BASSETT FURNITURE INDUSTRIES INC - Quarter Report: 2005 May (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended May 28, 2005

OR

For the transition period from              to             

Commission File No. 0-209

BASSETT FURNITURE INDUSTRIES, INCORPORATED

(Exact name of Registrant as specified in its charter)

3525 Fairystone Park Highway

Bassett, Virginia 24055

(Address of principal executive offices)

(Zip Code)

(276) 629-6000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

At May 28, 2005, 11,792,575 shares of common stock of the Registrant were outstanding.

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BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

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PART I - FINANCIAL INFORMATION

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS

FOR THE PERIODS ENDED MAY 28, 2005 AND MAY 29, 2004 – UNAUDITED

(In thousands except per share data)

Item 1. Financial Statements

The accompanying notes to condensed consolidated financial statements are an integral part of the condensed consolidated financial statements.

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PART I – FINANCIAL INFORMATION – CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

May 28, 2005 AND NOVEMBER 27, 2004

(In thousands)

The accompanying notes to condensed consolidated financial statements are an integral part of the condensed consolidated financial statements.

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PART I – FINANCIAL INFORMATION – CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE PERIODS ENDED MAY 28, 2005 AND MAY 29, 2004 – UNAUDITED

(In thousands)

The accompanying notes to condensed consolidated financial statements are an integral part of the condensed consolidated financial statements.

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BASSETT FURNITURE INDUSTRIES, INCORPORATED. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 28, 2005

(Dollars in thousands except share and per share data)

Note 1. Basis of Presentation:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In our opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

The condensed consolidated financial statements include the accounts of Bassett Furniture Industries, Incorporated (“Bassett”, “we”, “our”, “the Company”) and our majority owned subsidiaries of which we have operating control. The equity method of accounting is used for our investments in affiliated companies in which we exercise significant influence but do not maintain control, unless consolidated pursuant to Financial Accounting Standards Board (“FASB”) Revised Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN46R”).

Note 2. Interim Financial Presentation

All intercompany accounts and transactions have been eliminated in the consolidated financial statements. The results of operations for the three and six months ended May 28, 2005 are not necessarily indicative of results for the fiscal year. It is suggested that the interim consolidated financial statements be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended November 27, 2004.

Certain amounts in the 2004 financial statements have been reclassified to more closely conform with the 2005 presentation.

Note 3. Stock-Based Compensation:

We have elected to continue to account for stock options granted to employees and directors under APB Opinion No. 25 and are required to provide pro forma disclosures of what net income and earnings per share would have been had we adopted the fair value method for recognition purposes under SFAS No. 123.

For the periods ended May 28, 2005 and May 29, 2004, the effect on earnings per share would be as follows:

The pro forma results reflect amortization of the fair value of stock options over the vesting period.

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BASSETT FURNITURE INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 28, 2005

(Dollars in thousands except share and per share data)

Note 4. Inventories:

Inventories are valued at the lower of cost or market. Cost is determined for domestic furniture inventories using the last-in, first-out (LIFO) method. The costs for imported inventories are determined using the first-in, first-out (FIFO) method. Our 2005 inventories include the inventories acquired through the purchase of our licensee operator in Dallas, Texas (Note 9). During the second quarter and first six months of 2005, we liquidated certain LIFO inventories which decreased cost of sales by approximately $400 and $700, respectively.

Note 5. Unconsolidated Affiliated Companies:

The International Home Furnishings Center (“IHFC”) owns and leases out floor space in a showroom facility in High Point, North Carolina. We owned 46.9% of IHFC at May 28, 2005 and May 29, 2004 and accounted for the investment using the equity method since we do not maintain operating control of IHFC. Our investment reflects a credit balance of $11,955 and $12,578 at May 28, 2005 and November 27, 2004, respectively, which is reflected in the liabilities section in the accompanying consolidated balance sheets as “distributions in excess of affiliate earnings.” We have concluded, based on the leases that tenants must sign with IHFC and based on historical earnings that IHFC will generate future earnings in excess of the amounts recorded in the accompanying balance sheets. Based on current and expected future earnings of IHFC, we believe the market value of this investment is positive and substantially greater than its negative book value of $11,955 at May 28, 2005. We recorded income from IHFC of $2,966 and $2,849 in the first six months of 2005 and 2004, respectively. Additionally, we received dividends of $2,342 and $2,343 from IHFC in the first six months of 2005 and 2004, respectively. Summarized unaudited income statement information for IHFC for their first six months of 2005 and 2004, respectively, is as follows:

