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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended May 29, 2004

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 29, 2004, 11,681,792 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 29, 2004 AND MAY 31, 2003 – 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 29, 2004 AND NOVEMBER 29, 2003

(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 29, 2004 AND MAY 31, 2003 - 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 29, 2004

(Dollars in thousands except share and per share data)

Note A. 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 the opinion of management, 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 (the “Company”) and its majority owned subsidiaries of which the Company has operating control. In 2003, the Company adopted the Financial Accounting Standards Board (“FASB”) Revised Interpretation No. 46 “Consolidation of Variable Interest Entities,” (‘FIN46R’) for LRG Furniture, LLC (“LRG”). In the second quarter of 2004, the Company adopted FIN46R for all other entities with business relationships with the Company. (See Note J). The equity method of accounting is used for the Company’s investments in affiliated companies in which the Company exercises significant influence but does not maintain control, unless consolidated pursuant to FIN46R.

Note B. 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 29, 2004 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 the Company’s Annual Report on Form 10-K for the year ended November 29, 2003.

Certain amounts in the 2003 financial statements have been reclassified to more closely conform with the 2004 presentation.

Note C. Stock-Based Compensation:

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

For the six months and quarters ended May 29, 2004 and May 31, 2003, the effect on earnings (loss) 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 29, 2004

(Dollars in thousands except share and per share data)

Note D. 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.

Note E. Unconsolidated Affiliated Companies:

The International Home Furnishings Center (“IHFC”) owns, and leases floor space in, a showroom facility in High Point, North Carolina. The Company owned 46.9% of IHFC at May 29, 2004 and May 31, 2003 and accounts for the investment using the equity method since the Company does not maintain operating control of IHFC. The Company’s investment reflects a credit balance of $12,565 and $13,070 at May 29, 2004 and November 29, 2003, respectively, which is reflected in the liabilities section in the accompanying consolidated balance sheets as “distributions in excess of affiliate earnings”. Management has 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, management believes the market value of this investment is positive and substantially greater than its negative book value of $12,565 at May 29, 2004. The Company recorded income from IHFC of $1,787 and $1,684 in the second quarter of 2004 and 2003, respectively and $2,848 and $2,674 in the first six months of 2004 and 2003, respectively. Additionally, the Company received dividends of $2,343 and $1,874 from IHFC in the first six months of 2004 and 2003, respectively. Summarized combined unaudited income statement information for IHFC for the first six months of 2004 and 2003, respectively, is as follows:

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BASSETT FURNITURE INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 29, 2004

(Dollars in thousands except share and per share data)

Note F. Real estate notes payable:

During the second quarter of 2004, the Company acquired from a real estate developer in Texas, two real estate properties utilized by Bassett Furniture Direct (BFD) stores. These two properties were acquired through cash payments of $1,283 and assumption of mortgages totaling $7,506. These mortgages are payable over a period of six years and have interest rates of 8.28%. The current portion of these notes, $274, has been included as a current liability in accrued liabilities in the accompanying condensed consolidated balance sheet.

Note G. Comprehensive income:

For the quarters ended May 29, 2004 and May 31, 2003, total comprehensive income, net of tax, was $2,454 and $2,035, respectively. Included in total comprehensive income for each quarter was net income of $1,885 and $1,193, and unrealized holding gains, net of tax, of $569 and $842, respectively.

For the six months ended May 29, 2004 and May 31, 2003, total comprehensive income (loss), net of tax, was $4,336 and ($4,898) respectively. Included in total comprehensive income (loss) for each quarter was net income (loss) of $4,213 and ($5,232), and unrealized holding gains, net of tax, of $123 and $334, respectively.

Note H. Restructuring, Impaired Fixed Assets and Other Unusual and Nonrecurring Charges:

During the first quarter of 2004, the Company decided to restructure certain operating facilities and non-core assets and announced that it would close its Hiddenite, NC upholstery manufacturing plant and consolidate production into its Newton, NC facility. The land and building are held for sale, and are expected to be sold for an amount greater than net book value. Also during the first quarter, the Company reduced operations and headcount at its Macon, Ga. wood manufacturing facility. This headcount reduction and change in focus of the plant’s operations resulted in significant parts of the plant and machinery and equipment no longer being utilized. The Company also decided to close its BFD retail store located in Hickory, NC.. Restructuring charges of $2,840 were accrued at the end of the quarter for the above mentioned activities. $2,103 of the $2,840 restructuring charge represents an estimate of the impaired asset write-downs related to these actions. The remaining $737 represents severance and employee benefits for 50 employees associated with the closure of the Hiddenite facility, the restructuring at the Macon facility and related corporate office reductions. The annual depreciation related to the Hiddenite facility was approximately $179. The Company had $341 remaining in restructuring reserves as of May 29, 2004, and expects this amount to be paid out by the end of fiscal 2004.

