Overview

The following discussion should be read along with the unaudited condensed consolidated financial statements included in this Form 10-Q, as well as the company's 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission, which provides a more thorough discussion of the Company's products and services, industry outlook, and business trends.

Bassett Furniture Industries Inc., based in Bassett, Va., is a leading retailer, manufacturer and marketer of branded home furnishings. Bassett's products are sold primarily through Bassett Furniture Direct (BFD) and Bassett Home Furnishings (BHF) stores, with secondary distribution through multi-line furniture stores, many with in-store Bassett Design Centers. Bassettbaby cribs and casegoods are sold through specialty stores and mass merchants.

Bassett Furniture Direct ("BFD" or "store") was created in 1997 as a single source home furnishings retail store that provides a unique combination of stylish, well-made furniture and accessories with a high level of customer service. This service includes complimentary room planning, in-home design visits, quick delivery, and custom-order furniture. The retail store program had 115 stores in operation at the end of the first quarter of 2009, 34 of which we own and operate.

We define imported product as fully finished product that is sourced internationally. In the first quarter of 2009, 53% of our wholesale sales were of imported product compared to 58% in the first quarter of 2008. Our domestic product includes certain products that contain components which are also sourced internationally. We continue to believe that a blended strategy including domestically produced products primarily of a custom-order nature combined with importing certain product categories and major collections, provides the best combination of value and quality to our customers.

Overall conditions for our industry and our Company have been difficult over the past several years and have persisted throughout the first quarter of 2009. New housing starts are down significantly and consumers continue to be faced with general economic uncertainty fueled by deteriorating consumer credit markets and lagging consumer confidence as a result of volatile and often erratic financial markets. All of these factors have significantly impacted "big ticket" consumer purchases such as furniture. Consequently, this has put pressure on certain of our dealers' ability to generate adequate profits to fully pay us for the furniture we have sold to them. As a result, we incurred significantly increased bad debt related losses during the second half of 2008 as well as during the first quarter of 2009. Although management will continue to work closely with our licensees to ensure the success of both the licensee and Bassett, we expect an additional ten to twelve underperforming stores to close during the remainder of 2009 of which four are currently running liquidation sales. We also expect to increase the number of Company-owned stores during 2009, through acquisitions of certain licensee-owned stores. During the first quarter of 2009, we acquired licensee stores in Scottsdale and Tucson, Arizona and Fredericksburg, Virginia.

Maintenance of a strong balance sheet is a stated management goal and vital to our retail growth strategy. The store program entails key business risks, including the realization of receivables and the coverage of both direct and contingent liabilities primarily associated with retail real estate. We have established decision criteria and business disciplines aimed at minimizing potential losses from these risks.

Given the difficult and somewhat unprecedented environment, we have had no choice but to take several important actions aimed at improving our results and liquidity in the short-term. These include:

• Aggressively working with certain licensees to close those stores that are underperforming thereby limiting further exposure in our accounts receivable.

• Reducing our inventory levels to improve working capital and cash flow.

• Right-sizing our expense structure in both our wholesale and corporate retail divisions.

• Suspending our quarterly dividend.

• Delaying certain capital expenditures.

We will also continue to work diligently with our network of licensees to improve their operating results. With the existing and planned improvements in our retail program and our strong balance sheet, we believe we are well positioned not only to survive these turbulent times, but also to gain market share as some of our competitors exit the industry.