Note 6. Real Estate Notes Payable:

We have mortgages on five real estate properties utilized by Bassett Furniture Direct (BFD) stores. These notes payable mature over the next six to seven years and have interest rates ranging from 7.89% to 9.18%. The current portion of these notes, $441 at May 28, 2005, has been included as a current liability in accrued liabilities in the accompanying condensed consolidated balance sheet.

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BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

May 28, 2005

(Dollars in thousands except share and per share data)

Note 7. Long-Term Debt:

We have a $40,000 revolving credit facility which is secured by substantially all of our receivables and inventories. Borrowings under the facility, which matures November 30, 2006, totaled $4,000 at May 28, 2005 and $0 at November 27, 2004. The interest rate on this facility was 4.6% at May 28, 2005. Additionally, through our acquisition of our BFD licensee operator in Dallas, Texas, we assumed $1,388 of long-term liabilities (Note 9).

Note 8. Comprehensive Income:

For the quarters ended May 28, 2005 and May 29, 2004, total comprehensive income, net of tax, was $963 and $2,454, respectively. Included in total comprehensive income for each quarter was net income of $1,047 and $1,885, and unrealized holding gains (losses), net of tax, of $(84) and $569, respectively.

For the six months ended May 28, 2005 and May 29, 2004, total comprehensive income, net of tax, was $3,391 and $4,336, respectively. Included in total comprehensive income for each six month period was net income of $3,411 and $4,213, and unrealized holding gains (losses), net of tax, of $(20) and $123, respectively.

Note 9. Acquisition of Licensees and Subsequent Events:

On May 28, 2005, we acquired a 76% ownership interest in and operating control of our Dallas, Texas metropolitan area BFD stores (“BFD-Dallas”). We accounted for this transaction using the purchase method of accounting. As such, as of the end of our second quarter, we have consolidated BFD-Dallas’ financial position into our condensed consolidated balance sheet. BFD-Dallas operates eight BFD stores in the greater Dallas metropolitan area.

The purchase price totaled $11,154 which included $800 of cash, $2,500 of notes receivable converted to equity, and the assumption of $4,704 of liabilities. The total and fair value of assets acquired were $8,689 which included $3,553 of inventories, recorded net of inter-company profit elimination. We are in the process of receiving third-party evaluations of certain identifiable intangible assets, valuing certain liabilities and performing other opening balance sheet procedures; thus the allocation of the purchase price is subject to refinement. The following table summarizes the estimated fair market values of the assets acquired and liabilities assumed at the date of acquisition.

In conjunction with this transaction, we recorded a $2,465 impaired asset charge for the difference in the purchase price and the fair market value of assets acquired net of recorded reserves. The difference primarily relates to an impairment of a portion of goodwill created through the transaction. Pro forma results of operations for prior periods are not presented as they are deemed to not be materially different than previously reported results. Due to this transaction being completed on May 28, 2005, our results of operations for this quarter do not include the results of operations of BFD-Dallas. We will begin including BFD-Dallas results of operations in our results of operations in our 2005 fiscal third quarter.

Also, during the second quarter of 2005, we began negotiations to acquire certain assets and assume certain liabilities of our BFD licensee in Rochester, NY (“BFD-UNY”) which operates two stores in Rochester, NY and one store in Buffalo, NY. An interim agreement was signed in the second quarter giving us the ability to monitor BFD-UNY’s revenues and expenses. We expect the acquisition to be finalized in our third quarter.

