BASSETT FURNITURE INDUSTRIES INC - Quarter Report: 2007 August (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended August 25, 2007

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 a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer  ¨                    Accelerated Filer  x                     Non-accelerated Filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

At August 25, 2007, 11,806,334 shares of common stock of the Registrant were outstanding.

Table of Contents

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

TABLE OF CONTENTS

2

Table of Contents

PART I-FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS

FOR THE PERIODS ENDED AUGUST 25, 2007 AND AUGUST 26, 2006-UNAUDITED

(In thousands except per share data)

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

3

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

ITEM 1. FINANCIAL STATEMENTS

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

AUGUST 25, 2007 AND NOVEMBER 25, 2006

(In thousands)

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

4

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

ITEM 1. FINANCIAL STATEMENTS

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE PERIODS ENDED AUGUST 25, 2007 AND AUGUST 26, 2006-UNAUDITED

(In thousands)

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

5

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(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”).

In order to drive price consistency throughout the Company’s store network, the Company began, in July of 2007, invoicing certain wholesale customers on a fully landed basis such that the invoice price includes the freight charge for delivery. This business change resulted in approximately $1,020 of additional reported revenue and selling, general and administrative expenses for the quarter ended August 25, 2007.

As more fully discussed in our 2006 Form 10-K, the fiscal 2006 quarterly financial information was restated based on our review of the accounting treatment associated with our acquisition of three retail licensee operations in fiscal 2005 and the classification of certain notes receivable activity in the statement of cash flows. The effects of those restatements on the condensed consolidated financial statements for the quarter and nine months ended August 26, 2006 included herein are summarized below:

Note 2. Interim Financial Presentation:

All intercompany accounts and transactions have been eliminated in the condensed consolidated financial statements. The results of operations for the quarter and nine months ended August 25, 2007, are not necessarily indicative of results for the fiscal year. It is suggested that the interim condensed 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 25, 2006.

We calculate an anticipated effective tax rate for the year based on our annual estimates of pretax income or loss and use that effective rate to record our year-to-date income tax (provision) benefit. Any change in annual projections of pretax income or loss could have a significant impact on our effective tax rate for the respective quarter. Due to changes in our projected pretax loss, we recorded an additional tax benefit of $2,899 in the third quarter of 2007 to adjust the current tax benefit to the current anticipated effective tax rate.

Certain amounts in the 2006 condensed consolidated financial statements have been reclassified to more closely conform with the 2007 presentation.

6

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(Dollars in thousands except share and per share data)

Note 3. 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. During the quarter and nine months ended August 25, 2007 and August 26, 2006, we liquidated certain LIFO inventories which decreased cost of sales as follows:

Inventories were comprised of the following:

Note 4. 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 August 25, 2007, and August 26, 2006, 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 $13,427 and $11,726 at August 25, 2007, and November 25, 2006, respectively, which is reflected in the liabilities section in the accompanying consolidated balance sheets as “distributions in excess of affiliate earnings.” 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 $13,427 at August 25, 2007. This negative book value resulted from IHFC’s refinancing of its real estate based on the market value of the property and using the proceeds to pay a special dividend to its owners. We recorded income and received dividends from IHFC as follows:

Summarized unaudited income statement information for IHFC for its first nine months of 2007 and 2006, respectively, is as follows:

7

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(Dollars in thousands except share and per share data)

In addition to our investment in IHFC, we have a 49% ownership interest in Zenith Freight Lines, LLC (“Zenith”) and we recorded the following income (loss) in other income, net in our condensed consolidated statements of operations and retained earnings:

On February 28, 2007, we entered into an agreement with BFD Northeast, LLC (“BFDNE”) whereby we contributed our 30% interest in BFDNE to BFDNE in exchange for certain assets (primarily inventory and leasehold improvements) of BFDNE’s two stores in Boston, Massachusetts with an estimated fair value of $2,031, and the assumption of $770 of BFDNE’s outstanding bank debt. As part of the transaction, we also restructured amounts BFDNE previously owed us including converting $3,400 of accounts receivable into a long-term note receivable. As part of the purchase price allocation, we utilized existing accounts and notes receivable bad debt reserves. No goodwill or identified intangible assets were recorded as part of this transaction. The consolidated results include the operations of these two stores since March 1, 2007.