During the first quarter of 2003, the Company announced that it would close its Dublin, Ga., wood manufacturing plant, included in the Wood segment, and consolidate production into its Bassett, Va., facility. Restructuring charges of $3,200 were accrued at the end of the quarter which primarily related to the closing of this facility. $1,530 of the $3,200 restructuring charge represented an estimate of the impaired asset write-down of the Dublin, Ga., facility. The remaining $1,670 represents severance and employee benefits for 320 employees associated with the closure of the plant and also additional headcount reductions at the corporate office. The annual depreciation related to this facility was approximately $325.

Note I. Contingencies:

The Company is 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, it is management’s opinion that the final resolution of these matters will not have a material adverse effect on the Company’s financial position or future results of operations, therefore no additional disclosures are required.

The Company leases land and buildings that are used in the operation of its Bassett-owned retail stores as well as in the operation of independent and partnership licensee BFD stores. Additionally, the Company leases 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. The Company had obligations of $59,326 and $57,027 at May 29, 2004 and November 29, 2003, respectively, for future minimum lease payments under non-cancelable leases having remaining terms in excess of one year.

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BASSETT FURNITURE INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 29, 2004

(Dollars in thousands except share and per share data)

As part of the Company’s expansion strategy for its retail stores, Bassett has guaranteed certain lease obligations of licensee operators of the Bassett Furniture Direct program. Lease guarantees range from one to ten years. The Company was contingently liable under licensee lease obligation guarantees in the amount of $25,231 and $20,368 at May 29, 2004 and November 29, 2003, respectively.

The Company has also guaranteed loans from a bank to certain of its BFD dealers to finance initial inventory packages for those stores. The total contingent liability with respect to these loan guarantees as of May 29, 2004 and November 29, 2003 was $12,077 and $7,894, respectively.

In the event of default by an independent dealer under the guaranteed lease or loan, the Company believes 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 estimated proceeds of these options are believed to be sufficient to cover the maximum amount of the Company’s future payments under the guarantee obligations. The fair value of guarantees at May 29, 2004 and November 29, 2003 were $1,501 and $1,261, respectively, and are recorded in accrued liabilities in the accompanying balance sheets.

Note J. Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which addresses the consolidation of certain business enterprises (“variable interest entities” or “VIEs”), to which the usual condition of consolidation, a controlling financial interest, does not apply. FIN 46 requires an entity to assess its equity investments, among other interests, to determine if they are variable interest entities. As defined in FIN 46, VIEs are contractual, ownership or other interests in an entity that change with the changes in the entity’s net asset value. Variable interests in an entity may arise from guarantees, leases, borrowings and other arrangements with the VIE. An entity that will absorb a majority of the variable interest entity’s expected losses or expected residual returns, as defined in FIN 46, is considered the primary beneficiary of the VIE. The primary beneficiary must include the VIE’s assets, liabilities and results of operations in its consolidated financial statements.

On December 24, 2003, the FASB issued a revision of the Interpretation (the “Revised Interpretation” or “FIN 46R”). Revised Interpretation 46 modified both the proposed modifications and other decisions previously issued through certain FASB Staff Positions and supercedes the original Interpretation No. 46. Under the Revised Interpretation, special effective date provisions apply to entities that have fully or partially applied FIN 46 prior to issuance of the revised Interpretation.

The Company analyzed its two partnership licensees and its independent licensees under the requirements of the Revised Interpretation. All of these licensees operate as Bassett Furniture Direct stores and are furniture retailers. The Company sells furniture to these licensees, and in some cases has extended credit beyond normal terms, and made lease guarantees, loan guarantees, or direct loans. Consistent with the Company’s critical accounting policies, the Company has recorded reserves for potential exposures related to these licensees. See Note I for disclosure of leases, lease guarantees and loan guarantees.

