Forward-Looking Statements

Any statements in this report and the information incorporated herein by reference about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. You can identify these forward-looking statements by the use of words or phrases such as "believe," "may," "could," "will," "estimate," "continue," "anticipate," "intend," "seek," "plan," "expect," "should," or "would." We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions described in Part I, Item 1A. "Risk Factors" and elsewhere in this report.

Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

The interim financial statements and this Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the fiscal year ended January 3, 2009 and the related Management's Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the fiscal year ended January 3, 2009 filed with the Securities and Exchange Commission on April 1, 2009.

Overview

We are a retailer of distinctive modern design products to both residential and commercial customers. Our clients purchase through three integrated sales points, consisting of our studios, website and phone. We have developed a 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 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. 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.

We expanded our offerings in accessories called "DWR:Tools for Living." In this category we feature approximately 700 products, ranging in price from under $10 to over $2,000. The products all share good design and functionality. Each DWR:Tools for Living product is unique in how it solves a problem or makes something more comfortable or easier to use.

Our business strategy is based upon the premise that 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, thereby making integration across sales points more difficult.

We had 66 studios, two DWR:Tools for Living stores and three outlets operating in 25 states, the District of Columbia and Canada as of April 4, 2009. We opened one new outlet during the first quarter 2009. We closed our Southlake, Texas and Tigard, Oregon studios during the second quarter 2009. We believe that the number of available locations is currently limited to our 66 studios and three outlets, and we may need to close underperforming studios.

All of our sales points, other than our new DWR:Tools for Living stores, 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 United States and Europe. In the first quarter 2009, we purchased approximately 36% of our product inventories from manufacturers in foreign countries, with 20% of our product inventory purchases being paid for in Euros. 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 from other parts of the world including Latin America and Asia where product costs are generally lower. Our product development team has worked diligently to find qualified factories in North America, Asia 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 2009, we believe we can achieve product margin improvements from these efforts. We believe that within four years we may have less than 20% of our product coming from European factories.

Recent market and economic conditions have been unprecedented and challenging with tighter credit conditions, slower growth, and increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with declining business and consumer confidence and increased unemployment have recently contributed to volatility of unprecedented levels. The purchase of our products by customers is discretionary, and therefore highly dependent upon the level of consumer spending, particularly among affluent customers. Accordingly, sales of our products have been and may continue to be adversely affected by the current unfavorable market and economic conditions. As a result, we may be required to take significant additional markdowns in response to the lower levels of demand for our products.

In response to lower sales following the economic downturn and resulting losses from operations in 2008, we undertook several initiatives to lower our expenses to better match the forecasted reduction in revenues and improve liquidity in the fourth quarter 2008 and the first quarter 2009. We have restructured certain real estate lease contracts, reduced marketing and catalog expenses primarily by reducing the number of planned catalog mailings and the number of pages per catalog, delayed implementation of a new ERP system, renegotiated certain support contracts related to software maintenance and telecommunications, and lowered outside contractor fees as well as headcount in all areas of the Company. We reduced expenses by approximately $3 million in the first quarter 2009 and expect reduced expenses of approximately $15 million in the remainder of 2009 from the prior comparable periods in 2008. We also reduced inventory levels significantly from year-end 2008 levels to generate additional liquidity.

While we have generated sufficient liquidity to sustain operations with significant operating losses to date, if we fail to generate sales and margins at levels currently forecasted or do not obtain additional debt or equity financing, it is unlikely that we will be able to maintain sufficient liquidity to continue as a going concern.

In February 2009, we announced the engagement of Thomas Weisel Partners LLC, an investment banking firm, to assist in the review of strategic alternatives, including advice related to an unsolicited offer we recently received. In the review process, an independent committee of the board will consider a full range of possible alternatives, including, among other things, a possible sale, merger, strategic partnership or refinancing. We currently have no commitments or agreements with respect to any particular transaction, and there can be no assurance that our review of strategic alternatives will result in any transaction.