Prior to the BFDNE transaction, we accounted for our 30% investment in BFDNE using the equity method of accounting. Accordingly, we recorded the following losses in other income, net in our condensed consolidated statements of operations and retained earnings:

Note 5. Real Estate Notes Payable and Other Long-Term Debt:

Certain of our retail real estate properties have been financed through commercial mortgages which are payable over periods of four to twenty years and have interest rates ranging from 6.73% to 9.18%. These mortgages are collateralized by the respective properties with net book values totaling approximately $25,819 at August 25, 2007. The current portion of these mortgages, $658 and $622 as of August 25, 2007, and November 25, 2006, respectively, has been included as a current liability in other accrued liabilities in the accompanying condensed consolidated balance sheets. The long-term portion, $19,022 and $19,522 as of August 25, 2007, and November 25, 2006, respectively, is presented as real estate notes payable in the condensed consolidated balance sheets.

We amended our existing revolving credit facility in November 2005 by extending the agreement by one year to November 2007 and amending certain covenants. The credit facility provides for borrowings of up to $40,000 at a variable interest rate of LIBOR plus 1.5% (6.83% on August 25, 2007). The facility is secured by substantially all of our receivables and inventories. Borrowings under the facility, which matures November 30, 2007, totaled $6,000 and $4,000 at August 25, 2007, and November 25, 2006, respectively. Due to the maturity date, amounts as of August 25, 2007 are presented as a current liability in the consolidated balance sheet. We are in the process of finalizing an extension of the credit agreement and expect to have the amended facility in place by mid October 2007. After coverage for letters of credit and certain loan guarantees, we had $20,088 available for borrowing under the facility at August 25, 2007.

8

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(Dollars in thousands except share and per share data)

Note 6. Comprehensive Income:

For the quarters ended August 25, 2007, and August 26, 2006, total comprehensive income (loss) was $(215) and $574, respectively. For the nine months ended August 25, 2007 and August 26, 2006, total comprehensive income (loss) was $(6,828) and $5,066, respectively. Changes in accumulated other comprehensive income for the quarters and nine months ended August 25, 2007 and August 26, 2006 are as follows:

Note 7. Restructuring and asset impairment charges:

During the first quarter of 2007, we made the decision to cease operations at our wood manufacturing facility in Bassett, Va. The closure of the 323,000 square foot facility was completed during June of 2007 and affected approximately 280 employees or 15 percent of the Company’s workforce. The Company will source the majority of the products previously produced at this facility from overseas suppliers, continue to produce certain custom bedroom products domestically and discontinue providing certain slower selling items. As a result of this decision, we recorded a $3,609 charge in the first quarter of 2007 to writedown the value of the plant and equipment and a $960 charge in the second quarter of 2007 for severance benefits. As of August 25, 2007, we have disbursed $643 leaving $317 to be paid primarily during the fourth quarter of 2007.

During the second quarter of 2007, we also reduced our leased showroom space in the International Home Furnishings Center by approximately 60%. Accordingly, we recorded a $975 charge to writeoff the net book value of the corresponding capitalized tenant improvements. Beginning in May of 2007, we began incurring reduced rental expenses for the remaining showroom space.

Note 8. Lease exit costs:

As part of our expense reduction initiatives, we concluded during the second quarter of 2007 that three of our leased store locations would no longer be used by us as retail furniture locations. We have finalized sublease agreements for two of the stores thereby reducing our future cash outlays. Although no sublessee has been identified for the other store lease, we are actively marketing this location. In accordance with FASB Statement No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, we recorded a $1,934 charge to recognize the future obligations associated with the leases, net of estimated sublease income.

Note 9. 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 Company-owned retail stores as well as in the operation of licensee-owned stores. We had obligations of $99,820 and $96,765 at August 25, 2007 and November 25, 2006, respectively, for future minimum lease payments under non-cancelable operating leases having remaining terms in excess of one year. As part of the expansion strategy for our store 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 $12,985 and $20,566 at August 25, 2007, and November 25, 2006, respectively.