During the second quarter of 2004, the Company completed its assessment of licensees for potential VIEs. As previously disclosed, in 2003, the Company determined one licensee, LRG, is a VIE for whom the Company is the primary beneficiary and accordingly adopted FIN 46R for LRG in the fourth quarter of fiscal year 2003. Adopting FIN 46R for LRG required the Company to consolidate LRG as of the beginning of 2003. Upon consolidation of LRG, the Company recognized a cumulative effect of an accounting change, amounting to $4,875 (net of income tax benefit of $3,200) or $.42 per diluted share. In the second quarter of 2004, the Company completed its assessment for other potential VIEs, and concluded that these entities were not variable interest entities and, therefore, were not required to be consolidated by the Company. In future periods, the Company will reassess the status of potential VIEs when facts and circumstances surrounding each potential VIE change.

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BASSETT FURNITURE INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-UNAUDITED

MAY 29, 2004

(Dollars in thousands except share and per share data)

Note K. Earnings (loss) per share:

The following reconciles basic and diluted earnings (loss) per share:

Options to purchase 1.6 million and 1.9 million shares of common stock were outstanding during the first six months of 2004 and 2003, respectively, which could potentially dilute basic EPS in the future.

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 a loss occurs because to do so would have been anti-dilutive.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 29, 2004

(Dollars in thousands except share and per share data)

Note L. Segment Information:

Segment information for the periods ended May 29, 2004 and May 31, 2003 was as follows:

For the six months ended May 29, 2004

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 29, 2004

(Dollars in thousands except share and per share data)

The Company’s 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 independently-owned stores and stores owned by the Company and affiliates of the Company. The wood segment is engaged in the manufacture and sale of wood furniture to independent and affiliated retailers. The upholstery segment is involved in the manufacture and sale of upholstered frames and cut upholstery items having a variety of frame and fabric options to independent and affiliated retailers. The import segment sources product principally from Asia and sells these products to independent and affiliated retailers. The Company’s other business segment consists of other corporate support functions, including certain selling, general and administrative expenses and a contemporary furniture business. Capital expenditures in the Other segment primarily relate to BFD store properties. The retail segment consists of 13 corporately owned retail stores in North Carolina, Texas and Nevada. Inter-company elimination reflects the embedded wholesale revenue and profit in the Company-owned store inventory that has not been realized. Operating income by business segment is defined as sales less direct operating costs and expenses.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 29, 2004

(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 are sold through department stores.

The rollout of the 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 re-focusing company practices and strategies to the ultimate end user, the consumer. The strategy also focused on re-styling 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. The Company has embraced these changes through its BFD program and by reducing its domestic production of product that can be more efficiently sourced overseas. The Company strives to provide its 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. The Company also is continuing its focus on the BFD distribution channel. Continual improvements to the retail program are being made through improved product, new advertising and better delivery, service and training. Additionally, the Company continues to strengthen the business development and retail finance group to both provide more assistance and support to the ongoing operations of the BFD stores. The Company expects licensees to open between 20 and 25 new stores per year over the next several years. The Company believes that overall operating margins will be positively impacted through its efforts to reengineer manufacturing processes and source more product overseas.

Management intends to execute these strategies in such a way as to preserve the Company’s investments while simultaneously minimizing the need for borrowed funds. Maintenance of a strong balance sheet is a stated management goal. These strategies entail key business risks, including the realization of inventories and receivables and the coverage of potential contingent liabilities, for which management believes adequate reserves have been established.

On June 18, 2004, the Department of Commerce announced a preliminary determination in the antidumping duty investigation of wooden bedroom furniture from China establishing preliminary antidumping margins ranging from 4.9% to 198.1%. This recent U.S. Department of Commerce preliminary ruling is expected to result in an assessment of duties in the range of 8% to 11% on product sourced by the Company from Chinese vendors. The Company does not believe this ruling will have a significant impact on the Company’s overall results.

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

An increasingly important component of the Company’s balance sheet is retail real estate. The Company expects to continue to invest in high quality retail real estate as the BFD store program continues to expand. The Company will 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.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 29, 2004

(Dollars in thousands except share and per share data)

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

In fiscal 2004, the Company has three key areas of focus: one, continuing to improve and expand the BFD store network through additions of high quality dealers and new stores, two, continued emphasis on better value and service to our customers, and three, to improve the financial performance of the wood division through continued gains in productivity and cost management.

Critical Accounting Policies

The Company’s 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. Management uses its 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 the Company’s consolidated financial statements.