On March 19, 2009, we announced actions to reduce our overall cost structure that will result in lower expenditures for payroll, employee benefits, warehousing and distribution, marketing, and other miscellaneous items. Approximately 50 positions in departments throughout the Company were affected including corporate retail, administration, customer service, manufacturing, and marketing resulting in an approximate 6% reduction in payroll. Additionally, our Mt. Airy, N.C., distribution facility closed on March 1, 2009 and has been consolidated to other warehouses in the U.S. and Asia. Overall distribution costs will be reduced by 7%. The Mt. Airy facility has been listed for sale. Marketing expenditures will be trimmed primarily through reduced television production costs and upcoming changes to our consumer catalog format. We do, however, plan to continue to invest in our website. Upcoming improvements will feature enhanced aesthetics, easier navigation for individual items and collections, and improved E-commerce capabilities. The new site will debut approximately May 1st. As a result of these actions, we expect to realize annualized savings of $7,000 to $8,000. In addition, we plan to record severance charges during the second quarter of 2009 of $300 to $500.

Restatement of Previously Reported Results

During the first quarter of 2009, the Staff of the Securities and Exchange Commission (the "SEC") began its triennial review of our Form 10-K for the year ended November 29, 2008 and subsequently our Form 10-Q for the quarter ended February 28, 2009. Three primary issues were identified by the SEC as a result of their review. These included our initial valuation of notes receivable issued to our licensees (primarily for amounts converted from past due accounts receivable due from them), our methodology for determining reserves for our accounts receivable, notes receivable, and loan guarantees, and our classification of our revolving debt as current or long-term.

As a result of the SEC's comments, we began a review of the accounting policies and processes in the areas previously mentioned. Consequently, we determined that we should have recorded lower values for certain of our notes receivable upon inception and, subsequently, recorded additional reserves on those notes due to an error in how we determined an appropriate market rate of interest for those notes. In addition, we also concluded that we should have recognized revenue for certain customers on a cost recovery basis for shipments beginning in the first quarter of 2009 and that additional reserves for loan guarantees should be established. Therefore, we recorded an additional $3,280 of net charges in the quarter ended February 28, 2009 to account for these lower note values, increased reserves and reduced revenue. Of the amount recorded, $1,936 related to periods prior to the quarter ended February 28, 2009. However, based on our consideration of the underlying quantitative and qualitative factors surrounding the prior period errors, the effects on the previous annual and interim periods were determined to be immaterial and, therefore, prior periods have not been restated.

As a result, our net loss increased $3,280 to $11,963 and net loss per share increased $0.29 per share to $1.05 per share. The recognition of this additional expense and reduced revenue caused us to violate the net worth covenant contained in our revolving credit facility for the quarter ended February 28, 2009. As such, we have reclassified our debt under the revolving credit facility from long-term to current and have provided expanded disclosures around our liquidity.

Results of Operations - Period ended February 28, 2009 (restated) compared with the period ended March 1, 2008:

Net sales, gross profit, selling, general and administrative (SG&A) expense, and operating income (loss) were as follows for the periods ended February 28, 2009 and March 1, 2008:

                                                                     Quarter Ended
                                                           As restated
                                                        February 28, 2009         March 1, 2008

Net sales                                             $   57,811      100.0 %    $ 81,599   100.0 %

Gross profit                                              24,143       41.8 %      32,627    40.0 %
SG&A (see note below)                                     26,852       46.4 %      31,445    38.5 %
Bad debt and notes receivable valuation charges            5,892       10.2 %         770     0.9 %

Income (Loss) from operations                         $   (8,601 )    -14.8 %    $    412     0.6 %

Note: For comparability purposes, we have presented our selling, general and administrative expenses above without consideration of the effects of the bad debt and notes receivable valuation charges.

On a consolidated basis, we reported net sales for the first quarter of 2009 of $57,811, a decrease of $23,788, or 29.2% from sales levels attained in the first quarter of 2008. Due to our fiscal calendar, the quarter ended March 1, 2008 included 14 weeks compared to 13 weeks for the quarter ended February 28, 2009.

Segment Information

We have strategically aligned our business into three reportable segments:
Wholesale, Retail and Investments/Real Estate. The wholesale home furnishings segment is involved principally in the design, manufacture, sourcing, sale and distribution of furniture products to a network of stores (independently-owned stores, Company-owned retail stores and partnership licensees) and independent furniture retailers. Our wholesale segment includes our wood and upholstery operations as well as all corporate selling, general and administrative expenses, including those corporate expenses related to both corporate and licensee owned stores.