9

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(Dollars in thousands except share and per share data)

We have also guaranteed loans to certain of our licensees to finance initial inventory packages for those stores. The total contingent liabilities with respect to these loan guarantees as of August 25, 2007, and November 25, 2006, were $9,775 and $10,047, 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 (primarily inventory), 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 and loan guarantees (an estimate of the cost to the Company to perform on these guarantees) at August 25, 2007, and November 25, 2006, was $324 and $410, respectively, and is recorded in accrued liabilities in the accompanying condensed consolidated balance sheets.

Note 10. Post Employment Benefit Obligations:

We have an unfunded Supplemental Retirement Income Plan (the “Supplemental Plan”) that covers two current and certain former executives. The liability for this plan was $11,581 and $11,730 as of August 25, 2007 and November 25, 2006, respectively, and is included in post employment benefit obligations in the condensed consolidated balance sheet.

We have an unfunded Deferred Compensation Plan that covers two current and certain former executives and provides for voluntary deferral of compensation. This plan has been frozen with no additional participants or deferrals permitted. We recognized expense of $113 and $117 for the third quarter of 2007 and 2006, respectively and $338 and $341 for the nine months ended August 25, 2007 and August 26, 2006, respectively. Our liability under this plan was $3,470 and $3,533 as of August 25, 2007 and November 25, 2006, respectively, and is reflected in post employment benefit obligations.

10

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(Dollars in thousands except share and per share data)

Note 11. Earnings per share:

The following reconciles basic and diluted earnings per share:

Options to purchase approximately 1,342,000 and 1,431,000 shares of common stock at August 25, 2007 and August 26, 2006, respectively, were excluded from the computation as their effect is antidilutive.

Note 12. Sale of Macon Plant:

During the first quarter of 2007, we completed the sale of the Macon plant which was previously recorded in assets held for sale. Net cash proceeds, which were all received in the first quarter of 2007, were $1,009.

Note 13. 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 Bassett 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. During the second quarter of 2006, we sold our contemporary furniture business (Weiman), which was previously included in this segment.

11

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

AUGUST 25, 2007

(Dollars in thousands except share and per share data)

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 in our condensed consolidated statements of operations and retained earnings. 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 condensed consolidated balance sheet. See Note 4 for a further discussion of IHFC.

Inter-company net sales elimination represents the elimination of wholesale sales to our Company-owned stores. Inter-company income elimination represents the embedded wholesale profit in the Company-owned store inventory that has not been realized. These profits will be recorded when merchandise is delivered to the end retail consumer.

The following table presents our segment information:

12

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

August 25, 2007

(Dollars in thousands except share and per share data)

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 2006 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 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”) 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, fast delivery, and custom-order furniture.

A major component of our overall retail strategy involves our Company-owned stores. We believe a Company-owned retail division provides us the first-hand experience and immediate feedback to develop programs that are vitally important to the success of our entire store network. Pursuit of this strategy will also enable our retail division to acquire and operate additional stores as viable opportunities arise. We believe our organizational and financial strength, combined with our retail scale, will provide the platform, best practices and resources needed to drive uniformity throughout our store program and drive the improvement needed in the retail stores we have acquired from licensees.

In the first nine months of 2007, two stores in the network were opened and four were closed. No stores were opened during the third quarter and one store was closed. Last month, the Company unveiled a new store prototype opening a new Company-owned store in Atlanta and a remodeled store in the Charlotte area. The prototype was created to allow a more stylish, residential feel while highlighting Bassett’s custom manufacturing capabilities. Although retail conditions and our initiative to develop the new prototype store temporarily slowed store count growth, the Company expects three new licensee-owned stores to open in the next three to four months incorporating this prototype.

An important component of our retail strategy and our balance sheet is retail real estate. We expect to continue to invest in high quality retail real estate in our store program, and we may, on a selective basis, provide various forms of assistance to procure retail real estate for our licensees, including lease/sub-lease arrangements and lease guarantees.