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BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 28, 2005

(Dollars in thousands except share and per share data)

During our second quarter, we attempted to evaluate the BFD-UNY relationship under Revised FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46R”). Our involvement as a licensor does not give us the legal rights or practical ability to implement accounting policies and procedures of our licensee, mandate the hiring by licensees of accountants proficient in generally accepted accounting principles or to enforce other accounting related requirements upon our licensees. Accordingly, our ability to monitor or influence the complete and accurate preparation of financial information in a manner which is adequate to satisfy the requirements under FIN 46R are limited by the legal and practical nature of our licensee relationships. After all of the efforts we have exerted in this regard, we were unable to obtain sufficient information to determine whether we are the primary beneficiary or to perform the complete and accurate accounting required to consolidate the BFD-UNY entity.

As a result, we elected the “Scope Exception for Certain Enterprises That Are Unable to Obtain Information” contained in FIN46R as we have made the requisite efforts to obtain sufficient information from BFD-UNY. As part of the expected completion of the proposed acquisition in our third quarter, we will evaluate the acquired assets and assumed liabilities and account for them under the purchase method of accounting. Based on the proposed transaction amounts, we do not consider the consolidation of this entity to be material to our balance sheet. Wholesale shipments to BFD-UNY were $1,330 and $2,266 for the second quarter and first six months of 2005, respectively.

Note 10. Contingencies:

We are involved in various legal and environmental matters, which arise in the normal course of business. Although the final outcome of these matters cannot be determined, based on the facts presently known, we believe that the final resolution of these matters will not have a material adverse effect on our financial position or future results of operations.

We lease land and buildings that are used in the operation of our Bassett-owned retail stores as well as in the operation of independent and partnership licensee BFD stores. Additionally, we lease showroom space from IHFC, which is priced at the market rate. Lease terms range from three to 15 years and generally have renewal options of between five and 15 years. We had obligations of $76,751 and $47,171 at May 28, 2005 and November 27, 2004, respectively, for future minimum lease payments under non-cancelable operating leases having remaining terms in excess of one year. Obligations at May 28, 2005 include $19,628 of BFD-Dallas’ lease obligations.

As part of the expansion strategy for our BFD program, we have guaranteed certain lease obligations of licensee operators. Lease guarantees range from one to ten years. We were contingently liable under licensee lease obligation guarantees in the amount of $18,222 and $25,394 at May 28, 2005 and November 27, 2004, respectively. Currently, we have also guaranteed one real estate obligation for $750 and $804 and one warehouse lease obligation for $2,284 and $2,902, at May 28, 2005 and November 27, 2004, respectively.

We have also guaranteed loans to certain of our BFD licensees to finance initial inventory packages for those stores. The total contingent liability with respect to these loan guarantees as of May 28, 2005 and November 27, 2004 was $12,065 and $14,534, respectively.

In the event of default by an independent dealer under the guaranteed lease or loan, we believe that the risk of loss is mitigated through a combination of options that include, but are not limited to, arranging for a replacement dealer, liquidating the collateral, and pursuing payment under the personal guarantees of the independent dealer. The proceeds of the above options are expected to cover the estimated amount of our future payments under the guarantee obligations, net of recorded reserves. The fair value of lease guarantees (an estimate of the cost to the Company to perform on these guarantees) at May 28, 2005 and November 27, 2004 were $800 and $770, respectively, and are recorded in accrued liabilities in the accompanying balance sheets.

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BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 28, 2005

(Dollars in thousands except share and per share data)

Note 11. Recent Accounting Pronouncements

SFAS No. 123 (Revised 2004), “Share-Based Payments”, issued in December 2004, is a revision of FASB Statement 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123 (Revised 2004) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. This statement is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and we will adopt the standard in the first quarter of fiscal 2006. Although we have not completed our assessment, we believe the impact on our consolidated financial position or results of operations will not be material given the small number of unvested stock options currently outstanding.

Note 12. Earnings per share:

The following reconciles basic and diluted earnings per share:

Common stock equivalent shares are excluded from the computations if their effect is anti-dilutive. The effect of stock options is not included in the diluted computation for periods in which losses occur because to do so would be anti-dilutive. Options to purchase 1.4 million and 1.6 million shares of common stock were outstanding during the first six months of 2005 and 2004, respectively, which could potentially dilute basic EPS in the future.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

Note 13. Segment Information:

Our primary business is wholesale home furnishings. The wholesale home furnishings business is involved principally in the design, manufacture, sale and distribution of furniture products to a network of Bassett Furniture Direct stores (independently-owned stores, Bassett-owned retail stores, and partnership licensees) and independent furniture retailers and department stores.