Our retail segment consists of Company-owned stores. Our retail segment includes the revenues, expenses, assets and liabilities (including real estate) and capital expenditures directly related to these stores.

Our investments/real estate segment consists of our investments (Alternative Asset Fund and marketable securities), distributions in excess of affiliate earnings (IHFC) and retail real estate related to licensee stores. Although this segment does not have operating earnings, income from the segment is included in other income, net in our condensed consolidated statements of income and retained earnings.

The following is a discussion of operating results for our wholesale and retail segments:

Wholesale Segment



                                                                   Quarter Ended
                                                        As restated
                                                     February 28, 2009            March 1, 2008

Net sales                                          $   47,948       100.0 %     $ 69,309    100.0 %

Gross profit                                           13,189        27.5 %       20,992     30.3 %
SG&A (see note below)                                  13,013        27.1 %       17,339     25.0 %
Bad debt and notes receivable valuation charges         5,892        12.3 %          770      1.1 %

Income (Loss) from operations                      $   (5,716 )     -11.9 %     $  2,883      4.2 %

Note: For comparability purposes, we have presented our selling, general and administrative expenses above without consideration of the effects of the bad debt and notes receivable valuation charges.

Net sales for the wholesale segment were $47,948 for the first quarter of 2009 as compared to $69,309 for the first quarter of 2008, a decrease of 30.8%. Due to our fiscal calendar, the quarter ended March 1, 2008 included 14 weeks compared to 13 weeks for the quarter ended February 28, 2009. Approximately 53% of wholesale shipments during the first quarter of 2009 were imported products compared to 58% for the first quarter of 2008. Gross margins for the wholesale segment were 27.1% for the first quarter of 2009 as compared to 30.3% for the first quarter of 2008. This decrease is primarily due to lower realized margins on our wood furniture and certain discount programs designed to sell more furniture, partially offset by increased margins on our upholstered furniture due to its custom nature. Wholesale SG&A decreased $4,326 primarily due to decreased sales volumes. We recorded $5,892 of bad debt and notes receivable valuation charges for the first quarter of 2009 as compared to $770 for the first quarter of 2008.

Wholesale shipments by type:

                                            Quarter Ended
                                  As restated
                               February 28, 2009         March 1, 2008

                 Wood         $    25,338     52.8 %    $ 37,003    53.4 %
                 Upholstery        22,118     46.2 %      31,377    45.3 %
                 Other                492      1.0 %         929     1.3 %

                 Total        $    47,948    100.0 %    $ 69,309   100.0 %

Retail Segment - Company-Owned Retail Stores



                                               Quarter Ended
                                 February 28, 2009           March 1, 2008

              Net sales        $   23,743      100.0 %    $ 25,927      100.0 %

              Gross profit         11,180       47.1 %      12,049       46.5 %
              SG&A                 13,838       58.3 %      14,106       54.4 %

              Operating loss   $   (2,658 )    -11.2 %    $ (2,057 )     -7.9 %

Our Company-owned store network had sales of $23,743 in the first quarter of 2009 as compared to $25,927 in the first quarter of 2008, a decrease of 8.4%. On a comparable store basis, sales decreased 12.4%. Sales decreases were recorded for each major retail market for the Company-owned store network. Gross margins for the quarter increased 0.6 percentage points due to improved pricing and promotional strategies, coupled with less clearance sales activity as compared to 2008. SG&A decreased $268 due to lower sales. However, as part of the store acquisitions during the first quarter of 2009 and late in 2008, we did not acquire the existing delivery backlog at the time of acquisition. Consequently, we incurred significant SG&A expenses (rent and administrative payroll) without a commensurate level of delivered sales. Excluding the effects of these acquired stores, SG&A as a percent of sales would have been 56.0% for the first quarter of 2009.