The furniture industry continues to experience a rapid shift from traditional domestic manufacturing to offshore sourcing in lower cost markets, primarily China and the Pacific Rim countries. This shift in sourcing has resulted in downward pressure on retail prices and reductions in traditional channels of sales distribution, as many retailers can source their own products rather than relying on a traditional domestic manufacturer to supply goods. During the first quarter of 2007, we made the decision to close another large wood manufacturing facility, our plant located in Bassett, Virginia. This action resulted in reductions in headcount of approximately 280 employees and leaves us with one small wood assembly plant in Martinsville, Va. and an upholstery manufacturing plant in Newton, NC. We have closed and consolidated seven wood factories over the past six years. 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.

13

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

August 25, 2007

(Dollars in thousands except share and per share data)

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

We define imported product as fully finished product that is sourced internationally. During the first nine months of 2007, 47% of our wholesale sales were of imported product compared to 44% in the first nine months of 2006. For the third quarter, imported product represented 51% of our wholesale shipments. We expect this percentage to increase to approximately 60% in our fourth quarter. Our domestic offerings include 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.

We intend to execute our 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 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.

Two key components of our balance sheet are our investments in the Bassett Industries Alternative Asset Fund, L.P. (“Alternative Asset Fund”), a limited partnership, and our interest in the International Home Furnishings Center, Inc. (“IHFC”). For a description of these investments, see Note 4 of the condensed consolidated financial statements and Item 3 – Quantitative and Qualitative Disclosures About Market Risk.

Key marketing initiatives for Bassett during the first nine months of 2007 included the development of a new store prototype (as previously discussed), the mailing of three seasonal catalogs and the production of a new series of television commercials that began airing in April. The catalog better defines and enhances Bassett’s brand image while explaining to our consumers our product and service capabilities. The new television advertisements present the Bassett brand as a choice for an enhanced lifestyle. In addition to the catalog and television advertisements, the Company has several other marketing and merchandising initiatives underway including product introductions centered around the Company’s core middle price point category. We believe that our dealers’ reception to our new lines introduced in September 2007 have been positive. We plan further product introductions in the first quarter of 2008.

Amidst an extremely challenging retail environment, we must drive improvement in our retail segment’s results which should drive sales improvement in our wholesale segment. We are squarely focused on selling more furniture in our stores. This enterprise-wide effort involves every aspect of our Company – merchandising, marketing, operations, recruiting, training and information technology. We have developed a financial plan aimed at reducing our retail losses to a breakeven level within two to three years.

14

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

August 25, 2007

(Dollars in thousands except share and per share data)

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

As more fully discussed in our 2006 Form 10-K, the fiscal 2006 quarterly financial information was restated based on our review of the accounting treatment associated with our acquisition of three retail licensee operations in fiscal 2005 and the classification of certain notes receivable activity in the statement of cash flows. The effects of those restatements on the condensed consolidated financial statements for the quarter and nine months ended August 26, 2006 included herein are summarized below:

Certain items affecting comparability between periods are noted below in “Other Items Affecting Net Income”.

Results of Operations – Quarter and Nine months ended August 25, 2007 compared with the Quarter and Nine months ended August 26, 2006

Net sales, gross profit, selling, general and administrative (SG&A) expense, and operating income (loss) were as follows for the periods ended August 25, 2007, and August 26, 2006:

On a consolidated basis, we reported net sales for the third quarter of 2007 of $70,497, a decrease of $7,063 or 9% from sales levels attained in the third quarter of 2006. We reported net sales for the nine months ended August 25, 2007 of $219,349, a decrease of $32,363 or 13% as compared to the comparable period in 2006. This shortfall is primarily due to continued soft furniture retail conditions which have impacted both retail sales and wholesale shipments. Gross margins for the third quarter of 2007 were 35.0% compared to 30.1% for the third quarter of 2006. Gross margins for the nine months ended August 25, 2007 were 32.3% compared to 31.2% for the comparable period in 2006. These increases in margins are due to a shift in product mix from domestic to imported, improved retail margins and a change in classification of invoiced freight on wholesale shipments (as discussed in Note 1 to the unaudited condensed consolidated financial statements). Selling, general and administrative expenses increased primarily due to spending to support the Company’s key retail initiatives and the change in classification of invoiced freight as noted above.