Basis of Presentation

We operate on a 52- or 53-week fiscal year, which ends on the Saturday closest to December 31. Each fiscal year consists of four 13-week quarters, with an extra week added onto the fourth quarter every four to six years. Our 2009 and 2008 fiscal years end on January 2, 2010 and January 3, 2009, respectively. Fiscal year 2009 consists of 52 weeks and fiscal year 2008 consisted of 53 weeks.

Results of Operations

Comparison of the thirteen weeks ended April 4, 2009 (First Quarter 2009) to the thirteen weeks ended March 29, 2008 (First Quarter 2008)

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 and sales at our DWR:Tools for Living stores, 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 returned product from our customers. Outlet sales consist of sales at our outlets 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.

                                                                     Thirteen weeks ended
                                                       % of                            % of
(amounts in thousands,                April 4,          Net          March 29,          Net                          %
except percentages)                     2009           Sales           2008            Sales        Change         Change
Studio sales                        $     23,468        68.9%      $      31,314        66.7%      $  (7,846)      (25.1)%
Online sales                               5,206        15.3%              6,327        13.5%         (1,121)      (17.7)%
Phone sales                                2,365         6.9%              4,298         9.2%         (1,933)      (45.0)%
Other sales                                1,701         5.0%              1,420         3.0%            281        19.8 %
Shipping and handling fees                 1,336         3.9%              3,555         7.6%         (2,219)      (62.4)%

Net sales                           $     34,076       100.0%      $      46,914       100.0%      $ (12,838)      (27.4)%

Net sales decreased $12,838,000, or 27.4%, to $34,076,000 in the first quarter 2009 from $46,914,000 in the first quarter 2008. The decrease in the combined net sales of our three sales points (studio, online and phone) is related to a 5% decrease in the number of units of merchandise shipped, a decrease in prices due to an increase in promotional discounts and a change in product mix to a relative higher volume of lower priced DWR:Tools for Living merchandise. The average revenue per unit of product sold decreased by 23%. All of these factors are attributed to the impact of the unfavorable economy. Studio sales decreased $7,846,000, or 25.1%, in the first quarter 2009 compared to the first quarter 2008. We had 66 studios, two DWR:Tools for Living stores and three outlets open at the end of the first quarter 2009 compared to 68 studios and one outlet open at the end of the first quarter 2008. Online sales decreased $1,121,000, or 17.7%, and phone sales decreased $1,933,000, or 45.0%, in the first quarter 2009 compared to the first quarter 2008.

Other sales increased $281,000, or 19.8%, in the first quarter 2009 compared to the first quarter 2008. This increase is primarily related to an increase of $192,000 in sales generated from our outlets including our newly opened Palm Springs outlet, and an increase from warehouse sales of $82,000. Shipping and handling fees for delivery of merchandise decreased $2,219,000, or 62.4%, in the first quarter 2009 compared to the first quarter 2008, primarily attributable to the decrease in product sales and an increase in the amount of promotional free shipping.

Cost of Sales

Cost of sales decreased by $4,992,000, or 20.2%, to $19,746,000 in the first quarter 2009 from $24,738,000 in the first quarter 2008. The decrease in cost of sales is attributable to the decrease in net sales. Cost of sales as a percentage of net sales increased 5.2 percentage points to 57.9% in the first quarter 2009 from 52.7% in the first quarter 2008, primarily attributable to increased promotional sales discounts and negative margins on shipping because of promotional free shipping. The shipping margin was negative in the first quarter 2009 compared to a positive shipping margin in the first quarter 2008. We expect cost of sales as a percentage of net sales to increase in the second quarter of 2009 compared to 2008 as we utilize more promotional sales discounts and free shipping than the second quarter of 2008.

Selling, General and Administrative Expenses ("SG&A")

Selling, general and administrative expenses consist of studio, marketing, corporate and fulfillment center costs. Studio costs include salaries and studio occupancy costs. Marketing costs include consumer and online advertising expenses, and costs associated with publishing our catalogs. Corporate costs include salaries, occupancy costs, computer systems and web-site related costs and professional fees, among others. Fulfillment center costs include salaries, occupancy costs and charges for shipping merchandise from our fulfillment center to studios, DWR:Tools for Living stores, outlet and warehouse sales events. 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, while other companies, including us, may exclude a portion of those costs from gross margin, including them instead in other line items, such as selling, general and administrative expenses.