Our retail segment includes the expenses of retail real estate utilized by Company-owned retail stores. Rental income and expenses from our properties utilized by independent licensees and partnership licensees are included in our investment and real estate segment.

Investment and Real Estate Segment and Other Items Affecting Net Income (Loss)

Our investments and real estate segment consists of our investments (Alternative Asset Fund and marketable securities), distributions in excess of affiliate earnings (IHFC) and retail real estate related to licensee-owned stores. Although this segment does not have operating earnings, income (loss) from the segment is included in other income (loss), net in our condensed consolidated statements of operations. Our equity investment in IHFC is not included in the identifiable assets of this segment since it has a negative book value and is therefore included in the long term

liabilities section of our consolidated balance sheet. Income and expense items for the first quarter of 2009 and 2008, are as follows:

                                                      As restated
                                                   February 28, 2009             March 1, 2008

Loss from Alternative Asset Fund                  $            (1,192 )         $          (204 )
Income (loss) from marketable securities                       (1,151 )                     495
Income from unconsolidated affiliated
companies, net                                                    854                       812
Interest expense                                                 (954 )                    (989 )
Loan and lease guarantee expense                                 (426 )                     (34 )
Other                                                            (428 )                     107


Other income (loss), net                          $            (3,297 )         $           187

In accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", we review our marketable securities to determine whether a decline in fair value of a security below the cost basis is other than temporary. Should the decline be considered other than temporary, we write down the cost basis of the security and include the loss in current earnings as opposed to recording an unrealized holding loss. Due to the continued decline in the financial markets during the fiscal first quarter of 2009, many of our holdings sustained significant losses. Consequently, we recorded $1,255 in losses in our consolidated statement of operations for the quarter ended February 28, 2009.

Income from unconsolidated affiliated companies, net includes income from our investment in IHFC as well as income (loss) from other equity method investments. We recognized income from IHFC of $794 in the first quarter of 2009 as compared to $1,040 during the first quarter of 2008.

Loan and lease guarantee expense consists of adjustments to record the fair value of our loan and lease guarantee obligations that we have entered into on behalf of our licensees. We recognized expense of $426 and $34, respectively, for the quarters ended February 28, 2009 and March 1, 2008, to reflect the additional risk that we may have to assume the underlying obligations with respect to our guarantees.

Other includes several items including losses related to our real estate investments that support our licensees.

Income taxes

We calculate an anticipated effective tax rate for the year based on our annual estimates of pretax income or loss and use that effective tax rate to record our year-to-date income tax provision. Any change in annual projections of pretax income or loss could have a significant impact on our effective tax rate for the respective quarter. During the fourth quarter of 2008, we recorded a $23,383 charge to establish a valuation allowance against substantially all of our deferred tax assets as we were in a cumulative loss position for the past three years, which is considered significant negative evidence as to whether our deferred tax assets will be realized. Since we reported losses in the quarter and remained in this cumulative loss position, we recorded no tax benefits on the losses generated for the quarter ended February 28, 2009. The tax provision for the quarter ended February 28, 2009 represents the accrual of income taxes to be paid in certain states and the accrual of penalties and interest associated with certain unrecognized tax benefits.

The effective income tax rate for the first quarter of 2008 was 13.5% and was lower than the statutory rate primarily due to exclusions for dividends received from our investment in IHFC.

Liquidity and Capital Resources

The Company is committed to maintaining a strong balance sheet in order to weather the current difficult industry conditions, to allow it to take advantage of opportunities as market conditions improve, and to execute its long-term retail growth strategies.

Due to the continued housing slump and deterioration in the major financial markets and the overall recessionary economic environment, consumer spending has decreased resulting in significant financial losses for us and

damaging the ability of certain of our licensees to generate sufficient cash flow in their businesses. Currently, we are aggressively pursuing expense reduction and cash preservation initiatives throughout all parts of the business to enhance our cash flow. As previously discussed, we announced certain cost reduction actions that we expect to provide $7,000 to $8,000 in annualized cost savings.

