The consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). In our opinion, these statements include all adjustments necessary for a fair presentation of the results of all interim periods reported herein. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures prepared in accordance with generally accepted accounting principles in the United States have been either condensed or omitted pursuant to SEC rules and regulations. However, we believe that the disclosures made are adequate for a fair presentation of results of operations and financial position. Operating results for the interim periods reported herein may not be indicative of the results expected for the year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our latest Annual Report on Form 10-K.

On March 2, 2018, we sold substantially all of our assets (the “Asset Sale”) to Churchill Downs LLC (“Buyer”), pursuant to the terms of the Asset Purchase Agreement, dated as of November 20, 2017, as amended by the First Amendment thereto dated January 22, 2017 (the “Asset Purchase Agreement”).  Operations of the furniture business from January 1, 2018 through March 2, 2018 are reflected as discontinued operations pursuant to the provisions of Accounting Standards Codification 2015-20, Presentation of Financial Statements – Discontinued Operations for all periods presented. 

As a result of the Asset Sale, we have a variable interest in two entities that have been determined to be variable interest entities ("VIE"). If we conclude that we are the primary beneficiary of a VIE, we are required to consolidate it. To determine if we are the primary beneficiary, we evaluate whether we have the power to direct the activities that most significantly impact the VIE's economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our evaluation includes identification of significant activities and an assessment of our ability to direct those activities based on governance provisions and arrangements to provide or receive product and process technology, product supply, operations services, equity funding, financing, and other applicable agreements and circumstances. Our assessments of whether we are the primary beneficiary of our VIE requires significant assumptions and judgments. We have concluded that we are not the primary beneficiary of the two VIEs as we do not have the power to direct the activities that most significantly impact the VIEs’ economic performance and therefore are not required to consolidate these entities.

Critical Accounting Policies

Cost Method Investments - Long-term investments consist of cost method investments. These investments are classified in “Investment in closely held company” on the consolidated balance sheets. The company determines the appropriate classifications of its investment(s) at the acquisition date and re-evaluates the classifications at each balance sheet date. If the Company believes a decline in the market value of any cost method investment below cost is other than temporary, a loss is charged to earnings, which establishes a new cost basis for the security.  

Note Receivable – As of the date of the sale of substantially all of the assets, the note receivable was measured based on its fair value in accordance with ASC 810, Consolidation.  We estimated the fair value of the note receivable using discounted cash flow analyses, using market rates at the acquisition date that reflect the credit and interest rate-risk inherent in the note receivable. When impairment is determined to be probable, the measurement will be based on the fair value of the collateral securing the note.  The determination of impairment involves management’s judgment and the use of market and third-party estimates regarding collateral values.

Recent Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). The amendments in ASU 2016-13 require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendment is effective for public entities for annual reporting periods beginning after December 15, 2019, however early application is permitted for reporting periods beginning after December 15, 2018. The Company does not anticipate the adoption of ASU 2016-13 to have a material impact to the consolidated financial statements.

In February 2016, the FASB issued its final lease accounting standard, FASB Accounting Standard Codification ("ASC"), Leases (Topic 842) (“ASU 2016-02”), which requires lessees to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease).  The lease liability will be equal to the present value of lease payments and the right-of -use asset will be based on the lease liability, subject to adjustment such as for initial direct costs.  For income statement purposes, the new standard retains a dual model similar to ASC 840, requiring leases to be classified as either operating or finance.  For lessees, operating leases will result in straight-line expense (similar to current accounting by lessees for operating leases under ASC 840) while finance leases will result in a front-loaded expense pattern (similar to current accounting by lessees for capital leases under ASC 840).  Our leases as of December 31, 2016, principally relate to real estate leases for corporate office, showrooms and warehousing.  The new standard will be effective for the first quarter of our fiscal year ending December 31, 2019. Early adoption is permitted. As of March 31, 2018, we do not have any long-term leases. We will evaluate the effect that ASU 2016-02 will have on our consolidated financial statements and related disclosures at such time a long-term lease is executed.  The standard is to be applied under the modified retrospective method, with elective reliefs, which requires application of the new guidance for all periods presented.