                                                               Thirteen weeks ended
                                                  % of                       % of
(amounts in thousands,             April 4,        Net       March 29,        Net                          %
except percentages)                  2009         Sales         2008         Sales        Change         Change
Salaries and benefits              $  7,603        22.3%      $  9,360        20.0%      $  (1,757)      (18.8)%
Occupancy and related expense         6,735        19.8%         6,363        13.6%            372         5.8 %
Catalog, advertising and
promotion                             2,630         7.7%         3,283         7.0%           (653)      (19.9)%
Other expenses                        2,542         7.5%         3,319         7.1%           (777)      (23.4)%
Professional - legal,
consulting, SOX                         693         2.0%         1,034         2.2%           (341)      (33.0)%

Total SG&A                         $ 20,203        59.3%      $ 23,359        49.8%      $  (3,156)      (13.5)%

SG&A expenses decreased by $3,156,000, or 13.5%, to $20,203,000 in the first quarter 2009 from $23,359,000 in the first quarter 2008. As a percentage of net sales, SG&A expenses increased to 59.3% in the first quarter 2009 from 49.8% in the first quarter 2008, attributable to the decreased net sales. The decreases in SG&A are described below. In response to lower sales following the economic downturn and resulting losses from operations in 2008, we undertook several initiatives to lower our expenses to better match the forecasted reduction in revenues and improve liquidity in the fourth quarter 2008 and the first quarter 2009. We have restructured certain real estate lease contracts, reduced marketing and catalog expenses primarily by reducing the number of planned catalog mailings and the number of pages per catalog, delayed implementation of a new ERP system, renegotiated certain support contracts related to software maintenance and telecommunications, and lowered outside contractor fees as well as headcount in all areas of the Company. We reduced expenses by approximately $3 million in the first quarter 2009 and expect reduced expenses of approximately $15 million in the remainder of 2009 from the prior comparable periods in 2008.

• Occupancy and related expense increased $372,000, or 5.8%, to $6,735,000 in the first quarter 2009 compared to $6,363,000 in the first quarter 2008. This increase is due to a $294,000 increase in rent and operating expenses for new or relocated sales locations including one new outlet opened in the first quarter 2009, two new DWR:Tools for Living stores opened in the third and fourth quarters 2008 and two studios opened in the first quarter 2008, which did not operate during the entire first quarter 2008. In addition, we relocated one studio with increased rent and operating expenses in the second quarter 2008. The occupancy and related expense increase is also due to an $81,000 increase in depreciation expense. Occupancy and related expense is expected to increase in 2009 from 2008 as the result of the recently opened outlet and two DWR:Tools for Living stores and one relocated studio opened in 2008.

• Catalog, advertising and promotion expense decreased $653,000, or 19.9%, to $2,630,000 in the first quarter 2009 from $3,283,000 in the first quarter 2008. This decrease is due to a $300,000 decrease in catalog expense and a $236,000 decrease in media advertising expense. Direct response catalog costs were recorded as prepaid catalog costs, and during the first nine months of 2008 were amortized over their expected period of future benefit of approximately four months. In accordance with Statements of Position of the Accounting Standards Division No. 93-7, Reporting on Advertising Costs ("SOP 93-7"), advertising costs must be expensed unless the advertising elicits sales to customers. During the fourth quarter 2008, we no longer adequately tracked the required information required by SOP 93-7. Consequently, catalog costs were expensed as the catalogs were distributed in the fourth quarter 2008 and first quarter 2009. The cost of catalogs distributed in the first quarter 2009 decreased by approximately $280,000 from the cost of catalogs distributed in the first quarter 2008. The number of catalogs we distributed in the first quarter 2009 increased by 16% from 2008. However, the increased costs from higher circulation was offset by a 38% decrease in the total number of pages of all catalogs distributed in the first quarter 2009 from 2008. In addition, we distributed a relatively more expensive annual catalog in the first quarter 2008 without a comparable catalog in the first quarter 2009. We plan to reduce overall spending on catalogs and advertising in the remainder of 2009 from the prior comparable period in 2008 by approximately $8,000,000 based on our initiative to lower our expenses including reduced advertising and fewer planned catalog mailings and fewer pages.

