benefits of our re-sourcing efforts.

All of our sales points utilize a single common inventory held at our Hebron, Kentucky fulfillment center. Because we don't offer a "cash and carry" option in our studios, we are able to more fully utilize selling space and avoid the operational issues that often arise with stock balancing and store replenishment. We currently source our products primarily in the U.S. and Europe. In fiscal year 2007, we purchased approximately 42% of our product inventories from manufacturers in foreign countries, with 33% of our product inventory purchases being paid for in Euros. To mitigate our foreign currency exchange risk, we purchased foreign currency contracts to pay for merchandise purchases. As fiscal year 2008 progresses, we expect to have an increasing amount of products being sourced from factories outside of Europe. We plan to increase our efforts to develop products internally and include more exclusive items in our mix, and in doing so, source products in other parts of the world including Latin America and Asia where product costs are expected to be lower. During the last twelve months, our product development team has worked diligently to find qualified factories in North America and elsewhere that can provide us with the quality our clients expect but free us from the impact of fluctuations in the price of the Euro. By the end of 2008, we believe we can achieve significant product margin improvements from these efforts. We believe that within five years we may have less than 20% of our product coming from European factories.

On October 1, 2005, we shortened the estimated useful lives for certain computer systems costing approximately $5,100,000 from three years to 18 months as a result of our plans to replace them. This change resulted in additional depreciation expense in fiscal years 2006 and 2005 of approximately $1,000,000 and $324,000, respectively. Depreciation expense decreased by approximately $2,263,000 in fiscal year 2007 from 2006 as these assets became fully depreciated. During fiscal year 2006, we selected a software vendor, and during fiscal year 2007, we began the process of implementing the new system. During 2008, we expect to install the new information technology systems and an enhanced website that will substantially increase depreciation expense.

Results of Operations

Net Sales and Other Data. The following table presents our results from operations for fiscal years 2007, 2006 and 2005 including our net sales by sales point both in dollars and as a percentage of net sales:

                                               % of                         % of       Fiscal          % of
                            Fiscal Year         Net      Fiscal Year        Net         Year           Net
(amounts in thousands)          2007           Sales         2006          Sales        2005          Sales
Net sales:
Studio sales                $    126,199         65.1%   $    107,963        60.6%   $    88,240        55.8%
Online sales                      29,004         15.0%         30,004        16.8%        29,215        18.5%
Phone sales                       19,179          9.9%         19,441        10.9%        22,324        14.1%
Other sales                        6,910          3.6%          5,132         2.9%         1,763         1.1%
Shipping and handling
fees                              12,644          6.4%         15,602         8.8%        16,694        10.5%

Total net sales                  193,936        100.0%        178,142       100.0%       158,236       100.0%
Cost of sales                    107,014         55.2%        103,681        58.2%        90,400        57.1%

Gross margin                      86,922         44.8%         74,461        41.8%        67,836        42.9%
Selling, general and
administrative expenses           87,651         45.2%         87,555        49.1%        71,422        45.1%

Loss from operations                (729 )      (0.4)%        (13,094 )     (7.3)%        (3,586 )     (2.3)%
Other income, net                  1,778          0.9%            212         0.1%           568         0.4%

Incomes (loss) before
income taxes                       1,049          0.5%        (12,882 )     (7.2)%        (3,018 )     (1.9)%
Income tax expense
(benefit)                            726          0.3%         (4,593 )     (2.5)%          (949 )     (0.6)%

Net income (loss)           $        323          0.2%   $     (8,289 )     (4.7)%   $    (2,069 )     (1.3)%

The following table presents the number of studios open at the end of each fiscal period, and the approximate number of catalogs circulated, the approximate number of online sessions and the approximate average order during fiscal years 2007, 2006 and 2005:

                                                                  Fiscal Year
                                                   2007              2006               2005
Number of studios and outlets open at end
of fiscal period                                         67                64                 56
Number of catalogs circulated                     6,102,000         5,970,000         11,971,000
Number of online sessions                         8,348,000         5,751,000          4,484,000
Average order                                   $     1,400       $     1,100       $      1,050

Comparison of Fiscal Year 2007 to Fiscal Year 2006

Net Sales. Net sales consist of studio sales, online sales, phone sales, other sales and shipping and handling fees, net of actual and estimated returns by customers. Studio sales consist of sales of merchandise to customers from orders placed at our studios, online sales consist of sales of merchandise from orders placed through our website, phone sales consist of sales of merchandise through the toll-free numbers associated with our printed catalogs, and other sales consist of warehouse sales and outlet sales. Warehouse sales consist of periodic clearance sales at our fulfillment center of product samples and products that customers have returned. Outlet sales consist of sales at our outlet of product samples, returned product from our customers and to a lesser degree full price product. Shipping and handling fees consist of amounts we charge customers for the delivery of merchandise.