Our wood segment is engaged in the manufacture and sourcing of casegoods products, primarily bedroom, dining room, home entertainment, occasional and juvenile furniture. Our upholstery segment is involved in the manufacture and sourcing of upholstered frames and cut upholstery items having a variety of frame and fabric options.

Our “other” business segment consists of a contemporary furniture business, real estate for non-Company-owned BFD stores and corporate selling, general and administrative expenses, which are included to reconcile segment information to the consolidated financial statements.

Our retail segment currently consists of 22 Bassett-owned stores in North Carolina, South Carolina, Nevada, and Texas. This includes 8 stores operated by BFD-Dallas which were acquired on May 28, 2005 and therefore, whose results of operations are not yet included in our results of operations but will begin to be included in our results of operations in our third quarter. The 2004 first six months’ retail segment consisted of 13 stores in North Carolina, Nevada, and Texas. Our retail segment includes the revenues, expenses, retail real estate and capital expenditures directly utilized by these stores.

Inter-Company profit elimination includes both the elimination of sales and profit in inventory. Inventory profit elimination reflects the embedded wholesale profit in the Company-owned store inventory that has not been realized. These profits will be recorded when merchandise is shipped to the retail customer.

Operating income by business segment is defined as sales less direct operating costs and expenses. Identifiable assets are those assets used exclusively in the operations of each business segment. Identifiable assets for our wood, upholstery and retail segments consist primarily of inventories, retail real estate and property, plant and equipment.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

Segment information for the periods ended May 28, 2005 and May 29, 2004 was as follows:

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

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

Overview

Bassett Furniture Industries, Incorporated, based in Bassett, Va., is a leading manufacturer and marketer of branded home furnishings. Bassett’s products, designed to provide quality, style and value, are sold through Bassett Furniture Direct ® stores (BFDs), At Home with Bassett ® galleries, and other furniture and department stores. Bassettbaby ® products, primarily cribs and casegoods, are sold through specialty stores and mass merchants.

The inception and growth of our Bassett Furniture Direct (BFD) store program, which began in 1997, entailed not only the creation of a new prototype store, but also includes an internal, cultural transformation aimed at refocusing Company practices and strategies to the ultimate end user, our consumer. The strategy also focused on restyling the Bassett lines and suites with accessories. Bassett Furniture Direct acts as both a furniture design center and a moderate price point leader - two characteristics that combined with custom product and quick delivery offer the Company a unique selling proposition in the furniture industry.

The furniture industry continues to experience rapid change. The change has been precipitated by both the growth of imported furniture (which has included downward pressure on retail prices) and reductions in traditional channels of distribution. We embraced these changes through our BFD program and by reducing our domestic production of product that can be more efficiently sourced overseas. We strive to provide our customers with home furnishings at competitive prices and, with that goal in mind, will continue to evaluate the cost effectiveness of domestic production on a product by product basis. Continual improvements to the retail program are being made through new and improved products, marketing programs and training initiatives. The opening of successful BFD stores will continue to drive the Company’s growth over the next several years and we expect 10 to 20 new BFD stores will be opened each year. While interest in our BFD program remains strong, we continue to be more selective in approving new licensees to open stores and remain focused on improving the profitability of our current licensee and corporately owned stores. We believe that overall operating margins will be positively impacted through continued efforts to improve manufacturing processes and source more products overseas.

Our retail strategy is currently focused on developing a more uniform set of business practices to assist licensees in the operations of their BFD store(s) and working with licensees to improve the profitability of their BFD stores. We plan to utilize our retail division to implement best practices and drive the uniformity in our BFD program that we believe is key to the overall success of the BFD program. Pursuit of this strategy will enable our retail division to acquire and operate additional BFD stores. Our recent acquisition of BFD stores in Dallas, Texas and our current plans to acquire BFD stores in Upstate NY further bolster our retail division and also provide the organizational and financial strength needed to improve the performance of these stores.