• Professional, accounting, legal and SOX expense decreased $341,000, or 33.0%, to $693,000 in the first quarter 2009 compared to $1,034,000 in the first quarter 2008. The decrease is primarily due to a $363,000 decrease in accounting and consulting fees directly related to SEC reporting and Sarbanes-Oxley Act of 2002 compliance.

Interest and Other Income and Expenses

We had no significant interest income in the first quarter 2009 compared to interest income of $57,000 in the first quarter 2008 due to significantly less invested capital and lower interest rates. In the first quarter 2009, excess cash balances were used to pay down borrowings under our loan agreement compared to being swept into an interest bearing investment account in the first quarter 2008. Interest expense increased $66,000 to $114,000 in the first quarter 2009 compared to $48,000 in the first quarter 2008 primarily due to increased borrowings under our loan agreement. We had no significant other income (expense) in the first quarter 2009. Other expense of $144,000 in the first quarter 2008 primarily consists of foreign currency exchange losses related to the value of the dollar decreasing approximately 7% relative to the Euro.

Income Taxes

No income tax benefit was recognized in the first quarter 2009 because it was uncertain whether the tax benefit of the year-to-date pre-tax loss would be realized. In the first quarter 2008, we recorded a tax benefit of $696,000 calculated at the projected annual effective tax rate of 52.8%. The difference between the statutory rate of 39.5% and effective tax rate was primarily due to projected stock-based compensation expense related to incentive stock options not being deductible for tax purposes.

Liquidity and Capital Resources

Cash and cash equivalents

Cash and cash equivalents were $3,099,000 and $6,496,000 as of April 4, 2009 and March 29, 2008, respectively.

Working capital

Working capital was $4,910,000 and $24,743,000 as of April 4, 2009 and March 29, 2008, respectively. The decrease in working capital is primarily the result of significant operating losses incurred in the second quarter 2008 through the fourth quarter 2008 and the first quarter 2009. Specific component changes in working capital were increased borrowings of $7,149,000 under the loan agreement and decreased inventory of $11,132,000.

Cash flows

Net cash provided by (used in):

                                             Thirteen weeks ended
          (amounts in thousands)      April 4, 2009        March 29, 2008
          Operating activities      $           1,350     $            (401)
          Investing activities                   (720)               (1,196)
          Financing activities                 (6,215)                2,442

Net Cash Provided by (Used in) Operating Activities

Net cash provided by operating activities of $1,350,000 in the first quarter 2009 was primarily attributable to a reduction of inventory of $6,511,000 that was offset by the loss from operations of $5,984,000. Net cash used in operating activities of $401,000 in the first quarter 2008 was primarily attributable to the net loss from operations in the first quarter 2008.

Net Cash Used in Investing Activities

Cash used in investing activities was for the purchase of property and equipment related to our new outlet and studios, and information technology systems in the amounts of $720,000 and $1,196,000 in the first quarter 2009 and 2008, respectively. We opened one new outlet in the first quarter 2009 and two new studios in the first quarter 2008.

For the remainder of fiscal year 2009, we anticipate that our investment in property and equipment will be approximately $500,000, primarily to relocate one studio in the second quarter 2009. We plan to finance this investment from borrowings under our revolving line of credit facility.

Net Cash Provided by (Used in) Financing Activities

Net cash used in financing activities in the first quarter 2009 was primarily comprised of repayment of borrowings under our loan agreement of $4,266,000, the restriction of $2,000,000 of cash related to our loan agreement and repayment of long-term obligations of $207,000. Net cash provided by financing activities in the first quarter 2008 was primarily comprised of borrowings of $2,534,000 under our loan agreement.

Cash Availability and Liquidity

As of April 4, 2009, we had available $6,935,000 in working capital resources for our future cash needs as follows:

. . .