Net sales increased $15.8 million, or 8.9%, to $193.9 million in fiscal year 2007, compared to $178.1 million in fiscal year 2006. The increase in net sales is primarily related to a $18.2 million increase in studio sales and a $1.8 million increase in other sales. The increase in sales is related to a higher average unit retail, in part due to price increases and product mix. Comparing fiscal year 2007 to fiscal year 2006, the average order increased by approximately 27%, partially offset by a 11% decrease in the number of orders.

The increase in studio sales is attributable to the incremental sales of approximately $7.1 million generated from seven studios opened in fiscal year 2006 which operated less than 12 months in fiscal year 2006 and the three new studios opened during fiscal year 2007. In addition, the increase in studio sales is related to price increases and product mix as we sold more higher priced merchandise. We had 66 studios and one outlet open at the end of fiscal year 2007 compared to 63 studios and one outlet open at the end of fiscal year 2006. We expect net sales to continue to increase in fiscal year 2008, as we open additional studios including our new Tools for Living stores. However, we cannot assure you that sales will increase due to uncertain economic conditions.

Other sales increased $1.8 million, or 34.6%, compared to the same period last year. This increase in other sales is primarily related to an increase of $2.6 million in sales generated from our outlet that opened at the end of the second quarter of 2006. This increase was partially offset by the decrease in warehouse sales of $0.9 million primarily related to a large warehouse sales event in fiscal year 2006 that was not repeated in fiscal year 2007.

Online sales decreased by $1.0 million, or 3.3%, and phone sales decreased $0.3 million, or 1.3%, in fiscal year 2007 compared to fiscal year 2006. The decreases in online and phone sales resulted from lower average orders and a decrease in the number of orders in fiscal year 2007 compared to fiscal year 2006.

Shipping and handling fees received from customers for delivery of merchandise decreased $3.0 million, or 19.0%, to $12.6 million in fiscal year 2007, compared to $15.6 million in fiscal year 2006. This decrease is primarily attributed to our generally charging lower shipping and handling fees to our customers and eight free shipping promotions during fiscal year 2007 compared to four free shipping promotions during fiscal year 2006.

Cost of Sales. Cost of sales increased $3.3 million, or 3.2%, to $107.0 million in fiscal year 2007 from $103.7 million in fiscal year 2006. The increase in cost of sales is due to the increase in sales. As a percentage of net sales, cost of sales decreased to 55.2% in fiscal year 2007 from 58.2% in fiscal year 2006. Cost of sales consists of cost of product sales and freight shipping costs. Of the 3.0 percentage points decrease in cost of sales as a percentage of net sales, 2.2 percentage points is attributable to product-related margin improvements and 0.8 percentage points is attributed to lower freight shipping fees and costs in fiscal year 2007 compared to 2006. Shipping fees decreased by 19.0% and shipping costs decreased by 17.2% in fiscal year 2007 compared to 2006. Consequently, with product revenues increasing, shipping fees are a proportionally smaller component of revenues in fiscal year 2007 compared to 2006 resulting in an overall margin improvement of 0.8 percentage points. Shipping margins remain a key ongoing focus for us. We expect to break even in fiscal year 2008.

Selling, General and Administrative Expenses. ("SG&A"). Selling, general and administrative expenses consist of studio costs, including salaries and studio occupancy costs, costs associated with publishing our catalogs and maintaining our website, and corporate and fulfillment center costs, including salaries and occupancy costs, among others. Our gross margins may not be comparable to those of other companies because some other companies include all of the costs related to their distribution network in cost of sales, and others, including us, may exclude a portion of them from gross margin, including them instead in other line items, such as selling, general and administrative expenses.