As part of the improvement plans with one of our licensees, we converted $1,100 of trade accounts receivable to long-term interest bearing notes during the quarter ended February 28, 2009 and expect additional conversions of accounts receivable to long-term notes over the remainder of the year. We continually assess our level of bad debt reserves and recorded $5,892 in provisions for losses on accounts and notes receivable in the first quarter of 2009, a $5,122 increase over the corresponding period in 2008. A continuing difficult and weak retail environment could result in further bad debt expenses, reduced revenue and store real estate charges, including lease termination and impairment charges. Although we believe we have adequate reserves for bad debts, we will continue to work with our licensees to help limit bad debt exposure. We expect ten to twelve underperforming stores to close during 2009.

We used $5,056 of cash in operating activities during the first quarter of 2009 primarily due to the continued difficult environment at retail resulting in lower collections on accounts receivable as well as increased cash requirements to fund the January new product rollout. These cash requirements were funded through $12,900 of investment redemptions and $2,811 in dividends from our investment in the International Home Furnishings Center. We expect to receive additional redemptions from the Alternative Asset Fund of $2,000 to $3,000 over the remainder of the year. In addition, we expect our wholesale inventories to decrease $3,000 to $4,000 over the remainder of the year through improved management and coordination with our foreign suppliers. As a result of an anticipated debt refinancing for IHFC, it is likely that dividend distributions will decrease or be eliminated for the remainder of 2009.

We currently have $18,000 outstanding on our revolving credit facility which provides for borrowings of up to $45,000 at a variable interest rate of LIBOR plus 1.75% (1.92% on February 28, 2009). The facility is secured by a pledge of certain marketable securities and substantially all of our receivables and inventories and matures on November 30, 2010. It contains, among other provisions, certain defined financial covenants including a minimum level of net worth that requires us to have Tangible Net Worth, as defined in the credit agreement, of $118,000 as of the quarterly testing dates. As a result of the impact of the adjustments made as outlined in Note 2, we were no longer in compliance with the Tangible Net Worth covenant which represents an Event of Default as defined in our credit agreement. Consequently, our bank has the ability to immediately demand repayment of the loan and we have reclassified the debt to the current liabilities section of our condensed consolidated balance sheet. During the quarter, our tangible net worth decreased by $11,931 due primarily to operating losses of $8,601 and both realized and unrealized losses associated with the Alternative Asset Fund and our marketable securities portfolio of $2,369. This covenant violation also prevents us from making any additional borrowings under the facility until the covenant is waived and/or amended. However, had there been no covenant violation, we would have had an additional $8,013 of availability under the facility.

We have begun discussions with our lender to amend the Tangible Net Worth covenant. We expect to complete these discussions during the third quarter of 2009. We currently believe that we will be successful in obtaining an amendment. However, should we be unsuccessful, the lender has the ability to accelerate repayment under the facility. If such liquidity needs were to arise, we would explore other liquidity options such as negotiating with another lender, sale of our interest in IHFC, sale of existing investment real estate or mortgaging other investment real estate. Should we be unsuccessful with these and all other potential options in obtaining the necessary liquidity, this could have a material adverse effect on our operations.

We currently have eight retail real estate properties that have been financed through commercial mortgages with interest rates ranging from 6.73% to 9.18%. These mortgages, with a total balance of $21,962, are collateralized by the respective properties with net book values totaling approximately $29,814 at February 28, 2009. Two of the mortgages mature in the first quarter of 2010 with another maturing in the second quarter of 2010. Collectively, the balance for these three mortgages at February 28, 2009 was $8,377. Although negotiations have not begun, we expect to refinance, obtain alternate financing or forbearance of payment by the stated maturity dates. However, there can be no . . .