15

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

August 25, 2007

(Dollars in thousands except share and per share data)

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

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 Bassett stores (licensee-owned stores and Company-owned retail stores) 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. During the second quarter of 2006, we sold our contemporary furniture business (Weiman), which was previously included in this segment.

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 operations and retained earnings.

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

Wholesale Segment

On a wholesale basis, we had net sales of $58,482 for the third quarter of 2007, 13% below the third quarter of 2006. Net sales for the nine months ended August 25, 2007 were $184,216, 16% below the corresponding period in 2006. For the first nine months of 2007, 73% of wholesale shipments were to BFDs compared to 70% in the first nine months of 2006. Additionally, approximately 51% and 47% of wholesale shipments were imported products for the three and nine months ended August 25, 2007, respectively, as compared to 44% for the three and nine months ended August 26, 2006. Sales for the third quarter and the first nine months of 2007 were lower than 2006 levels due to the continued overall soft retail conditions. This shortfall is partially offset by $1.0 million of reported revenue due to a change in the company’s invoicing practices with respect to freight for the delivery of wholesale furniture to certain dealers. During July, the Company began invoicing these customers on a fully landed basis such that the dealer invoice price includes the freight charge for delivery. Reference Note 13 to the condensed consolidated financial statements for the segment breakdown of wholesale, retail, and inter-company sales for all periods presented.

Gross margins for the third quarter of 2007 increased 1.2 percentage points compared to the third quarter of 2006. Gross margins for the first nine months of 2007 decreased one percentage point compared to the first nine months of 2006. Excluding the effects of the change related to invoiced freight, margins were essentially flat for the third quarter as compared to 2006 and decreased 1.4 percentage points for the nine month period. Margins have been negatively impacted by the wind-down costs and inventory markdowns associated with the closure of the Bassett plant and lower volumes in the Company’s two domestic production facilities. Wood margins have improved during the third quarter of 2007 with the closure of the Bassett plant and a change in mix to more imported furniture. Although down slightly, upholstery margins remain solid due to the retail acceptance of our custom programs and the

16

Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

August 25, 2007

(Dollars in thousands except share and per share data)

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

new fabrics introduced over the past several years. Additionally, margins were positively impacted by lower domestic wood inventory levels which led to reductions in accompanying LIFO inventory reserves. With the closing of the Bassett wood plant, our domestic wood inventory levels will continue to decrease while our import levels will increase. Our import inventories are valued on the first-in, first-out method (FIFO).

While wholesale SG&A as a percentage of sales increased 3.9 percentage points, SG&A in dollars only increased $576 in the third quarter of 2007 as compared to the third quarter of 2006. SG&A as a percentage of sales increased 3.3 percentage points for the nine months of 2007 as compared to 2006. Excluding the effects of the change related to invoiced freight, SG&A increased 2.5 and 2.9 percentage points for the quarter and nine months ended August 25, 2007 as compared to the quarter and nine months ended August 26, 2006, respectively. This increase as a percentage of sales is primarily due to the fixed nature of many of the costs being spread over the lower sales amounts. In addition, we incurred increased spending associated with the development and distribution of three seasonal catalogs, the development of the new store prototype, additional television advertising and the addition of new retail management personnel.

Our allowance for doubtful accounts represents our best estimate of potential losses on our accounts and notes receivables and is adjusted accordingly based on historical experience, current business levels, individual developments with certain licensees and economic trends. We recorded $817 and $953 of provision for losses on accounts receivable in the third quarters of 2007 and 2006, respectively, and $2,205 and $2,633 in the first nine months of 2007 and 2006, respectively, to cover any potential losses that may arise.

We expect improved wholesale operating results in the fourth quarter of 2007 from a full quarter of improved product mix coupled with aggressive cost control. With the continued difficult furniture retail environment, we will continue to assess and adjust our wholesale cost structure to match associated demand.

Wholesale Shipments

Retail Segment – Company-Owned Retail Stores