We intend to execute these strategies in such a way as to preserve our investments while simultaneously minimizing the need for borrowed funds. Maintenance of a strong balance sheet is a stated management goal and vital to our retail growth strategy. The BFD program entails key business risks, including the realization of receivables and the coverage of contingent liabilities. We have established decision criteria and business disciplines to minimize potential losses from these risks.

Two key components of our balance sheet are our investments in IHFC (Note 5) and the Bassett Industries Alternative Asset Fund (BIAAF), a limited partnership (See Item 3, Market Risk, for a discussion of BIAAF.)

An increasingly important component of our balance sheet is retail real estate. We expect to continue to invest in high quality retail real estate as the BFD store program continues to expand, and may, on a selective basis, continue to provide various forms of assistance to procure retail real estate for licensees of BFD stores with a focus on lease/sub-lease arrangements or short-term lease guarantees.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

In fiscal 2005, we have two primary areas of focus: one, to work to improve the profitability of licensed BFD stores in part by refining and promoting more uniform business practices, and two, to improve the financial performance of our domestic wood operations.

Critical Accounting Policies

Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America which requires that certain estimates and assumptions be made that affect the amounts and disclosures reported in those financial statements and the related accompanying notes. Actual results could differ from these estimates and assumptions. We use our best judgment in valuing these estimates and may, as warranted, solicit external advice. Estimates are based on current facts and circumstances, prior experience and other assumptions believed to be reasonable. The following critical accounting policies, some of which are impacted significantly by judgments, assumptions and estimates, affect our consolidated financial statements.

Consolidation – The consolidated financial statements include the accounts of Bassett Furniture Industries, Incorporated and its majority-owned subsidiaries for whom we have operating control. We also consolidate variable interest entities for which we are the primary beneficiary.

Impairment of Long-Lived Assets - We periodically evaluate whether events or circumstances have occurred that indicate long-lived assets may not be recoverable or that the remaining useful life may warrant revision. When such events or circumstances are present, we assess the recoverability of long-lived assets by determining whether the carrying value will be recovered through the expected undiscounted future cash flows resulting from the use of the asset. In the event the sum of the expected undiscounted future cash flows is less than the carrying value of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded.

Allowance for Accounts and Notes Receivable - The BFD program entails key business risks, including the realization of receivables. We have established decision criteria and business disciplines to minimize potential losses from this risk. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on a review of specifically identified accounts and notes receivable in addition to an overall aging analysis. Judgments are made with respect to the collectibility of accounts receivable based on historical experience and current economic trends. Because of varied historical experiences, differing economic conditions in various parts of the country and uncertainties with retail business conditions, additional allowances may be required.

Inventories - Inventories are stated at the lower of cost or market. Cost is determined for domestic furniture inventories using the last-in, first-out method. The cost of imported inventories is determined on a first-in, first-out basis. We estimate an inventory reserve for excess quantities and obsolete items based on specific identification and historical write-offs, taking into account future demand and market conditions. If actual demand or market conditions in the future are less favorable than those estimated, additional inventory write-downs may be required.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Investments – Investments are marked-to-market and recorded at their fair value. Unrealized holding gains and losses, net of the related income tax effect, on available-for-sale securities are excluded from income and are reported as other comprehensive income in stockholders’ equity. Realized gains and losses are included in income and are determined using the specific identification method for ascertaining the cost of securities sold.

Revenue Recognition - Revenue is recognized when the risks and rewards of ownership and title to the product have transferred to the buyer. This generally occurs upon the shipment of goods to independent dealers or, in the case of Bassett-owned retail stores, upon delivery to the customer. Our wholesale terms vary from 30 to 60 days. An estimate for returns and allowances has been provided in recorded sales.