Consolidation – The consolidated financial statements include the accounts of Bassett Furniture Industries, Incorporated and its majority-owned subsidiaries for whom the Company has operating control. In 2003, the Company consolidated LRG Furniture, LLC (LRG) pursuant to Revised FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (FIN46R). Additionally, in the second quarter of 2004, the Company completed its assessment under FIN 46R for other potential VIEs and concluded that these entities were not variable interest entities and, therefore, were not required to be consolidated by the Company. In future periods, the Company will reassess the status of potential VIEs when facts and circumstances surrounding each potential VIE change. (See Note J to the Condensed Consolidated Financial Statements.)

Impairment of Long-Lived Assets - The Company periodically evaluates 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, the Company assesses 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 Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its 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. Actual losses could differ from those estimates.

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. The Company estimates 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 29, 2004

(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. The net asset values of the investments in the Bassett Industries Alternative Asset Fund, L.P. are determined by the investee fund based on its underlying financial instruments. 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 from securities classified as available-for-sale 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. Terms offered by the Company vary from 30 to 60 days. An estimate for returns and allowances has been provided in recorded sales.

Loss Reserves - The Company has a number of other potential loss exposures incurred in the ordinary course of business such as environmental claims, product liability, litigation, restructuring charges, and the recoverability of deferred income tax benefits. Establishing loss reserves for these matters requires management’s estimate and judgment with regard to maximum risk exposure and ultimate liability or realization. As a result, these estimates are often developed with the Company’s counsel, or other appropriate advisors, and are based on management’s current understanding of the underlying facts and circumstances. Because of uncertainties related to the ultimate outcome of these issues or the possibilities 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 29, 2004 compared with periods ended May 31, 2003

In the first six months of 2004, the Company reported net sales of $156,923 which was an increase of 1.6% from $154,480 of net sales reporting in the first six months of 2003. Sales for the second quarter of 2004 were $80,355 which was an increase of 4.5% from the $76,866 of net sales reported in the second quarter of 2003. The increase for both the six months and second quarter of 2004 resulted from increased shipments to BFDs and greater demand for juvenile product. Overall business conditions for the second quarter of 2004 and entering the third quarter have remained relatively stable although still are fairly 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.

The Company has continued its drive to open BFD stores. The BFD store network consisted of 104 BFD stores at May 29, 2004 and 93 BFD stores at May 31, 2003, which included opening 11 additional stores in the first six months of 2004 and closing or converting 7 stores to other concepts. The BFD stores accounted for 57% and 42% of the Company’s total sales for the first six months of 2004 and 2003, respectively.

The Company has seen additional distribution and increased demand for Bassetbaby^® brand products especially with the three largest Bassettbaby^® customers, Babies R Us, Burlington Coat Factory and Target. The Company has continued to introduce new products and views 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 29, 2004

(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 (loss) as a percentage of net sales were as follows for the quarters ended May 29, 2004, and May 31, 2003:

Gross margin remained basically flat for both the first six months and second quarter of 2004 as compared to the same periods of 2003. The Wood Division experienced slightly better margins in both the first six months and the second quarter of 2004 as compared to the same periods of 2003, based on slightly lower sales for the first six months and slightly higher sales for the second quarter in addition to certain cost reductions for both the first six months and second quarter of 2004. For both the first six months and second quarter of 2004, the Upholstery Division experienced improved margins primarily through continued gains in operating efficiencies and cost reduction measures. For both the first six months and second quarter of 2004, the Import division experienced reduced margins due to more competitively priced products being sold. Gross margin for the three month period ended May 29, 2004 remained consistent with the same period of the prior year, as a result of fewer Company-owned retail stores resulting in lower retail sales, which typically have higher gross margins, and decreased margins for the Import Division being offset by slightly increased margins for the Upholstery Division.

S,G&A expenses were 24.4% and 24.6% of sales for the first six months of 2004 and the second quarter of 2004, respectively, compared to 26.1% and 26.0% of sales for the first six months and second quarter of 2003, respectively. The Company’s total S,G&A spending decreased from $40,288 in the first six months of 2003 to $38,280 in the first six months of 2004. The Company’s total SG&A spending decreased from $19,990 in the second quarter of 2003 to $19,783 for the second quarter of 2004. These reductions in S,G&A spending from 2003 to 2004 are primarily due to improvements in the cost structure and reductions in discretionary spending in the Retail Division. The Company continues to closely monitor discretionary spending of all of its divisions and search for opportunities to reduce costs.