In August 2016, FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The guidance is intended to reduce diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This standard will be effective for the first quarter of our fiscal year ending December 31, 2018. In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. We have reviewed the standard and determined that our statement of cash flows will include changes in restricted cash with related disclosures. We adopted ASU 2016-15 and ASU 2016-18 during the first quarter of 2018 and the adoption of these ASUs did not have a material impact to our consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09), which creates ASC Topic 606, Revenue from Contracts with Customers, and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition. The Company adopted the new accounting standard in connection with revenue recognition guidance that was issued by the Financial Accounting Standards Board (the “FASB”) with a date of the initial application of January 1, 2018, using the modified retrospective approach. Based on the Company’s analysis, the timing and measurement of revenues under the new revenue recognition guidance is consistent with the Company’s prior policies. Accordingly, no adjustment was required to the Company’s opening balance of equity as of January 1, 2018. Except for required disclosures of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, the changes resulting from the adoption of the new accounting standard did not have a material effect on the Company’s consolidated financial statements. Comparative prior period information has not been adjusted and continues to be reported under the accounting guidance in effect prior to the change of accounting, though is now reflected within discontinued operations due to the disposal of substantially all of our operations on March 2, 2018. The Company’s change in accounting policy for revenue recognition is detailed below. The revised policy was applied to all contracts with customers prior to the disposal transaction. Following the disposal, the Company did not have any contracts with customers for which revenue was recognized.

Revenue was recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. To achieve this principle, the Company performed the following five steps: (i) identification of a contract with a customer; (ii) identification of any separate performance obligation; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligation in the contract, if any; and (v) recognition of revenue when the Company had satisfied the underlying performance obligation if any. The Company recognized substantially all of its revenue at a point in time when control of the Company’s goods was passed to the customer, which typically occurs upon shipment, with the exception of consigned goods. The Company considered its performance obligation satisfied at the time this control was transferred. Customer payment terms for these shipments typically ranged between 30- and 90-days. The Company elected to treat shipping and handling performed after control has transferred to customers as a fulfillment activity, and additionally, elected the practical expedient to report sales taxes on a net basis. The Company recorded shipping and handling expense related to product sales as cost of sales.

The Company had a variable consideration element related to most of its contracts in the form of product return rights. At the time revenue was recognized, an allowance for estimated returns is established and any change in the allowance for returns was charged against net sales in the current period.

Periodically, the Company shipped finished goods to customers on consignment terms. Under these consignment terms, the customer assumed the risk of loss and had an absolute right of return for a specified period that typically ranged from six months to one year. The Company’s customers are generally required to make payments on consignment shipments within 60 days upon the customer informing the Company that the inventory has been sold. Accordingly, the Company did not recognize revenue on these consignment transactions until the customer informed the Company that the inventory has been sold.

On March 2, 2018, we sold substantially all of our assets (the “Asset Sale”) to Churchill Downs LLC (“Buyer”), pursuant to the terms of the Asset Purchase Agreement, dated as of November 20, 2017, as amended by the First Amendment thereto dated January 22, 2017 (the “Asset Purchase Agreement”). Operations of the furniture business from January 1, 2018 through March 2, 2018 are reflected as discontinued operation pursuant to the provisions of Accounting Standards Codification 2015-20, Presentation of Financial Statements – Discontinued Operations for all periods presented.