Loss Reserves – We have a number of other potential loss exposures incurred in the ordinary course of business such as environmental claims, product liability, lease and loan guarantees, litigation, restructuring charges, and the recoverability of deferred income tax benefits. Establishing loss reserves for these matters requires estimates and judgments with regard to maximum risk exposure and ultimate liability or realization. As a result, these estimates and judgments are often developed with the assistance of appropriate advisors, and are based on current understanding of the underlying facts and circumstances. Because of uncertainties related to the ultimate outcome of these matters or the possibility of changes in the underlying facts and circumstances, additional charges related to these issues could be required in the future.

Results of Operations – Periods ended May 28, 2005 compared with the periods ended May 29, 2004

In the first six months of 2005, we had net sales of $163,815 which was an increase of 4.4% from $156,923 of net sales reported in the first six months of 2004. Sales for the second quarter of 2005 were $83,063 which was an increase of 3.4% from the $80,355 of net sales reported in the second quarter of 2004. The increase for both the six month and second quarter of 2005 was primarily the result of growth in shipments into the BFD channel slightly exceeding the attrition in sales to traditional independent furniture stores. Overall business conditions for the second quarter of 2005 and entering the third quarter have remained fairly stable although they still are relatively soft at the retail level. Business was positive during the Memorial Day sale period, but maintaining momentum over longer periods of time during the summer months continues to be a seasonal challenge.

We have continued our drive to open BFD stores. The BFD store network consisted of 120 BFD stores at May 28, 2005 and 104 BFD stores at May 29, 2004, which included licensees opening nine additional stores in the first six months of 2005 and closing five stores. The BFD stores accounted for 65% and 57% of our wholesale sales for the first six months of 2005 and 2004, respectively. We expect to open 10 to 12 BFD stores in the second half of 2005.

We have continued to experience increased demand for Bassetbaby® brand products, especially with the three largest Bassettbaby® customers, Babies R Us, Burlington Coat Factory and Target. We have continued to develop new products in this category as an important means of introducing the Bassett brand to younger consumers.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Gross margin; selling, general and administrative (S,G&A) expenses; and operating income as a percentage of net sales were as follows for the periods ended May 28, 2005, and May 29, 2004:

Gross margin increased slightly in the first six months and the second quarter of 2005 as compared to the same periods of 2004. This was primarily attributable to increased sales of imported product within both our Wood and Upholstery Divisions. This was partially offset by slightly reduced gross margins on wood products domestically manufactured due to moderately higher raw material costs and inefficiencies experienced with the introduction of new products.

S,G&A expenses were 24.6% of sales for the second quarter of 2005 and the second quarter of 2004. Our total SG&A spending increased from $19,783 in the second quarter of 2004 to $20,460 in the second quarter of 2005. S,G&A expenses were 24.7% of sales for the first six months of 2005 and 24.4% for the first six months of 2004. Our total SG&A spending increased from $38,280 in the first six months of 2004 to $40,488 in the first six months of 2005. These increases in S,G&A spending are primarily due to increases in marketing costs related to the introduction of The John Elway Home Collection, higher professional fee expenses related to the Sarbanes-Oxley Act of 2002 and an increase in the allowance for doubtful accounts. We continue to closely monitor discretionary spending in all of our divisions and search for opportunities to reduce costs. These expenses are not allocated to specific business segments and are included in the increase in the spending of our “other” business segment.

At the end of the second quarter of 2005, we acquired a 76% ownership interest in BFD-Dallas. BFD-Dallas operates eight BFD stores in the greater Dallas, TX metro area. We accounted for this transaction using the purchase method of accounting. In conjunction with this transaction, we recorded an impaired asset charge of $2,465 primarily related to an impairment of a portion of goodwill created through the transaction (Note 9). As a result of this transaction, as of the end of our second quarter, we have consolidated BFD-Dallas’ financial position into our condensed consolidated balance sheet and will begin consolidating BFD-Dallas’ results of operations in our third quarter.

During the fourth quarter of 2003, we consummated a transaction to sell our former California upholstery manufacturing facility to a third party. The transaction was consummated through a short-term note issued to us which matured in February 2004. We deferred the recognition of the gain on this transaction until the proceeds were received due to the nature of the financing of the transaction. We recorded a $2,583 note receivable, net of the deferred gain, in other current assets in the November 29, 2003 balance sheet. During the first quarter of 2004, we received the proceeds from this transaction and recognized a $3,890 gain.