During the fourth quarter of 2003, the Company consummated a transaction to sell its former California upholstery manufacturing facility to a third party. The transaction was consummated through a short-term note issued to the Company which matured in February 2004. The Company deferred the recognition of the gain on this transaction until the proceeds were received due to the nature of the financing of the transaction. The Company 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, the Company received the proceeds from this transaction and recognized a $3,890 gain.

During the first quarter of 2004, the Company announced that it would close its Hiddenite, NC upholstery manufacturing plant, included in the Upholstery segment, and consolidate production into its Newton, NC facility. Also, during the first quarter. the Company restructured the operations of its 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 which primarily related to the impairment of fixed assets and severance and employee benefits. $2,103 of the $2,840 restructuring charge represents an estimate of the impaired asset write-down of the Macon, Ga. facility and certain other non-core assets. The remaining $737 represents severance and employee benefits for approximately 50 employees associated with the closure of the Hiddenite, NC facility, restructuring of the Macon, Ga. facility and also additional headcount reductions at the corporate office related to the reduced operations of these two plants.

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PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 29, 2004

(Dollars in thousands except share and per share data)

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

Other income was $2,914 and $2,963 for the first six months of 2004 and 2003, respectively, and $1,901 and $1,821 for the second quarter of 2004 and 2003, respectively. Included in other income are the Company’s regular investment earnings, earnings or losses from unconsolidated affiliated companies, real estate earnings or losses and interest expense primarily related to long-term borrowings and employee retirement obligations. Other income is expected to continue to be an integral component of the Company’s future earnings.

The effective tax provision (benefit) rate was 27% and (54%) in the first six months of 2004 and 2003, respectively. The effective tax provision rate was 26% and 13% in the second quarters of 2004 and 2003, respectively. The effective tax provision rates for the 2004 periods are lower than the statutory federal income tax provision rate due principally to dividend received deductions from the Company’s investment in IHFC. The effective tax rates for the 2003 periods are significantly lower than the comparable periods of 2004 due to a settlement with the IRS regarding the non-deductibility of interest expense on loans associated with the Company’s corporate-owned life insurance plan (“COLI” plan). The Company reversed certain reserves in the second quarter of 2003 related to this settlement.

In 2003, the Company adopted FIN 46R for LRG which required consolidation of the results and financial position of LRG into the Company’s results and financial position as of the beginning of fiscal 2003. Upon adoption of FIN 46R, the Company recorded a charge of $4,875 (net of income taxes) related to the cumulative effect of this accounting change in the first quarter of 2003.

For the six months ended May 29, 2004, net income was $4,213 or $.36 per diluted share, compared to net loss of ($5,232) or ($.45) per diluted share for the six months ended May 31, 2003. For the quarter ended May 29, 2004, net income was $1,885 or $.16 per diluted share, compared to net income of $1,193 or $.10 per diluted share for the quarter ended May 31, 2003.

Segment Information

The following is a discussion of operating results for each of Bassett’s business segments. The Company’s corporate spending is not allocated to the Company’s operating business segments but is included in the “other” category to reconcile segment information to the consolidated financial statements.

Wood Division net sales decreased in the first six months of 2004 from levels attained in the first six months of 2003 due to the continued erosion of department store sales and a continued shift from domestic production to imported product. Wood Division net sales increased slightly in the second quarter of 2004 from levels attained in the second quarter of 2003 due to increased sales to BFD stores, partially offset by continued erosion of department store sales and a continued shift from domestic production to imported product. In an effort to improve sales and margins in this segment, the Company is introducing new products, opening more BFD stores, repositioning the division through cost reduction initiatives, as well as improving product styling, quality and service.

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Table of Contents

PART I-FINANCIAL INFORMATION-CONTINUED

BASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES

MAY 29, 2004

(Dollars in thousands except share and per share data)

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

Contribution to profit and overhead is defined by the Company as gross profit less direct divisional operating expenses, but excluding any allocation of corporate overhead expenses, interest expense, or income taxes. Wood Division contribution to profit and overhead increased slightly in 2004 (7.6% and 7.7% for the six months and second quarter of 2004, respectively) from the 2003 periods (7.1% and 6.6% of sales for the six months and second quarter of 2003, respectively) as cost cutting initiatives enacted in late 2003 began to be realized. The Company’s plants continue to focus on improvements in material utilization and labor efficiency to improve profitability. Additionally, the Company continues to experience good results from the custom casual dining program and from recently introduced products manufactured at the Mt. Airy, NC facility. The implementation of both product and plant initiatives are expected to continue to improve operating results for this division in subsequent quarters.