As consideration for the Asset Sale, Buyer paid a purchase price consisting of cash in the amount of approximately $10.8 million (of which approximately $1.3 million was used to pay the outstanding amount under our credit agreement), a subordinated promissory note in the principal amount of approximately $7.4 million, and a 5% equity interest in Buyer’s post-closing ultimate parent company, Churchill Downs Holdings, Ltd., a British Virgin Islands business company.  At the closing of the Asset Sale, Buyer acquired approximately $193,000 of cash that was on the Company’s balance sheet, resulting in the Company recording net cash received of approximately $10.6 million from the Asset Sale.  The Buyer also assumed substantially all of our liabilities.  We retained certain assets and liabilities, which we refer to as excluded assets and excluded liabilities, including:

Loss on sale of assets and liabilities, net of tax, comprise the following (in thousands):

Loss from discontinued operations, net of taxes, comprised the following for the three months ended March 31, 2018 and April 1, 2017 (in thousands):

Transaction costs incurred for the three months ended March 31, 2018 included investment banking fees, legal fees, and other transaction costs directly attributable to the Asset Sale.

Net (liabilities) assets for discontinued operations are as follows (in thousands):

As a result of the Asset Sale, the Company has no revenue-generating operations.  While the cash and subordinated secured promissory note received as partial consideration for the Asset Sale generate interest income, the Company believes that the cash on hand is sufficient to fund operating expenses for at least 12 months from the date of these financial statements.  As previously announced, the Company may consider a rights offering of the Company’s common stock to existing shareholders to raise additional cash for acquisition purposes which could provide the Company greater resources and flexibility in acquiring non-furniture assets.

The Company received a $7.4 million subordinated secured promissory note from the Buyer as partial consideration for the sale of substantially all of our assets. The note matures on March 2, 2023, at which time the total principal amount is due. Interest on the principal balance of the note accrues daily at an annual fixed rate of 6.00%. Cash interest payments begin upon certain availability thresholds defined in Buyer’s senior secured loan facility. These thresholds were not met for the period ending March 31, 2018 resulting in the Company accruing approximately $37,000 of interest income on the note.

We evaluated the fair value of the subordinated secured promissory note as of the transaction date.  To determine the fair value of the note, the Company applied a discount of 18% to the note’s expected future cash flows.  The discount rate was based on a variety of factors, including current mezzanine/subordinated debt like returns in the market, the risk profile of Buyer (size and scale of underlying operations, balance sheet composition, lack of cash flow, recent decline in business performance, and transitions of ownership and management of the business), that interest was paid in kind due to availability thresholds not being met in March 2018, our second lien position on the Buyer’s collateral, and other qualitative industry and market factors.  This evaluation resulted in a fair value adjustment of $2.6 million down to a recorded value of $4.8 million as of the Asset Sale date. 

The Company received a 5% equity interest in Churchill Downs Holdings Ltd (“Churchill”), a British Virgin Island business company as partial consideration for the sale of substantially all of our assets. The equity interest is considered a variable interest in Churchill, which the Company determined to be a variable interest entity (VIE).  We concluded that we do not have the power to direct the activities that most significantly impact the economic performance of Churchill, and, therefore, we concluded we are not the primary beneficiary and accordingly have not consolidated Churchill.  The investment in the closely held company is accounted for under the cost method, in accordance with generally accepted accounting principles.  As of March 31, 2018, the investment had a carrying value of $168,000, which is reflected as an “Investment in closely held company” on the consolidated balance sheet and represents our maximum exposure to loss.

In the normal course of business, we are involved in claims and lawsuits none of which currently, in our opinion, will have a material adverse effect on our consolidated financial statements.

On February 5, 2018, a putative class action was filed in the United States District Court for the Middle District of North Carolina against us, our directors and certain former directors in connection with the Asset Sale. The lawsuit alleged, among other things, that we violated the Securities Exchange Act of 1934, as amended, by omitting certain material information from the proxy statement relating to the proposed sale of substantially all our assets. The complaint sought, among other things, injunctive relief preventing the consummation of the proposed sale of substantially all our assets until disclosure of the material information allegedly omitted from the proxy statement, rescission of the Asset Purchase Agreement to the extent already implemented, and the award of attorneys’ and experts’ fees and certain other damages. While we believed the claims were without merit, we determined to provide additional disclosure in a supplement to the proxy statement in order to alleviate the costs, risks and uncertainties inherent with litigation.  We reached an agreement with the plaintiff regarding our additional disclosures and the lawsuit was dismissed on March 12, 2018. 