                                  Fiscal       % of       Fiscal       % of
                                   Year         Net        Year         Net                       %
(amounts in millions)              2007        Sales       2006        Sales       Change       Change
Salaries and benefits           $     36.5      18.8%   $     34.4      19.3%   $       2.1       6.1 %
Occupancy and related expense         25.3      13.0%         26.1      14.7%          (0.8)     (3.1)%
Catalog, advertising and
promotion                              9.9       5.1%         10.6       5.9%          (0.7)     (6.6)%
Other expenses                        11.4       5.9%         10.6       5.9%           0.8       7.5 %
Professional - legal,
consulting, SOX                        4.6       2.4%          5.9       3.3%          (1.3)    (22.0)%

Total SG&A                      $     87.7      45.2%   $     87.6      49.1%   $       0.1       0.1 %

SG&A expenses increased $0.1 million, or 0.1%, to $87.7 million in fiscal year 2007 from $87.6 million in fiscal year 2006. Overall SG&A expenses are essentially unchanged in fiscal year 2007 from 2006 because of our efforts to contain those expenses. As a percentage of net sales, SG&A expenses decreased to 45.2% in fiscal year 2007 from 49.1% in fiscal year 2006, which is primarily due to our increased sales. Changes in the components of SG&A expenses are primarily due to the following:

• Salaries and benefits expenses increased $2.1 million, or 6.1%, to $36.5 million in fiscal year 2007 from $34.4 million in fiscal year 2006. This increase is primarily related to a $1.6 million increase in salary and contract labor expenses, a $1.0 million increase in commission and bonus expense in part related to the increase in net sales, and a $0.3 million increase in stock-based compensation expense, partially offset by a $0.8 million decrease in severance costs. Of the increase in salaries and benefits expenses noted above, approximately $1.4 million is related to the seven studios and one outlet opened in fiscal year 2006 which operated less than 12 months in fiscal year 2006 and the three new studios opened during fiscal year 2007. Salaries and benefits expenses are expected to increase due to benefit cost increases, increased commissions related to planned sales increases, if any, and headcount increases from new studios not operating in the prior comparable period. We may increase or decrease headcount depending on operating requirements and cost considerations that would affect salaries and benefits expenses.

• Occupancy and related expenses decreased $0.8 million, or 3.1%, to $25.3 million in fiscal year 2007 compared to $26.1 million in fiscal year 2006. This decrease is primarily due to a $1.9 million decrease in depreciation expense, of which $2.3 million was related to our information technology system, which was fully depreciated in the first quarter of 2007; partially offset by $0.3 million increase in depreciation expense as a result of the change in the estimated useful life of assets related to the early termination of a studio lease. This decrease was further offset by a $0.8 million increase in rent and related operating expenses associated with the seven studios and one outlet opened in fiscal year 2006 which operated less than 12 months in fiscal year 2006 and the three new studios opened during fiscal year 2007. Occupancy and related expenses are expected to increase with the opening of new studios. In addition, we anticipate increases in depreciation expense as our new information technology systems and enhanced website become operational in 2008.

• Other SG&A expenses increased $0.8 million, or 7.5%, to $11.4 million in fiscal year 2007 compared to $10.6 million in fiscal year 2006. The increase is primarily due to a $0.3 million increase in software and website-related expenses, a $0.3 million increase in sales related merchant fees and a $0.3 million increase in studio distribution expense.

• Professional, accounting, legal and SOX expenses decreased $1.3 million, or 22.0%, to $4.6 million in fiscal year 2007 compared to a $5.9 million in fiscal year 2006. The decrease is primarily due to a $0.7 million decrease in accounting and consulting fees directly related to SEC reporting and SOX compliance, $0.5 million decrease in legal expenses and a $0.1 million decrease in public company reporting costs.

Interest Income. Interest income increased $78,000 to $385,000 in fiscal year 2007 compared to $307,000 in fiscal year 2006, primarily due to higher yielding investments in fiscal year 2007 compared with fiscal year 2006. Invested capital in fiscal year 2007 was slightly lower than in 2006. During the third quarter of 2006, we liquidated our municipal bonds portfolio and invested our capital in a higher yielding bank money market account.

Interest Expense. Interest expense increased $373,000 to $625,000 in fiscal year 2007 compared to $252,000 in fiscal year 2006, primarily due to higher balances outstanding under our loan agreements in fiscal year 2007 compared with fiscal year 2006.

Other Income, Net. Other income primarily consists of a net gain of $2.2 million after related expenses as a result of the early termination of a studio lease per an agreement between us and the landlord and list rental income of approximately $68,000, partially offset by foreign currency exchange losses of $267,000.