During the first quarter of 2004, we announced that we would close our Hiddenite, NC upholstery manufacturing plant, included in our Upholstery segment, and consolidate production into our Newton, NC facility. Also, during the first quarter, we restructured portions of the operations of our Macon, Ga. wood manufacturing plant and made plans to sell certain non-core assets. Restructuring charges of $2,840 were accrued at the end of the first quarter of 2004 which primarily related to the impairment of certain fixed assets and severance and employee benefits.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

The decrease in overall operating income in the second quarter and the first six months of 2005 was primarily due to the recognition of a gain on the sale of our former upholstery facility in California in the first quarter of 2004. Excluding this gain and the restructuring charges in the first six months of 2004 related to the closing of our former Hiddenite, NC upholstery facility, and the impaired asset charge in the second quarter of 2005, our operating income increased slightly in 2005, primarily as a result of the growth of imported products within our Wood and Upholstery Divisions.

Other income, net, was $1,838 and $1,901 for the second quarter of 2005 and 2004, respectively, and $3,808 and $2,914 for the first six months of 2005 and 2004, respectively. Included in other income are our regular investment earnings, earnings or losses from unconsolidated affiliated companies and earnings or losses from real estate net of interest expense primarily related to long-term borrowings and employee retirement obligations. Other income increased in the first six months of 2005 largely due to the performance of IHFC and the Bassett Industries Alternative Asset Fund. Other income is expected to continue to be an integral component of our future earnings.

The effective tax provision rate was 1.5% and 25.7% in the second quarters of 2005 and 2004, respectively. The effective tax provision rate was 20.7% and 27.0% in the first six months of 2005 and 2004, respectively. The effective tax provision rates for both periods are lower than the statutory federal income tax provision rate due principally to dividend received deductions from our investment in IHFC and the impact of the previously mentioned restructuring and impaired asset charges and the gain on the sale of our former California facility.

For the second quarter of 2005, net income was $1,047 or $.09 per diluted share, compared to net income of $1,885 or $.16 per diluted share for the second quarter of 2004. For the first six months of 2005, net income was $3,411 or $.29 per diluted share, compared to net income of $4,213 or $.36 per diluted share for the first six months of 2004.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES INCORPORATED AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Segment Information

The following is a discussion of operating results for each of our business segments. Our corporate spending is not allocated to our operating business segments but is included in the “other” category to reconcile segment information to the consolidated financial statements. We define contribution to profit and overhead as gross profit less direct divisional operating expenses, but excluding any allocation of corporate overhead expenses, interest expense, or income taxes.

As we continue our transition towards becoming a more retail oriented company, we have re-organized our operating segments to be more product and merchandising focused and accordingly have adjusted our segment disclosures and analysis.

Wood Division net sales increased in the first six months and second quarter of 2005 from levels attained in the same periods during 2004 primarily due to the greater retail acceptance of product introduced over the past 12 months. Additionally, the sales of our Bassettbaby® brand products have significantly increased, especially those sales to the three largest Bassettbaby® customers, Babies R Us, Burlington Coat Factory and Target. Based on planned new product introductions, a continued shift to imported products and recent successes of key collections, we expect continued improvement in sales and contribution to profit and overhead from our Wood Division.

Wood Division contribution to profit and overhead as a percentage of net sales increased slightly in the first six months and second quarter of 2005 as compared to the same periods of 2004 as we experienced a better mix of imported product offset in part by increases in raw material costs and production inefficiencies related to the introduction of new products manufactured domestically. In an effort to further improve profitability in this segment, we have introduced new products (an imported bedroom collection and a domestically manufactured custom bedroom collection), opened more BFD stores and are repositioning the division through cost reduction initiatives. We also remain focused on reducing labor and raw material spending. Based on recent performance and the evolution of our product line, we continue to examine our Wood Division cost structure and the relative mix of domestically manufactured and imported products.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED. AND SUBSIDIARIES

MAY 28, 2005

(Dollars in thousands except share and per share data)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)