On March 2, 2018, the Company terminated its Credit Agreement, dated as of October 25, 2016, as amended, with Wells Fargo and the related Security Agreement with Wells Fargo, dated as of October 25, 2016. The company paid off the outstanding balance as of March 2, 2018 using $1.3 million of the proceeds from the Asset Sale.

During the first three months of 2018, we recorded a non-cash credit to our valuation allowance of $82,000 decreasing our valuation allowance against deferred tax assets to $9.6 million at March 31, 2018. The primary assets covered by this valuation allowance are net operating losses, which are approximately $31.2 million at March 31, 2018. The Company did not make any cash payments for income tax in the current three-month period ended March 31, 2018 and prior year three-month period ended April 1, 2017 due to our net loss. During the current three-month period, we recorded $19,000 increase in tax positions of prior years’ related to our unrecognized tax benefits position under FIN 48.

We maintain a valuation allowance against deferred tax assets that currently exceed our deferred tax liabilities. The primary assets covered by this valuation allowance are net operating loss carry-forwards. The valuation allowance was calculated in accordance with the provisions of ASC 740, Income Taxes, which requires an assessment of both positive and negative evidence when measuring the need for a valuation allowance. Our results over the most recent three-year period were heavily affected by our business restructuring activities. Our cumulative loss, excluding income from the Continued Dumping and Subsidy Offset Act, in the most recent three-year period, in our view, represented sufficient negative evidence to require a valuation allowance under the provisions of ASC 740, Income Taxes. We intend to maintain a valuation allowance until sufficient positive evidence exists to support its reversal, resulting in no deferred tax asset balance being recognized. Should we determine that we will not be able to realize all or part of our deferred tax asset in the future, an adjustment to the deferred tax asset will be charged to income in the period such determination is made.

Our effective tax rate for the current quarter and prior year quarter was effectively 0% due to our net loss.

Basic earnings per common share are based upon the weighted average shares outstanding. Outstanding stock options and restricted stock are treated as potential common stock for purposes of computing diluted earnings per share. Basic and diluted earnings per share are calculated using the following share data (in thousands):

In both the current three-month period ended March 31, 2018 and prior three-month period ended April 1, 2017, the dilutive effect of stock options was not recognized since we had net losses. Approximately 278,000 shares and 1.1 million shares in 2018 and 2017, respectively, were issuable upon the exercise of stock options, which were not included in the diluted per share calculation because they were anti-dilutive. Also, 43,000 shares and 485,000 shares in 2018 and 2017, respectively, of restricted stock were not included because they were anti-dilutive.

We will repurchase common shares that are tendered by recipients of restricted stock awards to satisfy tax withholding obligations on vested restricted stock. During the current three-month period, we repurchased 46,643 shares for approximately $30,000.

In July 2012, the Board authorized the purchase of up to $5.0 million of our common stock.  These repurchases may be made from time to time in the open market, in privately negotiated transactions, or otherwise, at prices the Company deems appropriate.  In the three-month period ended March 31, 2018, we repurchased 174,565 shares for $103,000. No shares were repurchased in the prior year three-month period ended April 1, 2017. As of March 31, 2018, we have approximately $2.9 million remaining on this authorization to repurchase our common stock.

A reconciliation of the activity in Stockholders’ Equity accounts for the quarter ended March 31, 2018 is as follows (in thousands):

All of the stock compensation expense of $391,000 for the quarter ended March 31, 2018 was related to discontinued operations.

As discussed in Note 3, cash interest payments on the subordinated secured promissory note begin upon certain availability thresholds defined in Buyer’s senior secured loan facility.  These thresholds were also not met for the month ending April 30, 2018 resulting in the Company accruing approximately $37,000 of interest income on the note during the month of April 2018.