Income Taxes. In fiscal year 2007, we recorded income tax expense of $726,000 compared to income tax benefit of $4,593,000 in fiscal year 2006. The income tax expense in fiscal year 2007 is primarily related to profitability in fiscal year 2007 compared to a net loss before tax benefit in fiscal year 2006. We have net operating loss carry-forwards of approximately $2.1 million and $11.4 million as of December 29, 2007 for federal and state income taxes, respectively. These net operating loss carryforwards will expire between fiscal years 2016 and 2027. The effective tax rate for fiscal year 2007 was 69.0%, which varies from the 34.0% statutory rate primarily due to stock based compensation expense of approximately $1.0 million related to incentive stock options which is not deductible for tax purposes and the effects of state income taxes.

Comparison of Fiscal Year 2006 to Fiscal Year 2005

Net Sales. Net sales increased $19.9 million, or 12.6%, to $178.1 million in fiscal year 2006, compared to $158.2 million in fiscal year 2005. The increase in net sales is primarily related to the $19.7 million increase in studio sales, as well as the $3.4 million increase in other sales. The increase in studio sales is primarily attributable to the incremental sales of approximately $12.7 million generated from 23 studios opened in fiscal year 2005 which operated less than twelve months in fiscal year 2005 and approximately $6.5 million in sales generated from seven studios opened during fiscal year 2006. Other sales increased $3.4 million, or 191.1%, compared to the same period last year. This increase in other sales is primarily related to sales generated from three warehouse sales held during fiscal year 2006 and sales from our outlet which opened at the end of the second quarter of 2006. Online sales increased $0.8 million, or 2.7%, and phone sales decreased $2.9 million, or 12.9 %, in fiscal year 2006 compared to fiscal year 2005. We believe the increase in online sales is due in part to increased online marketing initiatives including search optimization and more strategic use of e-mail databases, which increased the number of hits on our website by 28.2%. We had 63 studios and one outlet open at the end of fiscal year 2006 compared to 56 studios open at the end of fiscal year 2005. Shipping and

handling fees received from customers for delivery of merchandise decreased $1.1 million, or 6.5%, to $15.6 million in fiscal year 2006, compared to $16.7 million in fiscal year 2005, primarily due to the free shipping events in the second and third quarter of fiscal year 2006.

Cost of Sales. Cost of sales increased $13.3 million, or 14.7%, to $103.7 million in fiscal year 2006 from $90.4 million in fiscal year 2005. As a percentage of net sales, cost of sales increased to 58.2% in fiscal year 2006 from 57.1% in fiscal year 2005. This increase in cost of sales as a percentage of net sales is due primarily to the higher costs associated with shipping product from our distribution center, as well as a reduction in shipping revenue related to the free shipping promotions in the second and third quarter of fiscal year 2006. Product-related cost of goods sold, as a percentage of net sales excluding shipping and handling fees, remained relatively unchanged for fiscal year 2006 at 53.8% compared to 53.7% for fiscal year 2005. We believe that product-related cost of goods sold, as a percentage of net sales excluding shipping and handling fees, is a useful financial measure as it removes the impact of shipping revenues and related costs. We believe shipping operations do not reflect the core operations of our business and do not represent a profit center.

Selling, General and Administrative Expenses.



                                                 % of                    % of
                                    Fiscal       Net        Fiscal       Net                        %
(amounts in millions)             Year 2006     Sales     Year 2005     Sales      Change        Change
Salaries and benefits             $     34.4      19.3%   $     26.1      16.5%   $     8.3         31.8%
Occupancy and related expense           26.1      14.7%         20.1      12.7%         6.0         29.9%
Catalog, advertising and
promotion                               10.6       5.9%         12.7       8.0%        (2.1 )     (16.5)%
Other expenses                          10.6       5.9%          9.5       6.0%         1.1         11.6%
Professional - legal,
consulting, SOX                          5.9       3.3%          3.0       1.9%         2.9         96.7%

Total SG&A                        $     87.6      49.1%   $     71.4      45.1%   $    16.2         22.7%

SG&A expenses increased $16.2 million, or 22.7%, to $87.6 million in fiscal year 2006 from $71.4 million in fiscal year 2005. As a percentage of net sales, SG&A expenses increased to 49.1% in fiscal year 2006 from 45.1% in fiscal year 2005. These increases are primarily due to the following:

• Salaries and benefits increased $8.3 million, or 31.8%, to $34.4 million in fiscal year 2006 from $26.1 million in fiscal year 2005. This increase is partly due to the incremental salary and benefits of $3.0 million related to the 23 studios opened in fiscal year 2005 which operated less than 12 months in fiscal year 2005 and the seven studios and one outlet opened during fiscal year 2006, an increase in temporary help and subcontractors of approximately $1.0 million, stock-based compensation and severance costs . . .